Former Federal Reserve Board Chairman Alan Greenspan helped dampen a potentially massive financial confidence crisis in 1998. His most daring act is one the Fed should emulate during this foreclosure crisis.
Mr. Greenspan, with the assistance of the Federal Reserve Bank of New York, called an emergency meeting of the major financial players to create a $3.8 billion bailout of Long-Term Capital Management, a hedge fund that was about to go under.
Current Fed Chairman Ben Bernanke could do the same to help stem the homeownership crisis and the precipitously declining value of homes that threatens repayment, even by those who made substantial down payments.
The first step would be to call in all the major investment banks (such as Goldman Sachs, Merrill Lynch, and Bear Stearns), foreign banks (such as BNP Paribas and UBS) and our major regulated financial institutions (such as Citigroup, JPMorgan Chase, and Wells Fargo).
At this meeting the Federal Reserve should seek an initial $10 billion national loss-mitigation fund that could be administered by either the 12 Federal Reserve banks or a consortium of financial institutions that have a stake in resolving the foreclosure crisis.
According to data from CNNMoney.com, the average homeowner’s loss-mitigation cost would be $16,000. If the fund covered even half of this cost, over 1.25 million homeowners could be protected and moved, for example, into lower-cost, long-term, fixed-rate mortgages.
Some estimate that the potential number of foreclosures at 2.2 million. Some of those subject to foreclosure, however, probably should not be helped, especially those who purchased as speculators.
To maximize the protection for the 70% of Americans who live paycheck to paycheck, we would propose that the priority be given to those who have been hit hardest – people in low-income communities – and that eligibility be restricted to those who are at 120% or below the median income.
Another factor that may make the fund successful are the estimates by Fannie Mae that up to 50% of subprime borrowers were eligible or could be made eligible for prime-rate mortgages. In particular, this would be the case if alternative credit scoring methods were put in place that included monthly utility and rental payments.
If properly and expeditiously created, this could almost immediately stem declining home prices and eliminate the glut on the housing market.
What Mr. Greenspan accomplished in 1998 with Long-Term Capital Management may be far easier this time around. This is because the other regulators, in particular Federal Deposit Insurance Corp. Chairwoman Sheila Bair and Comptroller of the Currency John Dugan, have already called for innovative leadership and action. These regulators are already being supported in various ways by House Financial Services Committee Chairman Barney Frank, Senate Banking Committee Chairman Christopher Dodd, and three prominent Democratic presidential candidates: Hillary Clinton, Barack Obama, and John Edwards.
Paradoxically, the total lack of understanding as to the depth and impact of the subprime crisis on our entire financial industry could well add support for this privately financed bailout of the nonspeculator victims of runaway credit policies. Goldman Sachs CEO Lloyd Blankfein made the frank admission that “the only thing we know is that everything will happen.”
Further, Goldman has just raised $3 billion to bail out its own hedge fund, and Bear Stearns recently acknowledged that two of its subprime hedge funds are essentially worthless.
This week, Merrill Lynch downgraded shares of Bear Stearns, Citigroup, and Lehman Brothers to “neutral,” from “buy,” and lowered estimates for the firms’ earnings, due to their credit and mortgage market troubles.
Given the understandable reluctance of the new Fed chairman to assert his influence over the market, it might be well if the presidential candidates, Rep. Frank, and Sen. Dodd began discussing this solution. Of course, it wouldn’t hurt if a few prestigious financial institutions stepped to the plate, as they did during the Long-Term Capital Management crisis.
Perhaps even Henry “the Hammer” Paulson, our Treasury secretary and the former chairman of Goldman Sachs, might play a role in moving the Federal Reserve along.
Mr. Gnaizda is the policy director of the Greenlining Institute in Berkeley, Calif. Mr. Lizarraga is the chairman of the U.S. Hispanic Chamber of Commerce in Washington.