Martin Feldstein, the Harvard-based economist who served for a couple of years as chair of Reagan’s Council of Economic Advisors almost 30 years, tackles the lingering burden of mortgage debt in today’s NYT: How to Stop the Drop in Home Values

He writes in part (emphasis added):

HOMES are the primary form of wealth for most Americans. Since the housing bubble burst in 2006, the wealth of American homeowners has fallen by some $9 trillion, or nearly 40 percent. In the 12 months ending in June, house values fell by more than $1 trillion, or 8 percent. That sharp fall in wealth means less consumer spending, leading to less business production and fewer jobs.

But for political reasons, both the Obama administration and Republican leaders in Congress have resisted the only real solution: permanently reducing the mortgage debt hanging over America. The resistance is understandable. Voters don’t want their tax dollars used to help some homeowners who could afford to pay their mortgages but choose not to because they can default instead, and simply walk away. And voters don’t want to provide any more help to the banks that made loans that have gone sour.

But failure to act means that further declines in home prices will continue, preventing the rise in consumer spending needed for recovery. As costly as it will be to permanently write down mortgages, it will be even costlier to do nothing and run the risk of another recession.

Feldstein recommends that we focus on the 11 million homes where the current mortgage debt is more than 110% of the actual value of the home. Through a combination of government injection of money and equal losses to banks, the principal for those 11 million properties would be brought down to 110% of the value. The “one-time cost” would be less than $350 billion, according to Feldstein.

Borrowers nationwide who take this deal would also agree to full recourse, meaning they could be sued by the government for other assets if they default.

Feldstein thinks that this system would significantly reduce the number of defaults, foreclosures, and presumably various other situations that lead to distressed sales. That would support prices. He writes:

Without a program to stop mortgage defaults, there is no way to know how much further house prices might fall. Although house prices in some areas are already very low, potential buyers continue to wait because they anticipate even lower prices in the future.

Before the housing bubble burst in 2006, the level of house prices had risen nearly 60 percent above the long-term price path. So there is no knowing how far prices may fall below the long-term path before they begin to recover.

I’ll note here that one reason that we’re in this position is because the homebuyer tax credits convinced some buyers to enter the market too soon and at too high a price. I’m anxious to see the first study — surely one will be coming within a year or two — of the number of homeowners who got the tax credit who are now significantly underwater.

Would Feldstein’s idea work? While it wouldn’t cure the economy overnight (ha!) it would have small impacts immediately and certainly help over the long term. It would almost certainly pay for itself many times over in increased economic activity.

It’s hard to imagine Americans going for it, however, especially those who have played by the rules and bought houses they could and still can afford.

Of course, by arguing against any form of principal reduction, those very homeowners will see their own wealth impacted.

I like Feldstein’s idea if only because it’s a bold move, one that seems a) doable and b) commensurate with the scale of the ongoing problems and potential worsening of the crisis.