A not so dumb idea

In a WSJ op-ed, Ed Glaeser takes aim at the Republican proposal to reduce mortgage rates to 4 percent, which I advocate. He writes:

... it is particularly disappointing to see Senate Minority Leader Mitch McConnell embrace "providing government-backed, 4% fixed mortgages to any credit-worthy borrower" as his alternative to the Barack Obama/Nancy Pelosi stimulus package.
...
This massive lending program is justified as a means of boosting housing prices. But over the past 28 years, a 100 basis point reduction in the interest rate has been associated with a 4.6% increase in housing prices. Today's mortgage rates stand at 5.35%. If Mr. McConnell's proposal dropped rates by 135 basis points, history suggests that prices would rise by 6.2%. This bump would be barely noticeable in markets like Phoenix, Ariz., where prices have fallen by more than 40%, and it would do little to stem the wave of foreclosures.

...
Moreover, since lenders have recovered their sanity and are once again requiring appropriate down payments, buyers are more constrained by the need to come up with 20% of the purchase price than they are by interest rates. Today's down-payment requirements and low interest rates suggests that mortgage markets are working well and have little need for governmental "help."

I would take issue with two aspects of Glaeser's criticism. First, the goal of the GOP plan is not to raise house prices back to their pre-crash levels (40 percent higher in Phoenix) -- that would invite another disaster of the sort we're now experiencing. Rather, the plan seeks to keep house prices from falling even more. Analysis from my colleagues Glenn Hubbard and Christopher Mayer of Columbia Business School suggests that relative to rental prices, house prices have already fallen to where they have been historically (before the housing bubble) and are still headed down. The goal is to keep them from overcorrecting, not to re-inflate them.

Secondly, I don't think the fact that lenders are again requiring appropriate down payments implies that credit markets are now "working well," since average mortgage rates are still well above the historical average of 1.6 percent spread over ten year Treasury bonds. And although the risk to investors of borrower default should surely command a larger share of that spread now than historically, the risk of prepayment on mortgages taken out at these low rates is virtually nil. So the standard by which to judge whether credit markets are working properly should arguably be whether mortgage spreads are significantly higher than 1.6 percent over ten year Treasuries -- currently they are about 2.6 percent. This also bring us to the cost of the plan, which Glaeser characterizes as "wildly expensive." But if 1.6 percent is indeed a reasonable spread in the current climate, then as Mayer points out, taxpayers might well make money on the plan. In any event, Glaeser's appraisal of the plan seems unduly harsh.