John McCain's New Mortgage Plan Is Worse than I Had Imagined Possibly, Even Given What I Know About John McCain

Douglas Holtz-Eakin says, this morning:

[W]e would in fact be taking the negative equity position and putting it on the taxpayers books instead of putting it on the private lenders books or the homeowners books. We think the balance of risk has shifted to the point where this is the way to go...

What does this mean? It means that John McCain wants to give $100 billion of taxpayers' money to America's worst-behaving mortgage financiers.

Let's back up. For the past month the debate about how to deal with the collapse of the debt-trading portion of America's financial markets has been between two plans: the Paulson plan and the Elmendorf plan:

• The Paulson Plan: Have the government buy up distressed securities at market value, thus reducing the supply of high-yield debt securities that the private sector must hold. When you reduce the supply of anything you raise its price. Hence the Paulson plan's $700 billion purchases will push the prices of risky debt securities up, and so companies will then be able to sell their bonds again and so hire more workers, and depression will be averted.

• The Elmendorf Plan: Have the government directly invest in and take an equity stake in troubled banks, thus reassuring their depositors and creditors that they are sound. The banks will then be able to profit by buying up distressed securities--hence raising their prices--and by directly lending to companies that will then be able to hire more workers, and depression will be averted.

The argument for the Paulson plan was that the Elmendorf plan was socialism.

The argument for the Elmendorf plan was that it held the promise of doing a much better job of preventing depression, for each dollar committed to the Paulson plan reduces the gap between the demand and supply of distressed securities by only $1, while each dollar invested in a bank is then leveraged 8-to-1 as bank creditors and depositors are then willing to keep more money in the bank and so reduces the gap between the demand and supply of distressed securities by $8. Eight times as much bang for each federal buck, and the Elmendorf plan ensured that the taxpayers were protected to a greater extent: we did not just have the socialization of loss after the privatization of gain, we had the socialization of any gains that might occur if banks' equity values ever recovered.

The argument for passing Paulson-Dodd-Frank was:

• Time is of the essence: something needs to be done right now.
• Paulson-Dodd-Frank has sufficient flexibility that Assistant Secretary Neel Kashkari and his successors can do either Paulson or Elmendorf, at their judgment.
• The logic of the situation will over time drive Kashkari and his successors toward an Elmendorf-like solution as he deals in the markets.

Now comes John McCain with something worse than Paulson:

Ben Smith's Blog: Moral hazard: Moral hazard My colleague Victoria McGrane, late of our Capitol Hill bureau, emails with the most lucid explanation I've seen of what McCain did last night. The crucial shift from a recent congressional housing bill to McCain's more dramatic plan, she writes, was a move away from concern about moral hazard:

Details provided to reporters by senior adviser Doug Holtz-Eakin Wednesday morning make one thing clear: Taxpayers would directly pick up the tab for the difference in cost between a homeowner’s old, too-expensive mortgage and the cheaper one provided by the government... something that congressional lawmakers, led by House Financial Services Chairman Barney Frank (D-Mass.) specifically avoided when they crafted their own landmark housing bill, which passed in late August and took effect Oct. 1.

Congress’ bill – which Holtz-Eakin says provides at least part of the authority McCain would need to carry out his plan – provided a $300 billion program to help distressed borrowers refinance into cheaper Federal Housing Authority mortgages. But to participate, lenders and mortgage investors would have to reduce the mortgage principal...

Not so McCain's plan. McCain's plan is for the government to buy up $300 billion of distressed mortgages not at current market value but at full face value:

“Clearly we face the trade off that we would in fact be taking the negative equity position and putting it on the taxpayers books instead of putting it on the private lenders books or the homeowners books,” Holtz-Eakin told Politico. “We think the balance of risk has shifted to the point where this is the way to go.”

The McCain plan is:

• Take $300 billion.
• Pay double current market value to banks that have troubled mortgages on their books, thus:
  • Give a present of $100 billion to the bankers who made the loans.
  • Acquire and regularize the mortgages of only two-thirds as many homeowners as could have been accomplished if the $300 billion were invested wisely.

There's a big difference here: Democrats want to prevent depression and support the financial markets by investing taxpayer money in banks with troubled assets. Republicans want to give taxpayers money away to the shareholders and managers of banks with troubled assets.

I would say that this is unbelievable, but I do believe it.

