How Government Actions Miss the Point (Hint: It's About Mortgages)

DJ: There’s this perception that we can “fix” the price of individual mortgages. But shouldn’t the price of homes find its natural equilibrium?
CC: The market price is not decreed by God. The market price is an outcome of a variety of things. Recapitalizing the banks is helpful for giving them breathing room, and for providing credit in the meantime. But it doesn’t resolve the problem. The problem is the completely opaque distribution of losses because no one knows how to value these mortgage losses. The way to solve the problem is from the bottom up.

There’s loss-sharing to encourage write-downs of mortgages. It was done in Mexico in 1995. If holders can arrive at a write-down in lieu of foreclosure that leads to sustainable mortgage, we as taxpayers would sustain the rest. It lets the market work the problem out and creates the motivation for doing it quickly.

You could also have the government offer to buy any mortgage for 40 cents on the dollar. It would create immediate liquidity, because mortgage backed securities would rise on that scenario, all would be truncated at 40 cents.

Third, we could refinance all healthy mortgages at 5%, at 30-year fixed financing. Allan Meltzer has idea about giving tax credits for buying homes, they’re all good ideas. The problem with what we’re hearing from Paulson does not have much to do with any of this.