McCain's Mortgage Measure Misses Its Mark
Almost exactly three weeks after he pronounced the fundamentals of the American economy strong, Sen. John McCain now comes forward with his first proposal to address what he concedes is the nation's worst economic crisis of his lengthy lifetime. He rightly focuses on an economic demographic uniquely imperiled by the crisis: U.S. homeowners.
Mark Zandi of Moody's Economy.com estimates that one-sixth of all mortgage holders now owe more than their houses are worth. That's a looming catastrophe for them, their neighbors and communities, and the economy at large.
But McCain's proposal - the American Homeownership Resurgence Plan - is superfluous, rife with moral hazard, and unduly burdensome to taxpayers at any cost, let alone the $300 billion dollars in deficit spending that he estimates.
McCain proposes to grant the Treasury the authority to buy mortgages from delinquent or at-risk borrowers at face value, provide those borrowers with loan guarantees at affordable rates, and relieve lenders of these bad assets entirely. What's not to like?
Superfluous: In general terms, nothing. In fact, the same approach, designed by House Financial Services Committee Chair Barney Frank of Massachusetts, was enacted by Congress and signed by the president in July. That law, which incidentally provided $300 billion in loan guarantees, similarly enabled lenders and borrowers to renegotiate mortgages at mutually favorable terms. So McCain's proposal is, at best, superfluous, right?
At best. Frank's proposal involved loan guarantees, not outright purchases by the government, and certainly not at face value. As bad as things are, only a very small fraction of existing mortgages will go into foreclosure. Participating lenders would have to pay Treasury a premium to participate in the program. And any profits eventually realized by homeowners on resale would be repaid to the Treasury. For these reasons, the Congressional Budget Office estimates the cost of Frank's bill to taxpayers at $2.5 rather than $300 billion.
Morally Hazardous: Moral hazard arises when bad actors are bailed out of their mistakes at no expense to them, thereby rewarding their bad behavior. McCain's proposal takes pains to require borrowers to provide documentation of their income and assets at the time of purchase. But no equivalent requirement is imposed upon lenders, including predatory lenders, to show that they did not act recklessly or fraudulently when offering mortgages.
Burdensome to Taxpayers: I thought everyone learned the lesson last week when Congress shot down Treasury Secretary Paulson's audacious bid to bailout out Wall Street at taxpayers' expense. Once congressional negotiated taxpayer protections by granting them equity in any assets purchased by Treasury, and the rest of Congress had more than 24 hours to digest this new provision, the measure gained 113 converts in the House - over one in four members - in the space of four days. Most of these were Democrats who went along with the Senate's unpaid-for tax cut add-ons despite the $110 billion they added to the national debt.
McCain's proposal contains a nonsensical provision - setting the purchase price of the mortgages the government buys at face value - a mark-to-market pricing mechanism. Virtually none of the mortgages that the government would be allowed to buy under the program is worth face value, meaning that the government would be systematically overpaying for them. This might be acceptable if McCain provided for some kind of taxpayer protection mechanism. Alas, he doesn't. Because McCain does not say how he would pay for the program, that's $300 billion in deficit spending the taxpayer would be on the hook for - roughly $1,000 for every American citizen. That's more than they got earlier this year from the economic stimulus package, effectively vitiated by the McCain proposal.
It's good to see Sen. McCain trying to come to grips with the radioactive core of the nation's economic crisis and provide relief to the most vulnerable. But his idea sounds hastily drawn, redundant, unworkable, beneficial to miscreants and, in the end, punitive to taxpayers and a drag on our ailing economy.
Thanks, but no thanks.
Once Congress negotiated taxpayer protections by granting them equity in any assets purchased by Treasury, the measure gained 102 converts in the House . . . .
Bad history, no?
IIRC (fuggetaboutit; I ain't googling) "taxpayer protections" had been negotiated at the time the House rejected the bill.
It "gained 102 converts" after 1) it was loaded with pork and 2) the talking heads -- media, administration, and congressional -- had spread an adequate dose of panic among the American people.
October 9, 2008 7:41 PM | Reply | Permalink
So whatever the weaknesses of McCain's suggestion, it's not necessarily a completely stupid idea, and as you point out, he is grappling with the radioactive core of this crisis.
(It might also be said that rather than providing relief to the most needy the program would provide relief to the least greedy, i.e. homeowners rather than mortgage company executives.)
With repsect, there are a few practical inaccuracies in what you are saying, and a few ideas that have not yet been visited.
