The idea is so simple, it is surprising that no one (that I have heard about) has proposed it. One big problem the US government faces is the enormous pile of mortgage-backed debt held by Fannie Mae and Freddie Mac. Another problem is that many “home owners” are underwater with their mortgages. [How can you be a home owner if you have negative equity?] Finally, the popping of the housing bubble continues to be a drain on the US economy.
The solution I propose is making interest on mortgage-backed securities tax free for five years. This plan would immediately drive up the value of these “toxic” assets and drive down mortgage interest rates below historic lows. This would provide a tremendous boost to Fannie and Freddie and even the Federal Reserve. Increased demand for tax-free MBS would spur banks to issue more mortgages under easier terms, which would help prop up home prices. Naturally, fewer home owners would be under water.
This would also be a boon for investors, giving them access to another tax-free asset class. The incentive of tax-free MBS would be so powerful, it would threaten to take money away from tax-free municipal bonds. To help offset this risk, part II of my plan would make long-term capital gains on municipal bonds tax free for seven years. Like Cain’s 9-9-9 Plan, my plan would have a numeric title, the “5&7 Plan”. (To avoid confusion with the 5-7 Pistol, the “&” symbol is used rather than a dash.)
The long-term capital gains provision gives investors an incentive to hold municipal bonds for at least one year. The extra two years for municipal bond gains gives investors an added incentive to hold long-maturity municipal bonds.
The 5&7 Plan would expand the tax-free bond universe and introduce the concept of tax-free interest investing to a new group of investors… the middle class. Typically only high-income earners benefit from tax-exempt bonds because they offer lower interest rates than taxable bonds. Because high-income taxpayers face higher marginal tax rates, tax-free municipal bonds make sense despite lower interest rates. If the 5&7 Plan becomes law, higher-yielding MBS will become lucrative to savvy middle-class investors.
I encourage the 2012 presidential candidates to consider adopting the 5&7 Plan. I could see Romney offering the 5&7 Plan as a way of “cleaning up Newt’s Fannie and Freddie mess.” Similarly I could see Gingrich pitching the 5&7 Plan as a way of “fixing the Democrat’s Fannie and Freddie problems.” Finally, I could see Obama selling the 5&7 Plan as “an innovative way to clean up America’s mortgage crisis”.
If the 5&7 Plan gets enough press, it will revitalize the mortgage debate. It will help turn the debate towards real solutions and away from political blame games. And, if passed, 5&7 will energize the mortgage and housing markets in explosive ways compared to the tepid response all the other failed legislation of the past 3 years. If you like the 5&7 Plan, share this link. If you don’t, please share why. I will publish all non-spam replies. Let’s get the 5&7 debate started!