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Cut mortgage rates to build economy

Glenn Hubbard

TEXT OF COMMENTARY

BOB MOON: North Dakota Democrat Kent Conrad is the chairman of the Senate Budget Committee. The lawmakers who've been drafting that bill agreed last night to hand home buyers a tax break of up to $15,000. The cost of that add-on pushes the Senate version of the stimulus package to well above $900 billion.

Commentator R. Glenn Hubbard would like to see them go even further, with a plan he's been pushing to have the government subsidize mortgage rates. Mr. Hubbard argues that since housing is what got us into this mess, it just may be the most effective way to turn things around.


GLENN HUBBARD: President Obama is right to stress the need for a stimulus package to build a foundation for economic recovery. But the biggest bang for the buck lies in housing, the epicenter of the financial crisis.

The government can increase housing demand, house prices and consumer spending with one policy change -- by lowering mortgage rates. And it can do so with little cost to taxpayers. Here's how:

Remember that the government controls the mortgage market through its conservatorship of Fannie Mae and Freddie Mac. So the Treasury could issue bonds and fund the housing agencies. Their lower costs of funds would enable lower mortgage rates. How much lower? Say, 4 percent on a 30-year fixed-rate mortgage. A lower rate would still allow an ample spread to compensate for default risk, prepayment risk, and underwriting costs.

Current futures markets suggest that house prices will fall by at least 12 percent in the next 18 months. But lower mortgage rates would put a floor under falling house prices by increasing housing demand and raising house values.

Since Americans spend about 5 percent of home equity on consumer goods and services each year, increasing housing values by as little as 10 percent could raise consumer spending by about $100 billion per year.

And, if refinancings at the new lower rate were permitted, millions of middle-income Americans would receive a tax cut averaging $400 per month. Unlike a one-time rebate, this reduction in mortgage payments would be permanent, and a much greater spur to consumption.

This raises a bigger question: Given the chaos of the recent past, wouldn't a return to simple, long-term fixed-rate mortgages with a low rate be right for the long-term future? Such simplicity could limit the chance of a future mortgage crisis.

Certainly for now, the best foundation for stimulus and recovery is a house -- or at least a new mortgage.

MOON: R. Glenn Hubbard is dean of the Graduate School of Business at Columbia University.

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Please note that Professor Joseph Stiglitz (Also from Columbia) has suggested substituting a refundable tax credit for mortgage interest deductions. I have written a short piece putting specifics to his suggestions. Stiglitz proposal is simpler, easier, and requires far fewer changes than Professor Hubbard's proposal.

I'm in disbelieve every time I hear an economist or politician suggest that putting a floor on the housing prices will help solve our economic troubles. The part that I find most disturbing is the suggestion that is possible to put a floor on house prices. As long as the house prices are not aligned with household incomes, people will not be able to buy homes. The only reason house prices were inflated in previous years was because people were tricked into believing they could afford those huge mortgages. I think everyone is smarter about that now. At least I hope we are. They can lower interest rates and give purchase incentives, but it the house prices are still inflated, no one will buy. And finding out if the prices are still inflated is not that difficult. There is plenty of information out there to figure that out (Case-Shiller home price index, and more) I think there is a huge detachment from reality of these folks that make these suggestions about putting a floor on the house prices. They live in a world with a different reality and don't realize how strained people's budgets already are, and how much worst it will get with all these layoffs. They can lower rates and give incentives but if the prices don't go down to what they should be for normal people to afford them, no one will buy. Besides, haven't we learned anything about the complexity of this world economy. I'm just perplexed that there are these people out there that still want to simplify the solution to our complex economy woes to "the housing market" We are NOT in a downward spiral because people are just loosing their homes. We are in this mess bc people were tricked into a false sense of wealth that sustained frivolous spending during the last few years. Now that reality has caught up to everyone, everything needs to adjust to the cold reality of what we can REALLY afford.

I don't know if the stimulus plan is a good idea or not and I, of course don't know the solution to our economic problems, but I can certainly tell you that even after already being pre-qualified for a home loan, I will not buy until I feel that the value of the home is somewhat aligned with incomes in my area. I don't care how many incentives they throw at me.

I bit on more than I could chew but I sincerely paid off a big chunk of my mortgage working >80hrs/week. Now that my house costs less than the foreclosed home next to me. Why not give me the benefit of a lower rate than the sleaze ball who invested into 5 investor homes and is getting a good deal?
Can someone explain??

Mr. Hubbard proposes that mortgage rates be lowered so that housing prices will stop falling. However, during the bubble of the past several years, housing prices shot up far past their historical relationship to income. This is one of the reasons so many people are so far in debt. Housing prices need to fall until they are once again aligned with income levels - a point made by a few others who submitted comments. That will help the economy more in the long run than many other attempts at stimulus. The fact that so few commentators & almost no politicians recognize this is driving me NUTS.

Some peopel think falling hosue prices is the problem. It is not. They are just ADJUSTING to a level where the incomes can support. The problem was the house prices went up (another word bubble) and there was a disconnect from incomes. What this guy is suggesting is to create another bubble, by lowering the interest rates. Unfortunately people like this guy are running Federal reserve, Treasury.

Just think about this: Until 1998 bubbles were VERY RARE. But people like Hubbard (Federal reserve) managed to create 2 MASSIVE bubbles in a span of 8 years. That is very remarkable feat. Now being in bubble is real economy. That is what Hubbard is saying. Cut rates and create another bubble.

