Housing prices are still in decline. Prices have dropped between 20 and 40 percent in many U.S. regions since their peak values in 2006.
The Florida economy is almost stagnant — hardly creating jobs. Florida’s economic problems can be explained by the downfall in construction and related industries. In the current long recession, the economy has lost about 500,000 jobs, and around 360,000 of those jobs belong to construction. The number of housing permits in Florida has fallen to roughly one sixth of what it used to be.
Economists have learned that financial and housing crises are usually very long. Around 40 percent of homeowners in Florida are under water, meaning the consolidated value of the home debt is higher than the value of the property. It is expected that many of these homeowners will foreclose on their properties, which results in a great loss of personal wealth. These desperate homeowners are not able to benefit from the low rates of interest prevailing in the U.S. economy.
The revamping of the housing market seems, therefore, necessary for the U.S. recovery. There are some government programs such as the Home Affordable Refinance (HARP) and Home Affordable Modification (HAMP). However, these programs have had a limited impact because many homeowners have been unable to qualify.
The U.S. is one of the few countries in the world that is benefitting from very low interest rates. There seems to be an arbitrage opportunity for financial companies to bridge the current gap between low interest rates available in the market and the still high interest rates facing the majority of homeowners.
Recently, the Department of Economics at the University of Miami School of Business Administration held a discussion on housing that focused on the “60/40 Plan,” developed by Gustavo Diaz, as a new option for addressing the housing crisis. Unlike other plans, this one benefits both the banks and homeowners.
Under the conditions of the plan, a mortgage loan would be restructured into a two-part single mortgage. That is, Part A would represent 60 percent of the actual mortgage debt, and Part B would represent the remaining 40 percent. Part A of the modified mortgage would be financed and amortized by the homeowner, with 360 equal monthly installments. Part B of the modified mortgage would be a zero-coupon balloon with all payments deferred to maturity. Under the 60/40 Plan, a homeowner is still liable for the entire amount of the principle balance. The plan allows homeowners to stay in their property for 30 years. Under realistic price scenarios, it turns negative equity into positive wealth.
The 60/40 Plan is intended to decrease monthly payments by about 50 percent, and thus stop the current wave of foreclosures. The 60/40 Plan should be executed by private investors, but recognizes the role of monetary policy and government intervention to provide the right incentives as well as confidence and transparency in financial markets.
It is clear that to overcome the complex problem of home financing, the market requires the right cooperation between the government and financial agents so that home-owners can profit from the existing low-interest rates, and are able to remain in their properties.
Manuel Santos is chairman of the Department of Economics and holder of the James L. Knight Chair in Economics at the University of Miami School of Business Administration. For more information on the 60/40 plan, see Santos’ article in the March/April issue of the Federal Reserve Bank of St. Louis Review at http://research.stlouisfed.org/publications/review/article/9161