Another plan for easing the meltdown

This one comes from U of Chicago Prof Luigi Zingales.  He wants homeowners to be able to swap part of their mortgage– equal to the percentage by which “house” prices declined in their zip code since the mortgage was issued– for a share of equity.  Debt declines but equity increases.  Homeowners would have the option to do this, or not, but if they do it then, when they sell, the bank (or whoever holds the mortgage) would get “50% of the difference between the selling price and the new value of the mortgage.”  Zingales would limit this option to properties in zip codes where the Case-Shiller index shows a decline of at least 20%.

He proposes a sort of similar solution for banks.  Holders of bank debt would be able to force the bank into bankruptcy, wiping out the existing stockholders but giving ownership of the bank to the debt holders.  To avoid this happening to solvent banks, stockholders would have the option of paying their share of the debt and keeping their stock.

Zingales notes that both of his proposals are simple standard ways of doing what more often involves hordes of lawyers and complex negotiations.  Foreclosure is a very expensive process, for both sides, and corporate bankruptcy is hardly simple.

It seems to me there’s another advantage, which is that this plan gets the incentives right.   Those who wrote inappropriate mortgages will suffer a cost, but, if they were correct that “house” values are increasing they’ll eventually come out well.  If they weren’t, they won’t.   And stockholders who failed to keep control of bank management will also suffer.

The net result would be people staying in their homes, with manageable mortgages, and banks with enough equity capital to make loans. At virtually no cost to the general taxpayer, by the way.   It’s not especially Georgist, and it does little to prevent a future repeat, but it’s a lot better than what is actually going to happen.