The pot-holed road

Thoughts about India, the United States, and occasionally, the world at large.

Archive for April 2009

IMPROVING THE GEITHNER PLAN, WITH A SIMPLE MORATORIUM CLAUSE

with one comment

 

Predictably, the Geithner plan has evoked a mixed response among economists. Even liberal economists are a divided lot. Paul Krugman is very clear that it will not work (he called it “cash for trash”) while Brad DeLong (of UC Berkeley) is convinced it is a good bet. Without getting into the specifics of the arguments on either side, I believe there is a simple way in which the plan can be improved and made more effective.

 

As things stand, the plan would provide huge sums of taxpayer money to the private sector (in the form of equity, and, more substantially, debt) to enable them to purchase distressed assets (ultimately mortgages) from the banks through a process of competitive bidding among themselves. Implicit in this is the idea that once the distressed assets are acquired, the buyers would have the staying power (arising from the fact that much of funds laid out would come from the government at next-to-no cost) to bide their time till such time property prices have recovered. At this point, so the idea goes, they would be able to sell at a decent profit.

 

Here is a suggested modification to the plan. Instead of the idea of holding on to the property till a market turnaround being implicit, I suggest that the plan should incorporate a specific legal moratorium on the resale of such properties. This would be a statutory provision that would bar the resale of properties acquired under the plan for a minimum period of one year or more, the exact moratorium depending upon the location. In places where the supply of foreclosed properties is high and where real estate prices have fallen sharply (Florida, for instance), the moratorium period can be kept much longer, say as long as three years and more.

 

The advantage in putting in a legal bar on the sale or re-sale of such property is that it will immediately serve to choke the supply of foreclosed properties that have contributed so much to the downward spiral in real estate prices. I also believe the psychological impact on the market from supply being choked by a legal requirement (even as there is a stock available) would be far greater than when the market believes that some suppliers are merely waiting for a good price. Therefore, if the idea is to give a shot-in-the-arm to the real estate market, then obviously a situation where a certain portion of available stock cannot be legally sold would do a lot more than when some suppliers are known to be merely holding out for a “good” price.

 

This would, of course, impose an additional holding cost on the agencies vested with the authority to buy such assets from the banks. However, with the bulk of the funds coming from the federal government, the cost to the private partners would be negligible, though it might delay the eventual payout. Moreover, as against the delayed payout, there is also the prospect of better profits. And then, one way to minimise the holding cost, would be to have these properties (carrying a moratorium on their resale) rented out, in which case the rental income might substantially offset the interest/carrying cost.

 

Of course, in practice it would also be necessary to ensure that properties emerging from the moratorium are staggered out. Otherwise, if they all hit the market in a bunch, it would depress prices all over again. Also, the way things are now (thanks to securitisation), figuring out who actually owns a particular mortgage would be no easy task. But then, this is a different aspect to the problem which will have to be looked at separately.

 

As I put it in the title of this article, it is a simple idea, but one which might just be worth a shot. ◄►

 

Written by Ranjan Sreedharan

April 1, 2009 at 6:13 pm

Posted in US and the world