First is that the taxpayers already own a lot of these loans, they just don't control them. If any loan guaranteed by FNMA (or I assume Freddie Mac) goes bad, the bank's best bet by far is to force the property into foreclosure, hang onto it through the redemption period, then go to FNMA (meaning the taxpayers nowadays) and get the FULL amount of principal and interest. In return, the taxpayers get, via FNMA, a property that has probably sat empty, boarded and vandalized for some time. You say:
" That law, which incidentally provided $300 billion in loan guarantees, similarly enabled lenders and borrowers to renegotiate mortgages at mutually favorable terms. So McCain's proposal is, at best, superfluous, right?"
Maybe not so superfluous. Banks don't seem to be actually renegotiating these loans--the only company I know of that has renegotiated loans is Countrywide, and only because they lost a lawsuit. If you call a loan servicer, they will say that the Fed hasn't provided adequate guidance, and if you call FNMA they will tell you they "can't tell the servicers what to do," even though taxpayers are currently getting an absolutely terrible deal. As a taxpayer, you should be peeved about this.
What the govt ought to do is put together a program that leaves the bad loans in place (unfortunate but saves on the cost of rewriting them) and pays a chunk of interest and principal each month on behalf of the upside down homeowner. The program ends when the amount owed on the mortgage matches up to the value of the house, ie when the bubble mortgagers are on an equal footing with their peers. If housing prices come up a little in the hardest hit neighborhoods and stabilize in the least-impacted neighborhoods, the half trillion bucks will be well spent.
If they go into the worst neighborhoods first and manage the program well it could settle out the panic at a much lower cost that McCain is proposing.
October 10, 2008 12:04 AM | Reply | Permalink
I'd support forgiving the "excess" monthly interest paid by the government on behalf of the mortgagor but not granting a monthly principal reduction.
And too, I'd expect the mortgagor's reduced payment to be applied to interest, only.
October 10, 2008 3:18 AM | Reply | Permalink
The monthly principal reduction is what makes the program work, because it eventually puts that mortgage on the same level with the surrounding mortgages. Plus by paying down the mortgage faster, you reduce the total amount that the holders of the mortgage securities make off the deal. Not the best way to penalize the dorks who set this whole thing up but at least you're not paying them to rewrite the mortgage!
The focus of the plan is to help stabilize neighborhoods and housing values, and it forces all parties to work together to make it happen:
The homeowner gets to stay in the home, but even that is a challenge in some of these neighborhoods at this point. (I've played around with the idea of making homeowners do certain things like working on behalf of the neighborhood in order to qualify for the program, but maybe that would be too hard for people who are just struggling to stay afloat.)
The lender and the holders of the ultimate securities do get paid, but probably not as much as they had expected because the term of the mortgages is shortened. Bummer, guys. Maybe be a little less greedy next time.
Taxpayers get a housing market that functions again and a reduction in general panic.
I know it's not a fantastic plan in every way, but I haven't seen a better plan that goes straight to the housing crisis and doesn't cut off the nose of ordinary people to spite the face of ordinary people. I'm writing comment after comment on this subject in the hope that folks will come to share my opinion that mortgage workouts for our neighbors, while grating, are better than debt workouts for company executives.
I suspect that much of the effect of the interest-only ARM has been psychological. Five years into this mess, folks haven't paid anything off their principal and property values have dropped precipitously. People have been told that they made terrible decisions and bought worthless properties. I don't quite know how to describe this, but when I look at the housing situation, it seems to me that in some ways people have overreacted, become discouraged and that's why the housing market has ground to a halt. I haven't done a survey or anything, but I suspect that any plan that goes straight to the neighborhoods and gives people a little confidence in the value of their property will be a success.
It's just a matter of figuring out how to do it in a way that costs taxpayers the least.
October 10, 2008 11:33 AM | Reply | Permalink
Wait just a goldarn minute, now.
First, isn't your concern that failing to lower the principal balance will add to "the total amount that the holders of the mortgage securities make off the deal" misplaced? The holders -- as you've previously described them -- are the GSEs (the taxpayers), either directly or as insurers. The taxpayers aren't making money off the deal -- just trying to minimize their losses.
Second, there's no reason to reduce the principal balance until that becomes necessary to complete an arms-length sale. Reducing the balance allows subsequent appreciation to be captured by the mortgagor when, in my view, it fairly belongs to the taxpayers to the extent it makes them whole.
October 10, 2008 1:04 PM | Reply | Permalink
Good question.
