McCain’s Mortgage Refi Plan: Half a Good Idea

By :: October 8th, 2008

The most interesting thing I heard in last night's debate between John McCain and Barack Obama (in fact, the only interesting thing I heard) was McCain's call for a new federal effort to directly refinance residential mortgages into new low-interest loans. The plan got me thinking about a provocative way to pay for it—eliminate the mortgage interest deduction for these new loans.

The idea of government-subsidized refis isn't new. The bailout bill signed into law last week seems to permit them. Hillary Clinton suggested a similar plan during the Democratic primaries. Obama now says he thought of it first. And the scheme is based on the Depression-era Homeowners Loan Corporation. McCain's version seems to follow a plan designed by former top Bush economic aide Glenn Hubbard and Chris Mayer, both at the Columbia Business School.

But this homeowner bailout would cost taxpayers a ton. The McCain campaign says about $300 billion. Hubbard and Mayer say negative equity on owner-occupied houses is nearly $600 billion.

McCain doesn't say how he'd pay for it. This is a presidential campaign, after all. But there are a few ideas worth thinking about. Hubbard and Mayer suggest the government could take an equity stake in any refinanced homes. Thus, it would receive a share of any profits when the home is eventually sold. I think that isn't such a bad idea, although my colleague Len Burman is more skeptical. He argues that people would sell homes quicker than usual rather than share profits with the government.

Another possibility, heretical as it sounds, would be to make a deal with these bailed-out homeowners: The government will cut your interest rate, but you must agree to forego tax deductions on your new low-rate mortgage.

The current deduction doesn't mean very much for low-bracket taxpayers in any event. And even without the tax break, such a taxpayer would still be better off cutting, say, a 7% loan to 5.25%. Upper-income homeowners would not do as well, but do they really need two government subsidies—low mortgage rates and the tax break?

Trading off the tax deduction would help recover some of the expense of yet another bailout. But it is also important for fairness reasons. McCain's plan would reward many who irresponsibly took out mortgages they could not afford. But its cost would be borne by all taxpayers, including both those who played by the rules and borrowed responsibly and those who never purchased homes at all.

The idea of government refis is worth thinking about. But responsibly financing them ought to be an important part of the discussion.

4Comments

  1. Anonymous  ::  2:50 pm on October 9th, 2008:

    Howard: I love this idea. I came to the same conclusion this morning as I attempted to think through the discussion between a homeowner and the bureaucrat responsible for the HOME program.
    HOMEOWNER: I can't pay my mortgage. It's greater than the value of my home.
    BUREAUCRAT: No problem. The government will pay it off for you. But you'll have to reset the value of your home. What's it worth?
    HOMEOWNER: $300,000
    BUREAUCRAT: that seems low. Isn't it worth $400,000?
    HOMEOWNER: No. Since I haven't been able to keep the pool filled with the right chemicals either, it's really only worth $300,000. And, I haven't been able to cut the grass either.
    BUREAUCRAT: oh, ok. Don't worry. Your patriotic neighbors will pay the difference. You just have to pay this 30-year low interest mortgage. OK?
    This scared me alot.
    In the interest of fairness to the millions who do pay their mortgages on time, did put money down, do cut the grass and keep their pools chemically balanced, I think the annual mortgage interest rate deduction subsidy should be convertible to a one-time lump applicable to be paid against ANY mortgage. That way we can keep the government away from trying to value specific homes, and pump money directly into the banking world through millions of taxpayers cashing in their tax deductions this way.
    This should also be the end of the mortgage interest subsidy.
    No doubt, the Treasury will like this more since it is pulling forward liabilities that would otherwise be higher since people almost always earn more (higher tax brackets) than they do today.
    Trading off future subsidies for a direct cash infusion today makes a lot of sense to me and retains the personal responsibility that mortgagees must take for the predicament they find themselves in. It also doesn't reward the holders of undocumented mortgages while penalizing those responsible lenders that didn't fall down the rabbit hole, which is what HOME would do.

  2. Anonymous  ::  4:20 pm on October 13th, 2008:

    How would the size of the “lump” be determined?

  3. Anonymous  ::  1:27 am on February 19th, 2009:

    Certainly something needs to be done about this crisis and we should find a solution to solve it. However, I also don't agree that paln should be at the expense of others.

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