The main problem that has not been addressed, either directly or symbolically, is the most important: the economic meltdown. It looks increasingly likely that Citigroup and Bank of America will not be able to survive without government backing (either guarantees or outright nationalization). Accordingly, the whole US banking system is in danger. A comprehensive scheme must be passed sooner rather than later. If something is not announced by the end of the month, then we will be in trouble.
The housing problem must be directly addressed. Several routes are available. First, the government could alter bankruptcy rules, allowing those who file to have the terms of their mortgages adjusted by a judge. (Currently, this is only possible for secondary residences.) Such an alteration would decrease the number of foreclosures, and therefore, reduce the number of worthless assets on corporate balance sheets. (A foreclosure is likely to reduce the price of a housing asset by much more than a small adjustment in principle, interest, and terms.)
Unfortunately, the banking industry and the Republicans that they patronize are still subject to pre-bust wishful thinking. They think that the assets will magically appreciate over the next few years. With this thinking, any devaluation is an unnecessary lost. They fail to see that without a quarantine of the foreclosure contagion*, then the percentage of houses in foreclosure could head toward 20%.
Bankruptcy adjustment is just one component or option. Second, by nationalizing the banking industry, the government could unilaterally adjust the term of loans without house owners having to go through bankruptcy. This is a better option, because it will have a much larger effect. Only a portion of underwater, unable-to-pay home-owners will file for bankruptcy. A general program of adjustment, similar to the HOLC of the Depression-era, could buy up and change the principle and payments on mortgages. (This would result in major losses for the mortgage securities but not more than if we were to reach a 20% foreclosure rate.) This process can be accomplished outside of nationalization (as it was during the Depression), but the upfront cost would be much higher for a special plan. Additionally, in an age of too-big-to-fail banks, the circumstances that allowed the original HOLC to work -- the collapse of thousands of small banks -- will not be present. In either case, since the program would be government-run, the agency in charge would be better able to judge whether consumers really need the adjustment or are just trying to take advantage. But, we may in fact reach a point where such distinctions cease to matter. Moral hazard, as in the banking industry, becomes an ideal that no longer applies in a dire reality.
[A more controversial approach would be for the government to buy foreclosed and unoccupied properties and then rent them out as low income housing. This would be an alternative to home-ownership. Instead of subsidizing mortgages through Freddie Mac and Fannie Mae, we could merely push people into renting at low, subsidized prices. ]
By lessening the number of vacant, foreclosed, and underwater houses, we would be able to stop the rapid decline in house prices. Stopping asset deflation is a good way to shore up consumers and prevent this meltdown from spiraling further out of control. Coupled with stabilization of the banking industry (most likely through nationalization) and new, stringent regulation, we will be able to make it out of this crisis and begin a new era of finance.
