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A Different Solution to Mortgage Crisis? Economist Says Yes

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RISMEDIA, Dec. 21, 2007-The five-year freeze on mortgage interest rates recently announced by the federal government may be intended to help responsible homeowners avoid foreclosure, but a noted economist with the Real Estate Center at Texas A&M University says there may be a better solution to the mortgage crisis.

“The federal government has to be very careful in addressing this problem,” said Dr. Mark Dotzour, the Center’s chief economist. “Aggressive government intervention in the mortgage market will only create additional uncertainty for bond investors. Freezing interest rates is a bad idea. When you tell an investor that the contract they hold is no longer valid, it constitutes actual taking of private property.”

Dotzour added that if the government intervenes and rewrites the terms of existing mortgage contracts, bond investors will become leery of buying mortgage bonds in the future and will demand higher interest rates for the higher perceived risk.

Research Economist Dr. James Gaines, also with the Center, agrees, calling the basic premise of the plan shaky and the details sketchy.

“For the most part, the homeowners and borrowers likely to benefit from the interest rate freeze are the very same people who would have the best chance of renegotiating their loans with the lender in the first place – a borrower with a relatively sound credit rating and a history of making payments who simply needs a little help to keep from going into full default,” Gaines said.

So how can the federal government speed the recovery process in the U.S. housing markets?

The first thing the government should do, Dotzour said, is cut short-term interest rates to 2 or 3%. At the same time, they could aggressively purchase mortgage bonds and long treasuries to drive down the ten-year yield, which Dotzour said has already dropped below 4% in the past six months.

After that, the government needs to address the increased risk premium in the mortgage market by establishing conservative mortgage guidelines and creating a new government “seal of approval” for mortgage loans that meet standard underwriting guidelines. Dotzour said this would help raise confidence in private bond rating agencies and the mortgage insurance industry.

“Together, these efforts would drive down mortgage interest rates dramatically and allow American homeowners to refinance,” Dotzour said. “This looks like heavy-handed government intervention into the housing market, but we are likely to see heavy-handed intervention anyway, so we might as well do something that might actually work.”

For more information, visit http://recenter.tamu.edu.

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