Bankruptcy

Weller on Time to Avoid a Banking Bailout

By Bob Lawless

Former Credit Slips guest blogger Christian Weller wrote me over the weekend to point out that the charge-off rate on credit cards hit an eye-popping 5.47% for the second quarter of 2008. That led to an e-mail conversation about what was happening with the banking sector and how things look like they will get worse. Christian, who is an associate professor at UMass-Boston's Department of Public Policy and Public Affairs and a senior fellow at the Center for American Progress, made some really interesting points and, even more importantly, had some ideas for some actions that needed to be taken to prevent things from getting worse. I asked Christian if he would write up his ideas so they could be posted here, and he was kind enough to do so.

From Christian Weller:

Policymakers at the Federal Reserve and in the administration were slow to admit that they had a mortgage mess on their hands. The solutions have thus been tepid and so far not particularly successful in stemming the tide in foreclosures. Foreclosures are shattering previous records, setting new ones, just to be broken a few months later. The Mortgage Bankers Association reports that the share of mortgages that entered foreclosures in the second quarter of 2008 stood at 1.1% and the share of all mortgages in foreclosure was 2.8%. Since the 1970s, the share of mortgages entering foreclosure never exceeded 0.5% before the end of 2006 and the share of total mortgages in foreclosure never exceeded 1.5% before the second half of 2007.

And yet, many observers still believe that things will just be okay with a little tinkering. The track record of interest rate cuts and voluntary industry based work out efforts so far does not inspire confidence. The government's intervention in Fannie Mae and Freddie Mac seems sufficient proof that things aren't working out as planned.

Instead, policymakers need to address more forcefully the record foreclosures by helping struggling homeowners. The alternative is a massive bailout of the U.S. banking system.

One step would be to expand the ability of communities to purchase foreclosed properties. This is an idea that two of my colleagues, David Abromowitz and Andrew Jakobovics, at the Center for American Progress developed as the Great American Dream Neighborhood Stabilization (GARDNS) program. They advocated allocating up to $20 billion for this program, while Congress only allocated $3.92 billion in the last housing bill to this purpose. There is a lot more to be done and it should be done quickly.

Another option is to provide financial support to homeowners, especially lower-income ones. For instance, Sen. Obama has proposed a refundable "Universal Mortgage Credit" of up to 10% of mortgage interest.

Another possibility is to enact a second stimulus that is well targeted and temporary, e.g. by expanding fuel assistance and food stamps.

And finally, the bankruptcy code could be changed to allow bankruptcy judges to write down the part of a mortgage of a principal residence that is no longer secured by property because its value has gone down. This option already exists for vacation homes and second homes, but not for people?s own home and has been advocated by a number of consumer advocates, including the Center for Responsible Lending.

Full post as published by Credit Slips on September 07, 2008 (boomark / email).