Whan economists say deflation, they are not referring to CPI. They are referring asset price deflation. In another words deflation means bursting of bubble. And they dont want that. They want bubble economy and they want bubble to become bigger, because there is no real productivity in the economy. It is based on people buying things (saving is bad, spending is good), flip houses, financial services (creadit swap defaults, packaging mortgage backed assets) etc. I am not saying there is no real economy. But majority of this economy is based above activities. These economists want to support these activities.

When housing prices were going up at unsustained levels, where were these economists. Did they sound alarm. No? For them it is the real economy.

My stand is tax payers shouldnt be funding the bubbles.

OK, one more time now:

The problem is not that house prices are falling.

The problem is that house prices are still, in most places, way too expensive.

Government intervention to prop up house prices (absurdly low interest rates) is what got us into this mess; it certainly won't get us out.

I know it's a tired cliche at this point, but if low energy, food, and durable goods prices are good for consumers, why are lower housing costs bad?

The amount of money and energy being spent trying to find a way to prop up current absurd housing prices is, well, absurd itself. Housing prices need to drop levels that more or less align with historical price/income data, so that people can once again aford homes without requiring the kinky lending products that banks pushed relentlessly during the bubble.

I think this idea is a good one. For all the people complaining that this would not be a magic bullet and would not fix the joblessness problem, you are correct. But systematically lowering the mortgage rates *as part of an overall plan that includes other components* would certainly help address at least part of our problems. There is no ONE solution. Tax cuts clearly aren't the answer, either. We need a multi-pronged approach. If I get a 4% mortgage rate as one of those prongs, then GREAT!

I can't believe how idiotic this whole thing is becoming. The spin doctors are extremely well versed and we're so stupid to be biting on all of it.

Firstly, let's understand one thing...inflation of home values to their 'pre-bubble-burst' was sustained by Federal Reserve lending rates and the lenders...aka...Banks benefited greatly from that. Let's see...hmmm...make 5% on $200K, or 5% on $400K...no, no...let's make 5% on $600K. The banks were and still are making money hand over fist on the fact that the home values inflated to unsustainable levels. It's preposterous to think that a 2500 sf home is worth $500K! Give me a break!

The problem is, we all bought into it...because we felt that the 'increased' value of our homes was a great investment. My Dad always taught me that your home is not your investment...it is simply your home. You're not rich from your home...you are rich by saving and investing 'wisely' outside of your home. But we are a greedy lot...we like to think that as the values increased...we were better off...but we were WORSE off! As the prices rose...so did the interest payments.

Don't be stupid! Let the prices DEVALUE...let the market correct...and in 5-10 years we will all look back on this as one of the most valuable lessens that we've ever had!

The banks want nothing to do with deflated prices...they want interest rates to drop so that the prices can be kept high.

The best thing that can be done...is let everyone take their lumps and move on. Let the prices fall...and come back to reality! It is inevitable that this is what's going to happen anyhow.

People shouldn't be able to walk away from their debt obligations and because of that...this recession is going to hurt for quite some time. Don't make me pay for everyone's greed. I've been through this before (Canada 1989-1997) where I lost 35% of the value of my home after only having 25% equity in it. Took 9 years for the loss to come in at 15%...so I still lost.

That's the name of the game...

Glen Hubbard's proposal has even more benefits than he suggests. The banks are now holding complex financial assets are often referred to as �toxic assets,� a more appropriate name for these assets is �inscrutable assets.� The financial industry has found a way to create an asset that is so complex that it is almost impossible to untangle the assets and determine their value. We need to eliminate or at least reduce the amount of these assets in the system without creating new problems. Glen Hubbard's idea is has a good idea but it is important that it include refinancing of existing mortgages. If the plan included refinancing, then anyone with proper credit and enough equity in their home could refinance their mortgage at a low interest rate. If interest rates were low enough, then almost everyone with proper credit would want to refinance. This would greatly reduce the size of these inscrutable assets and reduce the problems these are causing on bank balance sheets. This would, perhaps, be a better way of dealing with these problems than nationalizing the banks or setting up bad banks to take these assets.

Mr. Hubbard seems to be aloof like the majority of "economists" I've heard in recent months. All I've heard for almost a year now is of countless plans, ideas, and ways in which to save the housing market.

They are missing the point and need to think of the problem on an extremely fundamental level. Mr. Hubbard is correct that housing is at the epicenter of the crisis. But the reason it did so was simply because the prices became grossly detached from real incomes. Furthermore, the last 3 to 4 years of the housing boom generated appreciation reliant on toxic loan products.

Sitting back and digesting the events of the last several years, its plain to see that housing prices not only will continue to fall, but MUST fall back to levels that real incomes actually support. For example, I live in an East Bay town outside of San Francisco. Despite having a median area family income of around $75,000, the avg. price for a home here is still close to $600,000. The prices have fallen somewhat but still remain out of reach for the majority. The correction in my opinion still have a long ways to go.

I'll even take this one step further. The line of thinking from people like Mr. Hubbard is that the US economy is based on selling houses to one another. That's the problem. We can't exist in an economy that doesn't rely on actual productivity. We need to step back from this line of thinking and learn how to make money again instead of counting on home appreciation instead.

Bottom line: in trying to stop what I see as a positive event- the correction of housing prices- you're only putting off the inevitable. If home prices came back to levels that everyday people making regular wages could afford, then the reality is that there would be a return of stability versus rampant cycles of booms and busts with young families getting priced out of markets and homeowners going bankrupt from heavy mortgages and defaults.

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