I think the piece I'm not making clear is that the current scenario--Scenario 1, is that the banks own/control the mortgages until the foreclosure is completed and then (tah dah!) taxpayers are contractually obligated via FNMA to hand the bank the full value of the loan plus interest. (The bank gives this money to the ultimate holders of the securities. I don't know who they are but they are probably not your ordinary taxpayer.)
In return for forking over the full value of the loan, FNMA gets the de-valued house, which has quite possibly been badly maintained, vandalized and sat empty for some time. FNMA (taxpayers) are then stuck with trying to get some of their money back by selling the property for whatever they can get. In most cases FNMA (taxpayers) will be lucky to get half of what they forked over to the banks after the foreclosure.
We don't like scenario 1, which is the status quo. It's great for the banks, good for the people who bought those crazy mortgage securities, but not good for the homeowner, the neighborhood or the taxpayer.
Scenario 2 is the John McCain idea of buying up all the mortgages. In this scenario, taxpayers buy up a bunch of mortgages from the banks at full price (or at some percentage of the full price.) This will involve writing up a new mortgage for every one of these things, and you know the banks are going to charge the govt for every paperclip and moment of time. Then the govt (taxpayers) get to take on the job of figuring out what the homeowners can/will pay in return for the opportunity to stay in their home, and they write another agreement about that. In this scenario, yes, you are correct that the taxpayers would want to figure out how to get some of the upside, because it's a pretty hard swallow if the homeowner gets a cheap house AND the bank gets paid, all at taxpayer expense. Without the upside, the only advantage for taxpayers over scenario 1 is that people stay in their houses instead of moving into their cars. (Which is actually a big deal if you factor in the cost of dealing with the newly-poor.)
There is probably a scenario 2A in which the govt declares foreclosures illegal and forces the banks to write down mortgage principals, but they've already tried that and the banks aren't going for it. (Not surprisingly, the banks are holding out for scenario 1 .)
Scenario 3 is what I've started to call the Am-erica plan (sorry!). Govt leaves loan in place so doesn't have to come up with full retail (Scenario 1 and 2) or write a jillion new mortgages (Scenario 2). Govt/taxpayers figure out what homeowner can/will pay, and govt/taxpayers make up the difference each month until the value of their mortgage meets up with the value of surrounding properties.
Say you paid $200k for a house in 2004, even though its value in 1998-2000 would have been 135k. Today, similar houses in your hood are going for 65k if they sell at all. The program would help you make your payment (principal and interest) and in a few years when you owe 135k and surrounding home values have leveled out at 135k, you're on your own again. You can live in your house like you bought it yesterday, or sell it and come out clean, whatever. Your fellow taxpayers have done their part for you, and someday when they're in the lurch you sure as hell better do your part for them!
This scenario rewards homeowners for staying in the house but doesn't commit the taxpayers to helping them out indefinitely, just until the "bubble values" of the bad mortgages meet up with the current values of surrounding properties--in other words, until the market stabilizes. (I am assuming that home values in bubble neighborhoods aren't going to drop much more and I saw in my crystal ball that values will eventually settle out at what they were in 1998-2001.)
The Am-erica plan doesn't inordinately reward the banks for having royally jiggered us, but it doesn't penalize them either. The reasons I would like to see taxpayers throw in a chunk of principal every month are: 1) it will encourage people, they will see their principal dropping; I know that's incredibly soft but there you have it and 2) It will bug the banks/mortgage security holders to get paid early because they won't collect so much interest on each loan as they would have if the loan had been paid over the full 30 years. (Take that, Snidely Whiplash!)
So the Am-erica plan keeps people in their houses, stabilizes neighborhoods, doesn't involve a huge chunk of money immediately, and can be phased out as home values normalize. It's pretty good for homeowners but not free. They will have to do something to qualify and will need to pay taxes on the benefit. It's neutral or a little less than neutral for banks and ultimate security holders, and about as good a deal for taxpayers as we're going to get from this mess. Oh, an additional benefit for taxpayers is that we get to stop worrying that our street will be next to turn into foreclosureville, which is important.
Does that help? If not, I'm going to hand in the gold star I got for clear prose back in grade school.
October 11, 2008 2:37 AM | Reply | Permalink
"....until the "bubble values" of the bad mortgages meet up with the current values of surrounding properties"
Should probably say "until the bubble values" of the bad mortgages met up with the future values of the surrounding properties"
October 11, 2008 2:45 AM | Reply | Permalink
ps thanks ellen!
October 10, 2008 11:37 AM | Reply | Permalink
um...does brak obama have a better plan? i dont think so!
