Fixing the cause of the housing bust, not the symptoms

In an interesting opinion piece in today's Wall Street Journal, MarketWatch's Irwin Kellner suggests that the fastest solution might be to simply align the interests of buyers and sellers with some plain, hard cash:

Let's start with the fact that falling home prices are affecting the wealth, confidence and thus spending of many homeowners, not just the relative few who are trying to sell their residences. Many others are unable to hold on to their homes because they borrowed at low interest rates that have since moved higher.

On the investment side, many of these mortgages were turned into securities whose value has now come into question because of falling home prices. This has frozen the credit markets, thus cutting down on bank lending, since no one is sure of the value of collateral.

Home prices are falling because there are at least 5 million unsold homes overhanging the market -- a 10-month supply at current selling rates, and twice the usual number. Their median price is $208,000. That's 10% below the peak, but still a high 3.2 times median family income.

Housing would be more affordable if the median home cost 2.8 times median family incomes, as it did in the 1980s when housing sold at a brisk pace. In today's dollars, this means a drop to $184,000.

Simple arithmetic tells us that this is a difference of $24,000, or about 12%.

If the government were to give sellers half of this, they would be able to lower their asking prices without losing any more money. And giving buyers the other half would enable them to pay more without having to come up with additional funds.

Make this offer good for a limited time only (say, six months) and the economy would get a jolt where it needs it the most. And the cost would be only $120 billion ($24,000 times 5 million unsold homes).

This plan may seem more complicated than the one now under discussion, but it does have a number of advantages that make it worth considering:

• It will encourage quick deals.



• It will stabilize home prices, thus wealth and confidence.



• It will establish a value to mortgage-backed securities.



• It will help thaw out the frosty credit markets.



• It will ensure that these funds will be spent domestically.



• It would not be perceived as a bailout, thus creating a moral hazard.



• It will help maintain homeownership.



• It will minimize the need for additional easing by the Federal Reserve.

A crazy idea? Not any crazier than passing laws which make it even easier for borrowers to simply skip out on mortgages...