Is Bailout the Best Plan to Rebuild the Housing Market?

Allan Meltzer gives out interesting plan to rebuild the current housing market in this article.

BUYER:
There is an excess supply of unsold houses in U.S. (surplus), so the housing prices will contine to fall as a result of that. The high risk associated with mortgage bundles will remain until the market knows how far the housing prices will fall. But in reality, no one can confidently say how far housing prices will fall (and the value of mortgages depends on those prices). The steeper the fall in housing prices, the more homeowners will default. Anyone buying a bundle of mortgages knows that part of the bundle is becoming worthless and, as prices fall, more will continue to be worthless. That's the risk that buyers of mortgage bundles have to accept.

SELLER:
Contrary to much public comment, sales of mortgage bundles are still occurring, that is, the mortgage market is still functioning. Usually, mortgages sell for less than 50 cents on the dollar of original value. Merrill Lynch sold a big stake for 22 cents on the dollar. Most financial firms that have large holdings would wipe out their capital if they sold at prevailing prices. Therefore, they expect to get a better price from the Treasury.

FLAWS OF PAULSON'S PLAN:
Allan Meltzer has found a number of flaws with Treasury Secretary, Hank Paulson's bailout plan.

The seller's problem is that selling most of his mortgage inventory will wipe out his equity. Purchases by the Treasury will not help. Unless the Treasury decides to "stick it" to the taxpayers by paying much more than the market price, the seller is no better off than if he sold in the market. That is one flaw in the Paulson plan.

Also, the plan only helps banks and lenders. It does not address the problem of an excess supply of housing. Eliminating excess supply will end the housing problem and help the mortgage market. Buying or adjusting mortgages will not do much for house prices. And any programme to rewrite mortgages in default encourages more defaults.

PLAN:
He proposes that the Congress and the administration should take actions that increase the current demand for housing.

For a limited time, the should allow buyers to use the value of their down-payment as a tax deduction. Or, reduce the tax rate for qualified buyers who purchase a house between now and January 2010.

Increased housing demand will work to stabilize prices -- it will reduce defaults by slowing price decline and brings nearer the time when homebuilding increases.

Some proposals urge the government to buy mortgages. This does little to remove the excess supply of houses, although it may reduce the number of defaults. But reducing defaults does not stimulate the demand for housing. It helps some who are hurt and may keep the problem from growing, but it does not relieve the problem of existing excess supply.

Congressional leaders talk about helping states with their budget problems or rebuilding infrastructure. The latter takes time to implement. Whatever the merits of these proposals, it is more important now to try to solve the main problem we face. We have to set priorities. Encouraging job growth by financing infrastructure may be in the long-run interests of taxpayers and the public, but there can be no full recovery without an end to the housing problem.