University of Chicago school of business professor Luigi Zingales has a plan to address the housing crisis that doesn’t involve bankruptcy judge cram downs or a federal government bailout. Before he gets to his plan, Zingales outlines what any government intervention in the marketplace must prove before it should be enacted:
1. the market imperfection that is being addressed must be clearly defined and explained;
2. the government cure must prove that it is not worse than the market disease.
The current stimulus bill, the TARP bailouts, and all of the housing bailout solutions floating around Capitol Hill fail either one or both of the above criteria. Zingales plan?
Congress should pass a law that makes a re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property. Why? Because there is no reason to give a break to inhabitants of Charlotte, North Carolina, where house prices have risen 4% in the last two years.
How do we implement this? … we have reliable measures of house price changes at the zip code level. Thus, by using this real estate index, the re-contracting option will reduce the face value of the mortgage (and the corresponding interest payments) by the same percentage by which house prices have declined since the homeowner bought (or refinanced) his property….
In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder.