If the financial sector bailout is to succeed, it must do more than just buy up shaky and non-performing debt from lenders, says former Reagan adviser Martin Feldstein.
The fundamental cause of the crisis is falling house prices, "that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities," Feldstein wrote in The Wall Street Journal.
Downward spiraling house prices gnaws away at the value of mortgage-backed securities and at the capital and liquidity of financial institutions, says Feldstein, and the $700 billion bailout bill will not remedy this problem.
With approximately 10 million homes with mortgages greater than the value of the residence, according to Feldstein, mortgage holders have an incentive to default.
Under the conditions of these mortgages, the defaulter's other assets or income cannot be attached. The inventory of foreclosed homes, therefore, will likely keep increasing, and prices will fall further, Feldstein says.
So, despite the huge infusions of cash into the financial sector that the rescue plan promises, Feldstein predicts that credit and liquidity will not be restored to the banking system until the housing crisis is resolved.
"The recent financial recovery plan that Congress enacted will not rebuild lending and credit flows. That requires a program to stop a downward over-shooting of house prices and the resulting mortgage defaults. The mortgage replacement loan program may be the best way to achieve that."
Former Fed Chairman Alan Greenspan, has a different view.
In recent remarks Greenspan said, the market will start coming back when investors "take steps towards reengagement with risk."
And that will come sooner rather than later, Greenspan says.
© 2017 Newsmax. All rights reserved.