Friday, February 27, 2009

The State of Things

. Friday, February 27, 2009

The new TNR econ blog passes along a juicy anecdote:

As another illustration of this, consider an example I got from Orin Kramer, a hedge fund manager and prominent Obama supporter. Kramer has a friend who recently bid on a bundle of home-equity loans the government was auctioning off (presumably after having seized a bank that owned them). The homeowners in this case weren’t subprime deadbeats but people with solid credit histories who were scrupulously making their payments. Still, the friend was the highest bidder at a measly 14 cents on the dollar—and, Kramer says, “I have another friend who claims he overbid.” (The government decided not to sell because it didn't like the price.)

This might sound like a classic "irrational despondence" issue—only 14 cents on the dollar for a bundle of perfectly upstanding loans? But there’s one big problem, as Kramer points out: None of the homes have any equity left in them. Thanks to the cratering housing market, these people's first mortgages exceed the value of their homes, which makes them good candidates to simply stop paying (both the original mortgage and the home equity loan).

The government essentially has three choices: let homeowners default on the loans and enter bankruptcy, destroying their credit and making banks endure the costs of foreclosure in exchange for a devalued house; force the banks to rewrite the terms of the mortgage; or take the risks of mortgage-default away from the banks, write-down the mortgages, and take the financial hit. President Obama's new housing plan tends towards a combination of second and third. But right now the banking industry is in a persistent state of flux. Obama should choose one of the three options, and go for broke with it.


The State of Things
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