Any Plan That Tries To Punish The Banks For Old Home Loans Won't Work

In the Financial Times, Larry Summers argues lenders should pay more for past bad loans, and also make more now:

First, and perhaps most fundamentally, credit standards for those seeking to buy homes are too high and rigorous.

Surely there is a strong case for experimentation with principal reduction strategies at the local level.

Fifth, there were substantial abuses by financial institutions and almost everyone in the mortgage industry during the bubble. Just compensation to the victims is a legitimate objective of public policy. But allowing negotiation over the past to dominate present policy creates overhangs of uncertainty that impose huge costs on the financial system and inhibits lending.

Bank regulators could facilitate inevitable restructuring of underwater mortgages by requiring banks to treat second mortgages and home equity loans in realistic ways.

Summers seems to recognise that punishing banks hurts new lending, but he also thinks some form of bank punishment would be just. Until they get over this and let the banks alone, lending will remain weak because banks are wary of the lookback option being giving to borrowers who ‘bought’ houses without the means or willingness to pay it back. In the US, loans are already ‘non-recourse’, meaning borrowers can walk away and let the lender eat most of the loss, but people want ‘just compensation’, which is a code word for an expropriation from banks to NINJA borrowers.

Until regulators, legislators, and the experts that advise them stop hounding banks for their old home loans, new home loans won’t be forthcoming. It’s all good and well to say we should just nationalize home lending, but if public housing is any guide that’s a disastrous endgame.

Obama’s latest housing effort seems like the last iterations (Hope Now, Hope for Homeowners, the Home Affordable Mortgage Program, the Home Affordable Refinancing Program, the Hardest Hit Funds), and until things like the Department of Justice’s lawsuit against banks gets cleared up, they won’t consider homelending anything but toxic.

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