Foreclosure

Congress is starting to take seriously tbe idea of modifying mortgage contracts in order to keep homeowners in those homes.

This is a terrible idea.

First of all, government should not be in the business of modifying the terms of private contracts. The enforceability of contracts is one of the linchpins of our economy and of the faith in it that has kept it strong and that will restore that strength in the future.

Second of all, it establishes a colossal moral hazard. Those in risk of foreclosure are in one or more of three situations:

1. They were misled by the institution that sold them their home. We already have criminal and civil justice systems for resolving this kind of conflict.
2. They purchased a home they couldn't afford. They may have known that up front, or there may have been a life change or job loss that caused a crisis, but in any case this situation is not unique to the present circumstances. We have the bankruptcy process to resolve these problems.
3. They took out a variable-rate loan, and the rate floated at a time when they were unable to refinance. The technical term for this is "getting caught with your pants down." I'm not sorry for you.

None of us deserves to own a home. Most of my peers have decided they cannot afford one and are renting. If you made a mistake, and lose your home, you will become one of us once more. Welcome; it's not so bad.

The reason that the government wants to keep people in their homes, of course, is not just because it wants grateful voters. It is concerned that a glut of foreclosures will depress neighborhoods nationwide. Needless to say, I have my own solution to offer humbly to you. It follows the same principles as the wider financial recovery plan:

1. Stabilize the financial system by injecting cash and stopping the free-fall.
2. Use taxpayer money to purchase equity in the hopes of recouping that money.
3. Don't bail out people who made bad decisions; wipe them out.

Here's how the system would work.

Suppose Todd and Sarah are behind on their home payments. If they and their bank are unable to come to a modified loan agreement that will keep them out of foreclosure, the government -- at the consent of both parties -- could step in and purchase the home at its current market value. The homeowners lose something: ownership of that home. The bank loses something: it must accept the current market value of that home as payment in full for the debt. But it also gains: it doesn't take ownership of the home either, so it doesn't have to figure out how to unload it again. And because it receives either cash up front or government bonds, it doesn't have to worry about a second default.

The former homeowners also gain something: they are allowed to stay in their home. In return, they pay the government rent in the amount of their previous monthly mortgage payment, as of just before they started to fall behind.

The government would hold the property at least until the value of the home has increased, such that a sale would recoup the taxpayers' money, perhaps with the addition of some minimal amount of interest. At any point after that, the original homeowners, if they are still tenants, would have the ability to purchase the home back again at whatever its market value is at that time. If at any point those first tenants move out, or after some additional period of time has elapsed, the government would be allowed to sell the property to any buyer -- again, at fair market value.

If there's to be a bail-out of any kind, I believe this system has several things going for it: Lendors are able to unload toxic assets and recoup at least a portion of the money owed them. Homeowners are allowed to stay in their homes and avoid bankruptcy. And taxpayers get to invest their money in something that will pay them back, while still feeling good about helping their neighbors. And as important as any of these reasons: it doesn't reward either homeowners or banks for bad or foolish behavior.