Sensible solutions to the lending mess
GOVERNOR DEVAL PATRICK is reportedly moving toward a proposal that would give up to $5,000 to people who lose their homes in a foreclosure. This is a sensible and humane response to the subprime crisis, but there may also be ways to help avoid more foreclosures altogether. If the state can induce lenders to offer refinancing at lower interest rates, by offering them a share of future housing price appreciation, then foreclosures could be reduced without trampling on creditors' rights.
Any sensible solution to the subprime mess must accept the abundant evidence showing that when lenders can't foreclose, there is little lending. Over the past 15 years, American credit has become far more democratic, as ordinary people have found it easier to borrow to buy homes or cars or send their kids to school. Between 1995 and 2006, minority homeownership rose from 43.7 to 51.3 percent. Lenders who broke the law should be punished, but a wholesale attack on creditors' rights will punish the prospective low-income borrowers of the future by making it impossible for them to get a loan.
The possible Patrick proposal makes sense because it is limited in size and targeted directly toward those who suffer most. To avoid arbitrary expropriation of lenders, the cost of the program should be shared between the lenders and taxpayers. When a lender did nothing more than offer a standard mortgage, the state must pick up the tab.
Since the rich should not be subsidized, the transfer payments should be means tested and limited to families earning less than $75,000 per year. There should also be income checks to make sure that applicants did not misrepresent their income on their loan application. In one sample of 1,000 loans that relied on stated rather than documented income, more than one-half of all loan applicants overstated their incomes by more than 50 percent. Finally, the transfer payments should be dependent on the good condition of the house in order to reduce the tendency of people to trash homes being foreclosed.
More can be done to avoid foreclosures than just urging lenders to renegotiate, but bailouts must be avoided and creditors' rights must be respected. A perpetual moratorium on foreclosures, for example, would be a foolish repudiation of the rights of lenders. Who would lend after that precedent?
Another way is to make refinancing at lower interest rates more attractive for lenders by encouraging shared-appreciation mortgages. These mortgages, which are relatively rare in the United States but more common in the United Kingdom, offer lower interest rates in exchange for some of the upside potential on the house. For example, a lender might offer a 6 percent interest rate instead of an 8 percent rate, in exchange for 50 percent of the increase in the value of the house at the time of eventual sale. Most borrowers don't want to lose this upside, but for someone facing foreclosure, losing the upside may be a lot better than losing the house altogether.
The best case scenario for shared-appreciation mortgages would be that with state regulatory encouragement, new private lenders would refinance some mortgages completely at a lower rate in exchange for some upside. Competition among lenders could help borrowers get the best deal possible.
In a more complicated scenario, shared appreciation could be used to generate a second mortgage, which would then be the basis for a more complete refinancing. For example, a lender might get up to 50 percent of the upside in exchange for a lower-interest second mortgage covering 25 percent of the value of the house. The second mortgages could then provide enough of a cushion so that other lenders would provide standard refinancing for the rest of the mortgage. Perhaps Massachusetts could broker an arrangement with the Federal Housing Administration or
Punish law-breaking lenders, not future borrowers. If we eliminate the rights of creditors to foreclose, then we will make it impossible for borrowers to get a loan. A better way is to offer financial aid to people who lose their homes, and to look for ways to induce lenders to refinance at lower interest rates.
Edward L. Glaeser, professor of economics at Harvard University, is director of the Rappaport Institute for Greater Boston.
