Foreclosure Vouchers?

David Colander has a Trickle Up plan to reduce foreclosures:

Trickle-Up Plan Aims to Stem Foreclosures, Real-time Economics: Now that the easy part — temporarily propping up the banking system — is done, it’s time to start thinking about … how to save millions of Americans from losing their homes in a way that will be politically acceptable but will also stop the economy from falling into a severe recession.

Sen. John McCain’s plan of a $300 billion dollar bailout is a non-starter. It subsidizes people who made lousy decisions about borrowing …without giving anything to those who made the better decision to live within their means. Politically, it goes against what Americans are clamoring for — accountability… As was the case with the rescue of the banking system, however, some bailout for distressed homeowners will be needed to prevent continuing economic and social fallout from the housing debacle. For the U.S. economy even to start to think about recovery, the housing market has to stabilize…

Rather than the McCain proposal … we should combine a mortgage assistance package that will ease some of the foreclosure pain with the sort of fiscal stimulus package that will be needed to reduce the depth of the coming recession.

The Trickle-Up Plan would … help keep people in their homes and create demand for housing currently in foreclosure. By doing so, it will help stop the fall in housing prices, and also increase the value of the lowest elements of the mortgage backed securities — precisely what governments wants to do.

The Plan works as follows: Instead of giving people a tax cut or rebate as in a standard fiscal stimulus package, the government would distribute to taxpayers mortgage foreclosure vouchers. These vouchers can be used either by homeowners to pay mortgages on homes in severe danger of foreclosure, or to help homebuyers to purchase foreclosed homes.

As with other stimulus packages, these vouchers would be distributed to taxpayers based on their incomes with those with the lowest incomes receiving the largest vouchers and those with incomes of, say, over $200,000 receiving nothing at all. … The vouchers, however, could only be fully used by homeowners facing foreclosure or interested in buying a house in foreclosure.

For the majority of taxpayers who cannot use them, the vouchers could be sold on a secondary market… [T]hese vouchers would likely sell at a discount, perhaps of about 25%. Since the plan will increase demand for foreclosed housing, it will stop the fall of housing prices, thereby helping to end the housing crises and starting the economy on the road to recovery. …

Instead of a rescue scheme that relies on the benefits trickling down from Wall Street to Main Street, the benefits of this plan will trickle up from Main Street to Wall Street.

Whatever plan is ultimately implemented to stave off foreclosures, should taxpayers demand a share of any profit (equity) the bailed out homeowner makes if the house is sold later, much like the equity stakes taxpayers will have in banks that are bailed out? Everyone gets something from the voucher program, true, but if the vouchers are purchased at a 25% discount, then the benefits won’t be equally distributed, i.e. some taxpayers will pay to bail out others. So should the people who are subsidizing others (in essence, giving them capital injections) in this or some other plan expect something in return if the bailed out homeowner profits later from selling the house? If we do demand a share, would that make some homeowners less likely to sell the house? (E.g. if they make $50,000 on the sale and had $25,000 in vouchers, they could be forced to sacrifice half of the equity, and that might make them less willing to sell, but perhaps this isn’t much of a distortion, or not one we should worry about.)

I’m not so sure we should demand anything, but what is the argument for not asking for a share of any profit? One is that this is a case where people made, for the most part, good ex-ante decisions, it was rational to buy the house given what they knew, what they were told by people they should have been able to trust, and what they believed about the future, but ex-post it was a horrible choice. Here, homeowners in trouble are mostly victims of things outside their control, they didn’t purposefully take a big risk knowing they could just walk away, or anything like that, they thought they were doing the right thing. If so, then I would argue that this is a case where social insurance is appropriate. When large disasters hit people and it is not their fault, we generally bail them out without asking for anything in return (e.g. we all pay unemployment insurance, then some people collect more than others when factors out of their control – a change in tastes, a business cycle downturn, technological change, etc. – causes their job to disappear. When there is a natural disaster that couldn’t be predicted, we all pitch in and help.)

So I think whether we ask homeowners to pay something back if they ever do profit from the house depends upon whether we think homeowners as a group are victims of circumstances out of their control, victims of shady practices, etc. – they did nothing wrong in most cases except try to buy a house to live in – or we think that their behavior was a big part of the problem (and actually, even then, I find myself hesitant to say they should have to pay anything back).

What do you think? If a household is given, say, a $25,000 break on a loan to avoid foreclosure (and only paying a quarter of that amount to buy the vouchers), someone has to pay for it. Should we demand anything in return?

Afterthought: I should have noted that the plan provides a windfall to lenders – they get paid off through the voucher system rather than having to take losses on the loans they made.

Originally published at Economist’s View on Oct 17, 2008 and reproduced here with the author’s permission.

2 Responses to "Foreclosure Vouchers?"

  1. Anonymous   October 19, 2008 at 11:35 pm

    Rather than have the govt shoulder 100% of the burden and give a gift to the bank that faces a loss, why not require that the bank share in the cost of the voucher– say 20%. The bank gets a solid mortgage instead of an empty house. The refinancer or buyer takes a foreclosed house off the neighborhood listings.

  2. Guest   October 24, 2008 at 11:24 am

    Lower Mortgage rates WILL essentially do the same thing. IF we get rates 5% or better, demand for homes will increase thereby reducing foreclosures. Also, lower rates will provide a significant boost to spending. Bill Gross, in April 2007, wrote that IF mortgage rates didn’t drop to 5% or better, we would see a crash..yada yada…Homeowners that have negative, or close to negative equity should be allowed to refi also (no cashout). That’s all we need, lower rates and looser LTV requirements. Give these 90 days and you will see the beginning of the end of the crisis. (note: on 4 seperate occasions, mortgage rates have aproached 5% BUT the Fed bailouts have driven rates up to 6%+. Hmmmm. Self Defeating.