Last week, Congress approved a $787 billion economic stimulus package to get the economy moving again. As President Obama has said repeatedly, this legislation was necessary to avert a catastrophic financial meltdown like the Great Depression. Most Americans are hoping that this record-setting plan for deficit spending and tax cuts will do the trick and, to quote the president, "jolt the economy" into recovery. The President also announced a major initiative to stem the tide of mortgage foreclosures through federal housing programs.
But what if these efforts are insufficient? Where's "Plan B?"
Now's the ideal time for state and local governments to swing into action, rather than waiting for Uncle Sam to solve every problem. Let's look for opportunities for state and local leadership -- with some facilitation from the feds. Grassroots government has the potential to provide economic stimulus as well, if Congress properly sets the stage. To paraphrase the character Gold Hat in Treasure of Sierra Madre, we don't need no stinkin' badges to rebuild America.
Remarkably, Plan B (Stimulus II) can actually give the economy more of a stimulus -- where it's most needed -- than Plan A (Stimulus I), at a small fraction of the cost to Uncle Sam.
Stimulus I includes over $120 billion for infrastructure projects that will re-employ construction workers, but it falls far short of the $250 billion plunge in single-family housing starts last year, just to name one sector of the much-larger construction industry. And construction jobs won't replace any of the hundreds of thousands of white-collar positions being eliminated in the banking, mortgage and financial services sector of the economy in this financial meltdown.
Housing and public finance legislation is needed. A growing number of economists suspect that Stimulus I is insufficient to "jolt the economy" and induce self-sustaining growth. The same problem plagues the mortgage market, where the administration's newly announced program is an important and necessary first step, but insufficient in scale and breadth. The overall economy cannot begin to recover until Congress acts directly and broadly on the problems in the housing and mortgage markets to stem the tide of foreclosures, mortgage defaults and plunging home prices. For that to occur, new buyers must return to the housing markets and struggling-but-credit-worthy borrowers need access to the lowest interest rates available in the capital markets. A massive housing and mortgage-market relief bill is necessary, unavoidable and inevitable. The questions now are When and What?
Thus far, the legislative process forced state and local officials to act reactively to proposals in Congress, begging for handouts directly from the U.S. Treasury. Those leaders must now do the footwork to present Congress a cohesive action plan to kick-start their half of the public sector. Instead of waiting for the next federal stimulus bill, state and local leaders should craft a specific Stimulus II proposal that can advance on its own merits or be attached to the much-needed housing and mortgage market legislation.
Here are specific strategies that governors, state treasurers, mayors and county executives can pursue through their respective associations:
o Low-cost federal incentives for infrastructure projects
o Tap the low-cost advantages of state housing authorities
o Leverage public pension funds
1. Federal guarantees for municipal infrastructure bonds. I've written about this in a previous column, so I won't review every detail here. With Stimulus I providing less than half the funding needed to offset the plunge in private sector housing activity, another $200 billion of state and local infrastructure spending is needed to replace private construction and re-stimulate local economies. This time around, however, it is the job of state and local governments to obtain the financing on their own through the decentralized capital markets. The problem now is that credit markets for municipal bonds have frozen up, so the cost of borrowing for states and localities is too high. Tax-exempt bond investors are leery of default risks and late interest payments, especially in states like California where the deficits have exploded.
Stimulus II Solution: A 2009-only federal guarantee of new-issue municipal infrastructure bonds would push borrowing costs to sufficiently low levels that states, local governments and school districts could afford to start building again -- with their local taxpayers' money. In my February 5 column, I explained how these guarantees can also be secured with private-sector bond insurance for municipalities with weak credit ratings. Rep. Gerry Connolly (D-VA) is receptive to these ideas.
2. Empower state housing finance agencies. Here's the most "targeted, timely and temporary" measure -- as well as the most practical and powerful one -- that's so far been proposed to address the housing meltdown. This strategy will provide the lowest mortgage interest rates in the country where they will be most effective and needed the most. The rates would be low enough to turn the housing market around and help clean up the mortgage mess. Here's how:
In his policy announcement yesterday, President Obama pledged to work with state housing finance agencies (SHFAs) to increase their liquidity. That's a step in the right direction, and I would urge more: Congress must also enable the SHFAs to issue their low-cost tax-exempt mortgage revenue bonds without volume caps in 2009, with a backup federal guarantee for deals insured by qualified private bond insurers rated AA or better. Throughout 2009, the alternative minimum tax should be waived for these new bond issues in recognition of their public purpose, to attract more investors and win lower rates.
