12/06/2008 05:12 am ET Updated May 25, 2011

The Mortgage Crisis: A Modest Proposal

The election of Obama did give him a clear mandate to use the powers of the Executive as well as his leadership in Congress to intervene in the economy. So here's a modest suggestion.

Everyone agrees that in dealing with the mortgage crisis it is critical to keep people in their houses. To do that we have to have ways to renegotiate their mortgages. During the campaign, Obama proposed using federal powers to clamp down on fraudulent lending practices (including the creation of a federal criminal offense), establishing a "Credit Card Bill of Rights" to help prevent people from being driven into bankruptcy in the first place, and reform of the bankruptcy system to allow estate trustees to renegotiate mortgages and an exemption for bankruptcies caused by medical expenses. Those are all good ideas, but there has to be a program to renegotiate predatory mortgages before bankruptcy occurs. The problem is to make sure that such a program is only used in appropriate cases of need to keep people in their houses, not gamed to increase the value of investment properties. Conversely, there is a problem of fairness if people who entered into mortgages they can not pay - whether through stupidity (defined here as "listening to Alan Greenspan") or fraud by lenders - are rescued on terms more favorable than those available to the people who acted prudently and carefully in the first place.

Historically, the way to get a large-scale social welfare benefit of this kind through is to make it extend to everyone: think Social Security and Medicare. It may be that as a combination of politics and economics the only alternative is to give every mortgage holder a one-time shot at a 30-year fixed rate set at a reasonable but not unduly favorable interest rate: say 7.5 or 8.0%. Such a rate is high enough that banks that were careful lenders are not being punished for the misdeeds of others. It is also high enough that people whose mortgages are already below that rate - the people who got good mortgages from prudent lenders -- will have no incentive to take advantage of the program. True, some people in the middle who are not truly in need will benefit, and some people will be unable to make the payments even on those terms and have to face foreclosure. But it is very difficult to conceive of another solution that does not end up rewarding the people who caused the problems in the first place while punishing people who "played by the rules."

A plan of this kind could be an excellent first objective for the new administration. It directly addresses the concerns of McCain supporters as well as Obama supporters, it could garner widespread bipartisan support, and it would demonstrate a clear departure from the Wall Street orientation of the Bush administration's approach. It's only one piece of a solution -- the bailout has to be modified to provide direct incentives for lending rather than just throwing money at banks, for starters -- and there is a lot left out of this description. But it might be a very good place to start.