How increased mortgage interest relief can save the economy
(James L. Melcher is the president of Balestra Capital, a New York-based hedge fund. He co-authored this article with Joan McCullough, macro-economic strategist at East Shore Partners. They are writing in a personal capacity and the opinions expressed are their own.)
Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke have been behind the curve in dealing with the breakdown in the banking system and financial markets. All of their initiatives have had only limited impact as they persist in treating the symptoms and not the cause. We are in the early stages of a severe global recession. It is critically important to take more aggressive steps.
The most vexing variable in this entire crisis has been the value of underlying collateral. Any remedy, therefore, is ineffective unless we acknowledge first that the fate of the collateral lies in the hands of the borrowers. Thus, it is imperative that triage measures be taken without delay to ensure the survival of the mortgagors.
Recent government decisions assume that the banking system and financial markets are the center of the universe. Thus all efforts are focused squarely on these areas to the gross disadvantage of our citizenry. Paulson and Bernanke have clearly opted to address the current crisis by pouring ever-increasing amounts of money into the banks with a view towards boosting lending activity. With other financial entities, such as AIG, they have enacted similar liquidity enhancements in a gambit to forestall the forced dumping of illiquid securities, which they believe would threaten the entire global financial system. A functioning banking system is required; but so far official efforts have failed to seize an opportunity to shore up both the mortgagees and the mortgagors.
Personal income tax relief offers a solution that would benefit both targets. The tax-deductible allowance on all home mortgage interest on principal residences should be meaningfully expanded beyond the amount of the interest for a period of at least three years, with the greatest multiple awarded to households in the lowest tax brackets. For a family in the 20 percent bracket, a deduction of four times its mortgage interest would effectively cut their mortgage interest cost by 80 percent. This tax incentive would serve to keep families in their homes from a pure financial-relief viewpoint. It would also entice prospective buyers to buy a home without further delay.
Housing prices would start to stabilize and “bad” mortgages could ostensibly be nursed back to health, having an immediate, positive impact on lenders’ balance sheets. This Mortgage Interest Relief Plan would eliminate the need to transfer risk unnecessarily and unjustly to the back of the U.S. taxpayer. By implementing this plan instead of yet another Washington-originated, one-by-one refinance initiative, any fear-mongering suggestion of an expropriating action by the US government would be silenced permanently. Washington would also be able to recoup some of the credibility it has lost, as both homeowners and Wall Street will be in a position to offer kudos instead of scorn.
There are, of course, significant details to be worked out. But key here is that the plan be executed with a blanket approach. This broad scope removes from the equation the complaint that only bad behavior is rewarded along with other perverse conditions as set forth in earlier government programs. It has the forward benefit, too, of acting as a deterrent to the spread of foreclosure fever further up the socio-economic ladder; in a protracted global recession prime loans also fall under pressure.
Non-mortgagor taxpayers can be compensated with enhanced stimulus checks from Treasury, further facilitating the equitable nature of the proposal with a view towards jump starting consumption across the board. And by using the IRS to effectuate and monitor the process, it can be implemented expeditiously and relatively simply.
There would be substantial benefits to the financial system also. Rather than having Treasury or the Fed buy or lend against distressed mortgage-backed securities (much of which will turn out to be worthless), keeping people in their homes and current on their mortgages will raise the value of those securities and bolster cash-flow to their holders. The effect would be enormously positive, directly and indirectly, to the entire financial system and would substantially raise confidence levels. Instead of trying to control the smoke, we could start to put out the fire.
The cost of this program in lost tax revenues would be enormous. However, the amount of money that the Fed and Treasury are pouring into the financial system is already huge. While these recent initiatives are producing a tremendous amount of resentment as the costs to the taxpayer mount, they are producing very little bang for the buck. This Mortgage Interest Relief Plan may turn out to be both less costly and more productive than the current economic “rescue” program.
Financial systems run on confidence, and confidence has vanished abruptly. People are afraid to buy a home and they are panicking out of the markets. Speed is critical. We cannot wait for the current program to produce results, if it ever will.
A radical expansion of the mortgage-tax deduction is a blunt tool, but so is a sledge hammer. This forceful, proactive initiative puts the money where it is most needed – in the hands of individuals. It could be the shock treatment that both the economy and the financial system desperately need right now.