Comments

[Ginger Yellow]

Holtz-Eakin's description may be the true one (it's the only way this makes sense as a financial rescue package rather than a homeowner bailout), but it flatly contradicts the description on McCain's website, which says "For those that cannot make payments, mortgages must be re-structured to put losses on the books and put homeowners in manageable mortgages. Lenders in these cases must recognize the loss that they’ve already suffered."

Now, given that the plan presented on McCain's website is utterly incoherent and probably illegal, I'm willing to give Holtz-Eakin the benefit of the doubt. But we have a right to know whether McCain's website or his economic adviser is lying.

[Richard Cownie]

There's something almost endearing about the cluelessness of kicking off your "spending freeze" with a $300B giveaway. I mean, endearing if you're confident he's going to lose; horribly scary if you're still worried that McCain might actually win.

[aimai]

Why wouldn't it be a better idea to simply force all the bad lenders to give the foreclosed homeowners title, free and clear? If they foreclose in a down market they can't sell the asset anyway. And the homeowner gets punished. Plus now the government is offering to bail everyone out. My plan simply says "hey, you can't foreclose *and* you don't have to walk away from your house." The lenders lose big, but they are losing big anyway and that'll larn 'em. But the homeowner wins big and can continue to be enslaved to the financial demands of home ownership which include property taxes and the cost of upkeep which keeps the lower level businesses like electricians, etc.. in business.

aimai

[Ed]

If the Government purchases the bad assets, this is an increase in demand for assets that will presumably increase asset prices. And, since the government will pay the banks for the assets, banks will be able to make more loans and buy more assets, if they desire. So, why is the ratio not closer to 8 to1 for this approach as well, instead of the 1 to 1 ratio stated by Brad DeLong?

[Don the libertarian Democrat]

It's Worse Than The Housing Bill Plan
The Curious Capitalist agrees with me about the McCain plan and gives more context:

"John McCain's announcement during the debate Tuesday night that he wants the government to spend $300 billion buying up mortgages and rewriting the terms was something of a landmark in the national discussion over what to do about our financial mess. Yeah, it was a half-baked proposal that made no acknowledgement of the fact that Barney Frank and Chris Dodd have already gotten a similar if far-less-bold and far less expensive plan enacted into law (without much help from either McCain or Obama, who missed both the April 10 the July 26 Senate votes on the bill). As the LA Times reports:...

According to the outline of McCain's newest proposal, the federal government would pay borrowers and lenders in full, regardless of how wise or fair the original transaction was. Lenders would be able to remove the bad mortgages from their balance sheets, and borrowers would be able to refinance into government-guaranteed loans. Mortgage holders would have to prove they lived in the home and had good credit at the time of the original loan. ...

By contrast, the housing bill passed by Congress over the summer, and which went into effect Oct. 1, required lenders to take a loss by writing down the principal on troubled mortgages to 85% of the house's current value. Borrowers with adequate incomes and credit records would then qualify for refinanced mortgages from new lenders.

Government funds were used only to help finance mortgage insurance for the new loans; cost estimate for taxpayers was roughly $20 billion."

This plan seems worse than the housing bill plan.

[dis]

the right word is not unbelievable, it's either insane or shameless or perhaps both shamelessly insane

[r€nato]

Why wouldn't it be a better idea to simply force all the bad lenders to give the foreclosed homeowners title, free and clear?

LOLZ! What about people like me who purchased responsibly with a boring ol' 30-year mortgage at a low rate? I'd like to have my mortgage paid off by Uncle Sugar too, and I am a LOT more deserving than someone who holds an exploding Option-ARM negative amortization loan on a screamingly overvalued asset!

Sorry aimai, I usually agree with you but not this time. Punishing the responsible and rewarding the irresponsible ain't gonna fly. I sure as shit would not support such a plan as you propose and there are a lot of others like me who would be mad as hell, as well.

[bakho]

Some estimates put the housing bubble (gap between peak bubble valuation and pre-bubble trend) at around $6 trillion. How does a paltry $300 Billion close a gap that may be $6 Trillion??

[elliottg]

Can you say gas tax holiday? This is bad economic policy that plays well as populism. Can the same set of economists who shot down the gas tax holiday by turning the media against it be mobilized to kill this? I hope so because the initial take of the stupid, undecided voters I heard being interviewed were very positive.

[Richard Cownie]

"If the Government purchases the bad assets, this is an increase in demand for assets that will presumably increase asset prices."

