Shiller: Homeowners Need New Type of Mortgage

Friday, September 26, 2008 2:03 PM

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Yale University economist Robert Shiller is urging for the creation of a new type of mortgage that would automatically adjust principal and interest payments in times of economic stress.


Shiller, who accurately forecast stocks' plunge in 2000 and today's real estate crisis, wrote in The New York Times that "in this time of economic crisis, help for troubled homeowners often arrives late, when it arrives at all."


So, change is necessary, he says.


"Mortgages could be structured differently, so that adjustments in payments would be made as a matter of routine — systematically, automatically and continuously — starting even before distress is perceived by borrower or lender."



The adjustments could be made based on movements in national housing-cost indices and economic indicators, such as unemployment, Shiller says.



"Continuous workout mortgages would be privately offered," he writes.



"They would not be bailouts; the cost of workouts would be priced into the original mortgage rate."



With the risk of these mortgages clear from the beginning, they are less likely to be overvalued in the market, which is what caused the current financial crisis, Shiller points out.



A huge bonus of the plan: "By avoiding millions of individual family crises, we might also make institutional crises, like the collapse of Lehman Brothers and Bear Stearns, less likely," he writes.



Many on Capitol Hill say more must be done to help homeowners right now. Sen. Barbara Boxer (D-Calif.) told the San Francisco Chronicle that such aid is necessary to "get to the root of the housing crisis and work to keep people in their homes through refinancing."

The catch, for he/she who buys such a flexible mortgage is, “the cost of workouts would be priced into the original mortgage rate” (quoting from your article). And how is this any different from adjustable interest rate mortgages? Even if it were different, for the sake of simplicity, if one were to imagine a market with two kinds of mortgages—say, 30 year fixed interest rate and a mortgage adjusted for economic upheavals, the risk of “moral hazard” would still not be eliminated. As a customer, I might opt for the 30 year fixed interest rate even though I might be a “bad agent” who is ill-equipped to deal with economic changes (i.e., more susceptible than Joe-Shmoe). Customers like me could once again cause trouble in the mortgage industry. Well, I am not an economist, and I am sure I am missing out on something obvious. I guess the smart thing to do would be to read Bob Shiller’s, “The Subprime Solution” and figure out exactly what he means.