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Economics focus
A helping hand to homeowners

Some economists think the credit crisis needs to be fixed at its source—in America’s housing market
Oct 23rd 2008 | from PRINT EDITION

GOVERNMENTS across the rich world have taken drastic steps to save the banking system. As the fears of outright collapse recede, their focus has turned to improving the supply of credit to households and firms by pushing market interest rates down and encouraging banks to lend more freely. But a growing number of economists, and now the Bush administration, believe that the credit crunch also has to be addressed at its source—in America’s housing market, where prices have fallen almost one-fifth from their peak, and foreclosures have soared (see chart).

Two features of housing finance make the crisis hard to resolve. The first is “no-recourse” home loans, which are standard in America (though not elsewhere). If a borrower defaults, a bank can claim back the property used as collateral, but nothing more. When the value of a home drops below the size of the mortgage, a borrower has a reason to default to escape his negative equity.

Borrowers’ freedom to disown their bad housing investments means the housing slump feeds on itself. A lender may recover as little as half the value of the mortgage from a foreclosure, after legal and other costs, because abandoned homes quickly fall into disrepair and can only be sold at a discount. And foreclosures intensify house-price falls by adding to the stock of unsold houses. An enlightened bank may be better off forgiving a part of a mortgage if that persuades borrowers to remain in their homes. But that route is often closed off because of a second feature of the housing market: securitised mortgages. When a troubled home loan is in a pool with other mortgages, held by a group of investors, there is no easy way to agree on a deal to forgive debt.

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