Without ground rules to play with in the financial markets, people will make stupid bets for short-term profit that cost everyone 100 times over in the long term. The U.S. had–I stress had–the best mortgage system in the world: 30-year fixed paper at a decent rate, with 20% down. This was a bet that created a whole middle class in America and let everyone build some equity. The kicker was it was pre-tax dollars, so the real effective interest rate was even lower. The question is, what is the harm in messing with a system that works? The answer is clear. Now not only do we now have the new alternative mortgages (which look a lot like a standard UK or Aussie mortgage), but we have messed up the standard American mortgage that created the American dream.
Now the question is, how do you, as a government, fix this mess and make it go away? The first solution is to create a clean new bond deal. Any bond or mortgage on an American piece of real estate should be tradable to a new government entity that will swap it for a 2.2%, 20-year bond that will be backed by the government. The deal, however, is it cannot be a secondary swap contract, or an insurance policy, or anything but a primary ownership of a loan. This new government-backed company will then have 20 years to clean up this mess. The first step needs to be to freeze foreclosures, just stop them. The fact is banks do not rent homes, so rents are going up, people are losing houses, and then the houses are sitting empty.
Next, the company would sit down and renegotiate one by one with borrowers. If you have to foreclose, create a group of investors in which no one is allowed to buy more than three homes. Offer these investors a 20%-down mortgage at fair value for the house. Give it a 20-year interest-only term with an interest rate set at 5%. To become an investor in this group, you will have to pass a basic knowledge test on real estate and finance. Trust me, if you spread it out and create a whole new group of people who own three rental properties, the market will stabilize. The mortgages have to be able to be supported by rent, but that should not be hard.
If people want to stay in their homes after renegotiation, the second step has to be create a required course at every community college that people have to take and pass if the government owns their mortgage and they want to stay in their home. Get people to learn basic finance. Heck, make finance a required course to pass high school. Let’s make people financially literate and understand the bets they are making. Then we might end up with less of a mess.
The basic point is if people are willing to take 10 cents on the dollar for real assets, why should the government not offer 100 cents on the dollar at a below-inflation rate of return. Get the underlying paper off the market, and the rest will clean itself up. An interest rate of 2.2% is not a bailout; it is a fire sale. I can promise over the next 20 years this bet will return 10s of billions of dollars in profit.
The underlying real estate is good, trust me. People will still need a place to live.
A lot of people with finance knowledge screwed up here.