Dealing with the Financial Crisis, Stage III: Nationalization

Stage I of dealing with a financial crisis is to provide liquidity to the banking system at high interest rates in order to keep commerce and finance liquid while punishing feckless overleveraged financiers. We passed out of Stage I at the end of last year. Stage II is forgetting about punishing feckless financiers and focusing on lowering interest rates in order to raise asset prices to keep finance solvent. We are now in Stage II.

Now Alan Blinder says that it is time to--in a limited way--move on to Stage III: nationalization.

Here is his case for a partial nationalization of mortgage banking:

From the New Deal, a Way Out of a Mess: I have several reasons for focusing on just one aspect of the mess: the potential tsunami of home foreclosures.... Foreclosures throw families -- some of whom were victims of deception -- into the streets. They erode home values, damage neighborhoods and reduce the values of other properties, thereby intensifying the decline in housing prices that underlies many of our current problems. And they might even cut into consumer spending, which would really throw us into recession.

A second reason is that reducing the wave of foreclosures would mitigate the closely related financial crises in home mortgages and the alphabet soup of financial creations based on them.... A third reason for focusing on foreclosures is that we've seen this film before. During the Depression, President Franklin D. Roosevelt and Congress dealt with huge impending foreclosures by creating the Home Owners' Loan Corporation. Now, a small but growing group of academics and public figures, including Senator Christopher J. Dodd, Democrat of Connecticut, is calling for the federal government to bring back something like the HOLC. Count me in.

The HOLC was established in June 1933 to help distressed families avert foreclosures by replacing mortgages that were in or near default with new ones that homeowners could afford. It did so by buying old mortgages from banks.... mThe scale of the operation was impressive. Within two years, the HOLC received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages.... Its total lending over its lifetime amounted to... 5 percent of a year's gross domestic product at the time. (The corresponding figure today would be about $750 billion.)

As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC's borrowers defaulted anyway.... The HOLC closed its books in 1951... with a small profit. It was a heavy lift, but the incredible HOLC lifted it.

Today's lift would be far lighter. And a good thing, too, because our government is far more timid and divided than Roosevelt's....

Details matter, so here are a few: First, any new HOLC should refinance only owner-occupied residences. Speculators can fend for themselves -- or go into default. Similarly, second homes or vacation homes should be ineligible, as should very expensive real estate. (Precise limits would vary regionally.) Third, mortgages obtained via misrepresentation by borrowers should be ineligible for HOLC refinancing, but cases of fraud or deception by the lender should be treated generously. Fourth, as the original HOLC found, not all bad mortgages can be turned into good ones....

What about the operation's scale? Based on current estimates, such an institution might be asked to consider refinancing one million to two million mortgages... as much as $200 billion to $400 billion. The midpoint, $300 billion, is one-seventh the size of Citigroup and would rank the new institution as the sixth-largest bank in the United States....

[T]he new HOLC seems likely to turn a profit, just as the old one did. But even if it loses a few billion, we must remember its public purpose: to help the economy recover, not to make a buck. By comparison, the new economic stimulus package has a price tag of $168 billion.