As Washington searches for a way to spend the remaining $300 billion to $400 billion of TARP funds, policy-makers should consider an approach that directly empowers taxpayers to solve the mortgage crisis. It is commonly accepted that current programs are overly complex, unfair, and not reaching homeowners. The main goals of any new plan should be to simplify and broaden access to mortgage relief.

The source of the mortgage crisis is rapidly eroding home equity. As home values plummet, an increasing number of homeowners find themselves “under water” with decreasing incentives to re-build equity by staying current on their mortgages. There is a growing consensus, from the San Francisco Chronicle to the Wall Street Journal, that the government has thrown gasoline on the mortgage delinquency fire with its existing plans. Government “solutions” are creating a moral hazard, whereby delinquency is the only path to relief. As it becomes more “acceptable” for homeowners to treat delinquency as “opportunity,” irreparable damage will follow.

Rather than tempting borrowers not to pay their debts, the government should promptly give Main Street the ways and means to fix the problem. Friction caused by intermediaries such as government agencies, banks or mortgage servicers must be reduced. This can be done through a process already in place: individual income tax returns. Through what I call the Homeowner Assistance and Relief for Taxpayers plan, homeowners will be able to direct their income tax payments to pay down debt on their primary residence. The borrower would simply check a box on his federal income tax return and redirect his income tax payments from the federal government to his mortgage lender. The Treasury Department would make the payment on the borrower’s behalf. HART would be broadly used and would increase fairness since any taxpayer could reduce his mortgage debt, and, in most cases, the means (money) would already be available due to payroll withholding.

HART is not a tax cut. Income taxes would still be paid at their respective rates. It is simply a reallocation of already collected or owed funds. It would benefit homeowners across all income levels. That said, those who pay higher taxes will receive a higher benefit. However, so this is not viewed as a giveaway to the “rich,” the total individual benefit could be limited by annual and cumulative caps.

HART is not a free lunch. Its sole purpose is to pay down mortgage debt. Its proceeds can only be applied to currently outstanding mortgage debt. Nor is it a gimmick to stimulate consumer spending or uphold living standards.

Resolving the mortgage crisis will require a lot of economic pain. The residential mortgage market is more than $10 trillion, and potential losses are in the trillions. A loss of that size can only be absorbed on a socialized basis and can only be funded by issuing additional government debt. The costs will have to be repaid by this and future generations. By acknowledging this, we can at least focus on the cure, get the medicine directly to homeowners and prevent the situation from becoming worse.

What’s the cost?

So how much taxpayer medicine is required and how long will the treatment be? There are approximately 48 million owner-occupied residences that also have a mortgage. The average household income is approximately $58,000 and the average gross federal individual income tax payment is approximately $7,225 (excluding FICA). If we assume that every “average” taxpayer/homeowner uses HART, the cost in 2009 would be approximately $350 billion to $400 billion. How long HART remains in effect is related to how much of an impact each annual installment has. It is safe to assume that one year won’t solve the problem, but the benefit should be finite.

By directly addressing the mortgage crisis at its source, HART offers a potential cure to a complex array of problems:

Mortgage relief that benefits borrowers who are not delinquent will reduce the moral hazard of public assistance – the temptation to become delinquent – and reduce the absolute amount of distressed homeowners.

A fairer plan will broaden public support, which will facilitate the political process and expedite relief delivery.

Fewer delinquencies will increase the success rate and decrease the cost of other programs, such as FHA Secure and the FDIC’s “IndyMac” plan.

Individual mortgage principal payments will “trickle up” to financial institutions and provide the financial system with liquidity.

Asset securitization will remain a viable source of future liquidity if more homeowners and institutions abide by their financial contracts.

Finally, and perhaps most important, HART will emphasize the importance of individual and shared responsibility. It is difficult to accept that current prescriptions for relief will have lasting effect when the disease has been defined in terms of “victimization.” Instead of relying on a passive government solution, each homeowner in America will be directly and mutually responsible.

A more engaged citizenry creates greater institutional accountability, which, ultimately, is the best defense against this ever happening again.

Christopher Skardon works for Gorelick Brothers Capital, a Charlotte, N.C.-based investment firm. E-mail at [email protected]

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