A Plan for Relief from the Mortgage Crisis

All the presidential candidates have announced grand plans to help homeowners keep their homes. Clinton's plan proposing FHA-backed relief and a $30 billion fund appears to be the most expensive. Obama's suggestion of a foreclosure fund will also considerably burden the taxpayer too. McCain is opposed to the Democrats' plan but has not proposed anything concrete.

An inappropriate plan or no plan will both worsen the current crisis. Then is a resolution possible? Let us list the desirable traits of a good plan and see if there is a way to achieve them.

1. Responsible people should not have to bail out the irresponsible ones. Increasing taxes to help someone who makes $30,000 a year keep a house worth $500,000 is ridiculous. The buyer is responsible for what he owes. A good plan should not make the common man pay for it.

2. One underlying cause for the high foreclosure rate is unaffordable ARM resets. Efforts to cap the resets will help present homeowners but drive down the income for the lenders. So they will raise interest rates in the future to offset their losses. This will discourage buying and drive home prices down further. One reasonable solution to this problem is to restructure the duration of the loan (say from 30 years to 40 years) and have people pay what they owe but in more affordable monthly payments.

3. If home values can be preserved, much of the credit crunch problem will get resolved and more families will have an incentive to stay in their homes and make regular payments. With 10-15% decline in home values across the nation many who bought their homes in the last 3-5 years have lost all their equity. Add to this an increasingly difficult market to find a buyer and the cost of selling commission and closing costs). Even people with good credit history and prime loans are defaulting because they would rather not pay towards a sinking asset.

There may be a solution to this. Currently capital gains up to $500,000 for a married couple ($250,000 if single) from the sale of a primary residence are not subjected to federal tax. With the kind of asset losses we have seen, we may never see such capital gains in the next 20-30 years. So instead why not allow tax breaks (capped by some amount) on payments towards the principal for the primary residence? A maximum tax exemption of $200,000 (spread over the duration of the mortgage) will be sufficient to wipe out the 10-15% of asset losses we have seen so far. At the time of sale, the owner's capital gain exemption should be correspondingly lower - in this example, $300,000 for a married couple ($50,000 if single). This will give an incentive to those who can afford to make payments to stay even if they have lost their equity. It will help maintain home values and will stimulate more buying. And most importantly, it will not tax the common man like the Clinton and Obama plans.

4. As all the candidates have expressed, a good plan should also go after predatory lending and set standards for higher transparency in all future transactions.

I invite readers to comment on the viability of these ideas.