Easing the mortgage crisis

As the Congress debates the stimulus package and the Fed cuts interest rates, the Senate Banking Committee is weighing in with a different tactic. According to a story in this morning’s Washington Post (Lawmakers Look to Tactic From S& L Crisis), Committee Chairman Chris Dodd is proposing a means to buy up bad loans:

The Home Owners’ Loan Corporation, as it is called, would offer to buy mortgages at steep discounts from mortgage firms and banks and then rework the loans based on the reduced value of the properties, making the payments more manageable for homeowners.

A hearing on the proposal is set for this morning.

I think this is a necessary step. It may not provide an immediate boost to the economy, but it will set the proper long term course. We need to be clear about one thing: this is a credit recession. Getting the credit market back on track is an important feature of any economic plan. We should take a lesson from what happened in the US and Japan at the last real estate bubble. In both cases, interest rates were cut. But the US created the Resolution Trust Corporation, took the financial hits and moved on. The Japanese banks and other financial institution kept the bad loans on their books. The US recovered; a decade of low (sometimes negative) interest rates in Japan were ineffective.
Bottom line: as long as the financial system is clogged with suspect loans, the credit market will be reduced to a dribble and the economy will falter. Take the pain, clean up the system and move on.

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