October 10, 2008 1:22 AM | Reply | Permalink
Yes, he does, and at least in part it goes like this:
"I get elected. Everyone breathes a sigh of relief upon learning that John McCain and Sarah Palin won't be running the country for the next four years, and the Dow goes up a thousand points."
October 10, 2008 2:35 AM | Reply | Permalink
Couldn't the reverse be true, those making over 250k take their money and run. Or do they invest and make more than enough to cover the taxes?
October 10, 2008 3:43 AM | Reply | Permalink
I don't follow the question. Could you explain?
October 10, 2008 11:38 AM | Reply | Permalink
To Erica, the only way the DOW can go up a thousand points, is that people will have to reenter the market.
If you were one of those making 250k, what will be the tax liability, as Baracks plan calls for taxing those with incomes above 250K?
So I was only responding to your comment basically saying, after Obama wins the election, the market goes up 1000 points.
I know that would be great, but even I, don't know, what to invest in, and I’M not so sure that I want to jump into the market just because Barack wins.
It’ll take time, to see how the market responds.
I suspect you were dreaming of a great scenario.
October 10, 2008 1:07 PM | Reply | Permalink
Er, no, actually I was trying to write a humorous reply to HotGuy's question about whether "brak obama" had a better plan. Although I do think that the knowledge that the current inmates are no longer running the asylum will have a calming effect on the markets.
October 11, 2008 1:25 AM | Reply | Permalink
Re: Couldn't the reverse be true, those making over 250k take their money and run.
And go where? Mars? Some 3rd world hellhole? The whole world is in crisis right now, and money is not entirely safe anywhere-- plus, even with Obama's suggested (and overall, rather minor) tax increases the US will still one of the most lightly taxed first world nations.
October 11, 2008 12:52 AM | Reply | Permalink
I guess that people making $250k a year or more could find a new place to live, with lower taxes, like the Bahamas. But the trouble with those places is that you have to spend a lot on razor wire, security systems and bulletproof glass to protect yourself from the people who make $250 a year or less.
Not to mention the cost of planting and maintaining the vines and shrubbery that hide all that razor wire.
Seriously, some might leave, but I think research has shown that higher taxes don't really drive many people out.
October 11, 2008 2:58 AM | Reply | Permalink
Maybe they'll move to Dubai?
October 11, 2008 3:44 AM | Reply | Permalink
Dubai. Well done.
October 11, 2008 6:11 PM | Reply | Permalink
The market is down, and until confidence is instilled, it will remain down.
You ask where will they go, probably not into the market.
How many people have to rely on the market going up, but they personally can’t get in because they have no real income to invest?
Haven’t the 401 K’s become vulnerable, because large investors have withdrawn. You want to tax those who have the income to risk. When they have to pay more in taxes, they have less to invest.
I guess they could be in Gold or in tax sheltered havens.
But to those who have the income, the market is not the only solution.
What irks me about the government and taxes is I go out and take the risk, if I fail what do I get? When I succeed I get taxed more.
When I evaluate my positions, I begin to question Why take the risk?
I’d much rather see a flat tax, and then the perception is one of fairness. Not a mob mentality that says get THAT ONE to pay.
As it would only be a perception, because the government takes the tax revenues collected, and redistributes it to help the less fortunate anyway.
Example each citizen pays the same premium, same tax rate, the difference is one gets back a greater benefit, proportion than the other.
So from the 250k earners point of view he receives less for his premium paid, but he also pays a higher premium
Another example: a worker gets 1.00 he pays his tax @ 25% his premium is .25
Another gets 100.00 his premium is 25.00 with the same flat rate the million dollar earner pays the same rate. But the 1.00 earner gets his premium back, in the form of Government services.
Discuss this and convince me why a flat rate is not fair. Really I’m humble enough to learn.
October 11, 2008 3:30 AM | Reply | Permalink
The monthly principal reduction is what makes the program work, because it eventually puts that mortgage on the same level with the surrounding mortgages. Plus by paying down the mortgage refinances faster, you reduce the total amount that the holders of the mortgage securities make off the deal. Not the best way to penalize the dorks who set this whole thing up but at least you're not paying them to rewrite the mortgage! God knows what will happen to the economic condition of certain classes of people. Anyone who has ever shopped for quotes on a mortgage to find out just how much it might cost has likely heard about mortgage points. Though the term might seem abstract, the concept is actually quite simple. Mortgage points are essentially fees that you pay on a mortgage loan when the loan is distributed. One point is equal to 1% of the mortgage value.Mortgage points describe certain charges to be paid in order to obtain a mortgage on a home.
December 24, 2008 1:24 AM | Reply | Permalink