Put Away the Wish List, and Help Households Bounce Back By PETER BERNSTEIN

The New York Times
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November 9, 2008
Put Away the Wish List, and Help Households Bounce Back By PETER BERNSTEIN

CAMPAIGN talk was all very well, but the new president will have to start his administration with serious business. He should begin his Inaugural Address by saying that most campaign promises must be put on a wait list while he gives his full attention to the critical condition of the economy. There is no time for lengthy deliberation and debate.

The restoration of some kind of liquidity and order to the financial sector is the first step to recovery. The departing administration has properly made the financial sector its priority, and its efforts appear to be bearing fruit. But these efforts have not been enough.

The president’s most important priority should be to support the household sector. Households and their mortgages were the key to the onset of crisis. Now, with unemployment rising and home prices still falling, the new administration must help households first if we are to have any hope of reversing the devastating course of a recession. Households are the primary customers of American business.

To begin, the president should ask Congress to immediately extend unemployment insurance benefits by six months. But that step, while welcome, is only a balm, not a cure. The cure will develop from a plan to bring stability to home prices. There are two reasons for this emphasis.

First, we can trace the origins of the crisis to the growing pace of defaults on subprime mortgages in the summer of 2007. Until we can contain the defaults on these mortgages and the resulting impact of foreclosure on home prices, the downward pressure on prices will persist. Without such action, these vicious problems will continue to feed on themselves, with further defaults, further fire sales of good homes, further declines in home prices, further threats to the solvency of financial institutions and, most important, further shredding of the morale and the hopes of millions of Americans.

The second reason for focusing on the household sector is the special situation of the current national economy. In earlier recessions, the household sector responded to the pressures of recession but was not the driving force behind those pressures. Now, because of a mortgage crisis induced by falling home prices, millions of people — including those who acted prudently — are in deep trouble with no clear path back to good jobs and steady incomes.

The risk here is not just humanitarian. Indeed, the risk is also to the preservation of the social structure of democracy and to the future progress of America.

There is a limit to how far government guarantees can go, because of the variety of complications in dealing with the mortgage mess. In particular, many mortgages were packaged as collateral for newly created fixed-income paper now owned by investors and institutions all around the world.

Treasury Secretary Henry M. Paulson Jr. proposed a federal government purchase of this so-called toxic paper from financial institutions, which had the attraction of setting a price on these obligations and rendering some liquidity to them. But the mortgages would still be outstanding, and the names of the homeowners who took out those mortgages would still be there. Hence, the ownership of the mortgages might change, but the debtor would still be the same family or individual owing the same amount of money. The main concern now is to help the lender and the homeowner simultaneously.

A solution to these dilemmas would greatly improve the chances of reaching the primary goal: stabilization of home prices. To achieve it, we must alter the terms of these mortgages to contain the foreclosure process and, in time, bring it to an end. Only then can we shrink the number of houses under forced sale conditions and stop the downward pressure on prices.

A compulsory change in mortgage terms would initially appear to damage the lender in order to protect the borrower. But lenders are in as much trouble as borrowers because they cannot collect the money owed them and have little chance of selling a home at a price that would enable them to come out whole. Lenders and borrowers are in this crisis together.

The best solution proposed so far has been from Sheila C. Bair, the chairwoman of the Federal Deposit Insurance Corporation. Under this proposal, servicers of mortgages would rewrite outstanding mortgages to a more affordable level for the homeowner by lowering the principal amount owed, by reducing the interest rate, by extending the maturity — which would reduce monthly payments — or by combining these steps. In addition, the government would share a portion of the losses in these mortgages if they went into default.

WHILE this arrangement would mean a lower return than the lender originally expected, the ultimate results would be better and less risky than the losses now being incurred.

Others will come up with improvements to this plan or offer different models, but the main point is to intervene promptly, directly and powerfully to counter the home price debacle.

Only then can we begin to restore hope and optimism to Americans and to the outlook for our economy.