Bernanke seems to be slowly working his way to the conclusion that the economy and the finance crisis can’t be fixed without helping homeowners.  As usual, he’s late to the party, but I suppose better late than never.  His proposals, such as they are, are vague.  Let’s run through how it has to be done if it’s going to be done right.

1) The face amount of the mortgage needs to be reduced by the long term value of the house, as if the housing bubble hadn’t occured. This is both to reduce foreclosures and to help reset housing prices where they should be.

2) Payments need to be set at a maximum of about 30% of income.  This is the decades old rule of thumb for how much a family should be paying for housing.  It’s also important because the more a person is spending on housing, the less they’re spending on anything else, and consumer spending recovering will be important to any lasting recovery.

3) Any government mortgage needs to be senior, with no other debt able to supersede it.  

4) Mortgage contracts going forward, sold by anyone, need to be defined by the government as to what the terms can be.  Maximum effective interest rates, which must include any possible combination of fees, must have a maximum set by the government (ie. a federal anti-usury law), probably at prime + X, based on prime at the time the mortgage was written.  This will limit balloon payments, jumpers and other such traps.

5)  A floor needs to be set under housing prices.  That floor should be set at either 30% what the median income in a zip code is, or at what prices were in 2002.  This is the value the government will buy out a mortgage for, and it means that everyone knows what the least a mortgage (and therefore the securities based on mortgages) are worth.

6) Bernanke wants to lower interest rates, but he wants to do it indirectly, by buying Ginnie Mae securities or having Congress subsidize the loans.  This is inefficient, the simplest way is to just use the banks taken over (which should include Citigroup) to make loans at whatever rate the Fed thinks is appropriate and avoid private banks refusal to lend.

7) Since a collapse in housing prices, while overall a good thing because it will increase real non-debt related consumer spending and will make Americans more competitive, will also cause deflationary pressure, some steps should be taken to increase the real economic value of houses.  This means:

  • Areas that will be eligible for federal aid in the form of mortgage repurchases and rewrites must change their zoning to allow home businesses;
  • A major broadband build-out must be done, with no usage caps, to allow folks to work from home.  The current 5 gig limit that the majors seem to be moving towards is too low;
  • As part of the infrastructure stimulus a massive refit of buildings for energy efficiency and generation must take place, to allow people to micro-generate power and make money that way; and,
  • The power net must be reconfigured to allow micro-metering so that people can sell the energy they produce and see how much energy is costing at any given time.

All of these things will increase the real economic value of houses, and after the initial suburban shock at the idea of someone working at home, will increase the value of houses, but will do so in a way that makes economic sense.  A place you can make money from, and not just live in, is worth more.  A place that takes less energy to run is worth more.

This will also set a floor under a significant cause of the financial crisis, allowing firms to have a chance of actually calculating losses.  The problem right now is no one knows where the bottom is, so it’s impossible to know how bad a shape anyone is in.  Finding that floor, or rather creating one, is essential to "restoring confidence".

(More detailed notes on resetting mortgages.)