Revitalize Mortage Market With Capital Gains Rate

As Congress begins hard work on our new president's Economic Recovery and Reinvestment Act, the challenges we face are immense and will require us to work together to shape, adopt and execute bold, sensible and creative solutions.

The credit markets and banks are at the heart of the current crisis. When they froze last fall, the negative effects quickly spread to every corner of our country. Credit lines were cut, consumer lending dried up and businesses stopped investing in new equipment and employees.

As investment retreated, manufacturing and construction orders went down, employees were laid off, consumer demand dropped and what started as a trickle of bad economic news turned into an avalanche with no visible end in sight.

The problems in the banking system are complex and not susceptible to quick and easy fixes.

In the run-up to the current crisis, banks and other financial institutions invested heavily and foolishly in mortgage and other asset-backed securities. When property owners are no longer able to make payments on their mortgages, these mortgage-backed securities become "troubled," "distressed" or "toxic" assets on the balance sheet of the financial institution. That, in turn, makes the banks unwilling to lend to consumers and businesses.

Last fall, Congress created a $700 billion Troubled Asset Relief Program (TARP) to prevent a full-scale collapse of the financial system. Initially, the Treasury Department intended to use TARP to buy these troubled assets from financial institutions, hoping that would free the banks to resume lending to businesses and consumers.

The pressure to act immediately and the difficulty of getting the program up and running quickly led Treasury instead to buy stock in the banks. While certainly well-intentioned, TARP hasn't done what we hoped it would do. Simply giving banks money, as the Treasury Department has done until now, has not removed the toxic assets or opened up the flow of credit.

As we enter a new stage in the effort to revive the economy, we must be open to new ideas. In that spirit, I want to suggest one change to the tax law that I believe will help breathe life into our credit markets by revitalizing the private market for mortgages and mortgage-backed securities:

The recovery of principal on deeply discounted, mortgage-backed securities should be taxed at the reduced long-term capital-gains tax rate rather than the higher ordinary income-tax rate.

Through this simple and straightforward change in the tax law, we could enhance the value and liquidity of mortgage-backed securities and breathe life into the secondary trading of these troubled assets.

My proposal would help banks unload their risky assets, improve their balance sheets and start lending again. It would help lift real estate values by freeing bank capital for new mortgage loans. It would unleash capital for consumer lending and help stimulate the real economy and save jobs.

Investors willing and able to take on significant investment risks would have an incentive to step in with the understanding that their return would be more substantial when the economy turns around because they would be paying lower capital gains taxes, not higher ordinary income taxes.

In the unlikely event this proposal does not succeed in stimulating demand for mortgage-backed securities, there will be no cost to the government.

I have written the economic leaders of the Obama administration and key congressional tax-writers encouraging them to include this tax proposal in the final economic stimulus bill. In order to create an extra incentive for investors to buy now, eligibility for the capital gains treatment could be limited to mortgage-backed securities purchased over the next 12 months.

Now more than ever, creative action is needed to address the problems plaguing our financial system. We owe it to future generations to look for innovative opportunities to lift the economy that do not add to the federal debt.

That is why I hope the new administration and my colleagues will embrace this carefully targeted tax incentive to encourage private investment in distressed assets, and help free the capital and credit that our economy desperately needs to grow again.