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It is time to tackle the systemic flaw in housing policy – reliance on leverage – and introduce minimum downpayment regulations for all homebuyers, writes Charles W. Calomiris

Without high leverage the subprime boom and bust could not have happened. Risky no-docs borrowers would have been unwilling to deceive lenders if they had to pledge a large amount of their own savings as a downpayment (deposit). House price declines would not have produced huge loan losses if homeowners had retained a minimum 20 per cent stake in their homes.

During the 1990s and 2000s leverage tolerances on US government-guaranteed mortgages rose steadily and dramatically at FHA, Fannie Mae and Freddie Mac. The average loan-to-value (LTV) ratio of FHA mortgages rose to 96 per cent, and a third of Fannie and Freddie’s purchases leading up to their insolvencies had LTVs of greater than 95 per cent.

Not only are high LTVs destabilising, they undermine the objectives of housing policy. Its central goal is promoting stronger communities by encouraging residents to have a stake in them. But a 97 per cent LTV creates a trivial stake; homeowners become renters in disguise, able to abandon homes at little cost. Read more

From the FT:

‘Too big to fail’ is too dumb an idea to keep – John Kay
Obama’s executive pay move is bad policy – Charles Calomiris
Speculators do drive prices, and it’s the developing countries that suffer – Andrew Mold Read more

By Charles W. Calomiris

Tim Geithner, US Treasury secretary, has his work cut out. Any successful plan to revive the financial system will have to raise banks’ asset and stock values, but helping banks is unpopular. Neither Republicans nor Democrats in Congress seem excited about spending money helping banks. And some in the Obama administration probably are counselling the president against taking the political risk of helping Wall Street. Many in the electorate are incensed by the idea of propping up banks and exposing taxpayers to risk of loss. Read more

By Andrew Smithers

The aim should be to avoid a deep recession or prolonged weak growth, and to avoid a rapid recovery, which would induce a rise in inflationary expectations. This means a year or more of sub-trend growth, i.e. GDP plus or minus 1 per cent per annum. I think we have a good chance of muddling through, but at the moment the risks of inflation are surely much less than the risks of a deep recession. If that occurs the cause will be inadequate credit growth induced by the inadequate equity of banks and also, very importantly, inadequate profit retentions to support balance sheet growth. (As the latest FDIC report shows, US banks had negative retentions in the first half of 2008.) Read more

by Charles Calomiris

The US government is considering broad-based assistance to stem the financial crisis. Hank Paulson, Treasury secretary, and Ben Bernanke, Fed chairman, have proposed the establishment of an entity that would purchase subprime-related assets from troubled financial institutions.

A broad-based approach is needed, but this is not the best way of achieving policymakers’ objectives. Government injections of preferred stock into banks, advocated by Senator Charles Schumer, inspired by the Reconstruction Finance Corporation’s policies in the 1930s, would be a better choice. Pricing subprime instruments for purchase would be very challenging, and fraught with potentially unfair and hard-to-defend judgments. If the price were too low, that could hurt selling institutions; if it were too high, that could harm taxpayers. Who would determine how much should be purchased from whom in order to achieve the desired systemic risk reduction consequences at least cost to taxpayers? How would the purchasing entity dispose of its assets? Read more