Existing SHFAs can sell low-cost tax-exempt bonds to fund mortgages for average Americans to buy a primary residence. For underwater-but-employed borrowers to refinance and keep their homes, the same agencies can provide an affordably low mortgage rate. After 10 years, the ultra-low SHFA mortgage rates can be re-set to the 30-year fixed mortgage rates now prevailing for loans of the same size and credit quality. Unlike an adjustable-rate mortgage tied to an index in the future, this enables the first-time buyers and distressed borrowers to know exactly their worst-case scenario after 10 years, fully disclosed. (No more excuses from borrowers who "didn't understand" their deal terms.)
The SHFAs will realize profits on their loan income once the interest rates re-set. Those excess revenues will be rebatable to the U.S. Treasury under existing arbitrage rules that control tax-exempt bond issues that make an investment profit, thereby reducing the federal cost of this program.
To prevent a re-run of the 2003-04 sub-prime fiasco, private mortgage insurance (PMI) should be required if the lending ratios are substandard or if the loan is a jumbo-refi. With that belt, plus the suspenders of federal bond guarantees, these SHFAs should attract interest rates at or below U.S. Treasury bond yields. Thus, 4 percent interest on a fixed-rate mortgage is feasible, even including the PMI.
To address the moral hazard of rewarding undeserving or scrupulous borrowers, Congress can require a 28 percent income tax on these participating borrowers' capital gains when their houses are sold, in exchange for the bargain interest rates and the insured-but-relaxed loan-to-value ratios. This "profit-sharing" feature (along with the federal arbitrage rebates/recaptures mentioned above) would greatly reduce the taxpayers' ultimate cost of this program in the long run. It would also discourage borrowers trying to "flip" houses at government expense: The tax rate could be even higher for short-term transactions. Non-participating homeowners and taxpayer watchdogs could not complain that these program participants got something for nothing as a reward for messing up.
At the end of 2009, this special program should expire. That deadline would give buyers incentive to enter the market now rather than waiting on the sidelines.
This federalist partnership would put a floor under the housing market at a lower but non-catastrophic level. A deepening banking crisis can be averted. Plus, the resulting new wave of refinancings would also refuel the economy as it has in the past, as traditional lenders drop their rates to remain competitive.
3. Public pension funds can help solve the mortgage meltdown. As noted in a companion column this week, Rep. Gary Ackerman, a New York Democrat, has proposed a bill that would provide incentives and guarantees to state and local government pension funds to provide Tier 1 capital to the nation's banking system. As I explain in that column, the bill has several fatal flaws. But it might be tweaked to provide a valuable source of patient, long-term capital to buy some of the trillions of dollars of toxic mortgage paper that the U.S. Treasury and even the Federal Reserve may be unable to swallow themselves without investment partners.
A viable public-private partnership is desperately needed to provide prudent investment capital to these distressed markets, and get the underwater loans off the banks' balance sheets at a fair price to all. State and local government pension funds can be part of the solution as prudent buyers of deeply discounted mortgage paper with a federal backstop that protects public interests, not private interests. Instead of taking public money from Uncle Sam, pension plans could be providers of capital in an unprecedented intergovernmental public-private partnership. They simply need to see terms superior to private-sector alternatives.
However, as noted in my other column, the role of pension funds is probably only 5 to 8 percent of the total capital necessary, so we need to be realistic about the scope of this opportunity. What Congress and the Obama administration need now is somebody to show them how best to put that money to work for the advantage of both state and federal taxpayers, as well as investors and pension plan participants.
It's clear, then, that there's a direct link between these public finance proposals, the nation's housing market and the banking system. There is a clear rationale to include these solutions in a single bill. Perhaps Connolly and Ackerman might co-sponsor a bill that ties these ideas together. Better yet, these two members could be joined by some bipartisan Republicans, especially in the Senate where an effort like this will die without broader support.
I am sure that other proposals would be attached these three core strategies, and the challenge will be to beat back the hair-brained and self-interested proposals that too often get attached to such legislation. My companion column on the lame lobbying for tax-exempt OPEB bonds spotlights a perfect example of the kind of legislative mischief that must be avoided. But if the leaders of state and local governments stick to the essential features outlined above, the state and local government sector could actually come to the rescue of the entire economy.
For those who thrive on crafting public policy solutions, this could be an exciting year. Hopefully, enough Republican governors, state treasurers and mayors can be mobilized to persuade their Congressional cohorts to support a bipartisan effort to build and flex some economic muscle at the state and local level they traditionally prefer over central government. The nation's governors will meet in Washington this weekend: Is anybody there thinking big these days?
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