To solve our economic crisis, prop up housing values

We are experiencing the greatest threat to the American economy since the Depression, triggered by the crash in housing prices, the mortgage debacle, the flood of home foreclosures and the devastating impact on our banking system, our mortgage underwriters and our entire fragile financial infrastructure.

Banks are in danger of being wiped out by enormous losses from worthless mortgages; millions of Americans are losing their homes through foreclosures because their mortgage obligations exceed their homes’ values and they cannot meet increased monthly payments.

Fannie Mae and Freddie Mac, which guarantee or own $5 trillion in home mortgages, are nearly bankrupt and could strap taxpayers with that huge obligation. Confidence is being lost, fearful institutions are reluctant to extend loans and the most important financial system in the world is in jeopardy.

Many remedies costing hundreds of billions of dollars have been proposed. Just to avoid Fannie Mae’s and Freddie Mac’s becoming insolvent, as some experts say they are, may cost anywhere from $40 billion or $50 billion to several hundred billion dollars. It might take additional hundreds of billions to stop mortgage defaults from crushing countless additional banks.

The last real estate meltdown and bank crisis of the late 1980s and early 1990s cost taxpayers $120 billion ($250 billion in today’s dollars). Helping millions of families avoid foreclosure, with its concomitant consequences to our entire financial system and the economy, could cost a minimum of $100 billion, and probably a massive multiple of that.

While it will be tremendously costly to work our way out of this dilemma, there is a way of minimizing the cost, pain and fallout.

Instead of trying to save failing entities directly, there is a far more effective way to solve this problem.

We need to raise the price of foreclosed and unsold homes by increasing demand for them and the ability to pay for them. This would stop the stampede that keeps pushing prices lower.

In the Great Depression, when farmers could sell products only at prices that would wipe them out, targeted agricultural subsidies saved them. These subsidies also fostered growth of a vital sector to the point that it has become one of the most vigorous and envied components of the economy. Sagacious political leaders did not bail out farmers by buying their farms or infusing dollars to prop up their balance sheets, but by the leverage provided by subsidizing prices.

Today, Congress should enact measures that will increase house prices. Congress could:

• Give green cards and a path to citizenship to foreigners who agreed to buy a foreclosed or unsold new home for at least $250,000, to live in and not resell for at least 10 years. (Each recipient would of course need to be appropriately cleared by U.S. immigration authorities.) This program would be available to up to 1 million individuals (with immediate families) until housing prices rose, excess inventory fell, the mortgage debacle was overcome and mortgage securities were no longer delinquent and ceased to threaten financial institutions.

• Reward citizens who buy a foreclosed home or unsold new home, to live in and not sell for the duration of the mortgage, by subsidizing the interest payments over the 30-year life of the mortgage. If a homeowner’s interest rate is 6 percent he would be required to pay only 4 percent and the government would pay a 2 percent subsidy, recoverable if he eventually sold the house at a profit. If the home were sold before 10 years at no profit there would be a penalty equal to the subsidy plus interest. Such subsidized mortgage financing would permit millions of families to afford to buy the excess inventory of homes and create the kind of demand that would rapidly raise the price of these surplus homes.

• Inflation and the accelerating cost of steel, lumber and concrete will push the replacement cost of these homes higher. This is what occurred when commercial real estate prices collapsed in the early 1990s. Desperate sellers, banks and the government-owned Resolution Trust Corporation were overly pessimistic and sold their real estate holdings for far less than the replacement value.

I am familiar with several individuals who bought prime office space for $100 a square foot at that time and today are getting annual rents almost equal to their purchase price. Even inflation can sometimes be a blessing, and inflating the price of available homes would go a long way toward eliminating the financial crisis brought on by the “irrational exuberance” of the housing and mortgage securitization bubble.

This combination of actions would prop up the value of housing, draw in private buyers and reduce surplus inventory. Along with the passage of a little time and the natural effect that inflation will have, these suggested measures will help to avoid the far more costly approach of injecting hundreds of billions of dollars to save the banks, insurance entities, mortgage holders and numerous other financial institutions, as well as the unimaginable billions of dollars to bail out the several million families in imminent danger of foreclosure and personal ruin. Surely it would be the most effective solution to our present economic crisis.

Davis, a shareholder in The Hill’s parent company, is an economist, an MBA graduate (with distinction) from Harvard Business School and author of From Hard Knocks to Hot Stocks (William Morrow and Co.) and Making America Work Again (Crown).