Question: if the government spend $100B buying dogshit, would that increase dogshit
demand from other investors ? How much ? Isn't dogshit still dogshit, even if some
fool is buying it for a short while ?

"And, since the government will pay the banks for the assets, banks will be able to make more loans and buy more assets, if they desire"

Think about a bank's balance sheet: it has the assets on the books at 50% of par. If
the government buys the "troubled assets" at market value of say 30%, then the bank
has to write off another 20% and its balance sheet gets worse; if the government buys
at 50%, the balance sheet stays the same; if it buys at 80%, then $1-00 of government
cash has boosted the balance sheet by $0-30. And if the government takes an equity
stake, then the bank's balance sheet gets the whole $1-00, which in turn makes it
more attractive for other investors to put in a few more dollars (like Buffett's
investment in Goldman Sachs).

Also take a look at the UK government's current bailout plan: they've taken equity
in the big banks, *and* as part of the deal the banks have to agree to keep making
credit available to businesses. Taking equity gives you power to make the bank act
in the national interest, which gives a further multiplier effect.

[aimai]

renato,
Yeah, I've got a regular mortgage too. But the question isn't whether "good people who were responsible" will be helped and "bad people will be punished." Its just which bad people and with what control over their assets will be helped. I prefer to see people who have only one home, who are trying to stay in it, put back on track and the banks that irresponsibly loaned money to them punished. Not because I think the homeowners are "nicer" thant he bankers, or more deserving, but because I think that bailing out the homeowner has a better chance on a return to me in terms of stability of the housing market and neighborhoods (over time) and return to me as a fellow taxpayer (since it maintains some of the tax base for our communities) and return to me as member of society since homeowners have an incentive to maintain their property while banks and lenders who are foreclosing have a very poor record of maintaining property.

I think there are a number of ways to bail out neighborhoods, or rather to stabilize neighborhoods, by keeping homeowners intheir homes. But I see no valid return to me in just giving money that was loaned under false pretenses to some homeowners back to the banks and fradulent loan guarantors etc... from my pocket as a taxpayer. I'm going to take the hit no matter what but I'd rather take the hit for somebodies aunt mildred down the street who took out a bad mortgage than for uncle bear stearns or saloman brothers or whoever we are talking about at the higher financial levels.

aimai

[Steve]

Some of the Senate Democrats, notably Dodd and Clinton, have been proposing doing more for home mortgages and folks who want to hold on to their house (singular). What of those proposals?

For some, the McCain proposal, at least as a generality, was a political issue insofar as it was NOT new, and was what Dems had proposed 2-3 weeks before; see:

http://tpmcafe.talkingpointsmemo.com/talk/2008/10/mccain-mortgage-plan-is-obamad.php

[J Thomas]

'Why wouldn't it be a better idea to simply force all the bad lenders to give the foreclosed homeowners title, free and clear?'

"What about people like me who purchased responsibly with a boring ol' 30-year mortgage at a low rate? I'd like to have my mortgage paid off by Uncle Sugar too, and I am a LOT more deserving than someone who holds an exploding Option-ARM negative amortization loan on a screamingly overvalued asset!"

I don't actually want to encourage this sort of thing, but here's a proposal to help you out:

First we give away all the foreclosed housing, and also the housing that's seriously troubled. (Because otherwise why should I keep paying my overpriced mortgage, just because I can?) Let anybody who wants to, give up his mortgage and get his house for free.

*BUT* once you have a free house, anybody who *didn't* give up their mortgage can trade houses with you if they want to. They keep paying the mortgage price they paid on their house, but they get *your* house instead. If two of them want the same house, give it to the one who's paying more. And if somebody with a valid mortgage wants the house you got swapped, they can have that one and you move into the third house instead.

So if you decide to throw away your mortgage and get a house for free, you do get a house for free. But the house you get will be one that *nobody in the country* who's still paying on an old mortgage wants more than they want their own house.

Would that soothe you? Do you lust after one of those overpriced McMansions? You could get a big share of the handout provided you're willing to move.

[Dan]

I'm a homeowner with a mortgage. If I believed McCain would win, then the logical thing for me to do is to stop making house payments now, so after McCain is in office, the government can pay off 1/3 of my loan, right?

A little more roundabout than an outright bribe...but yeah, maybe that IS change (and not the pocket kind) that I can believe in!

P.S. If you believe in moral hazard, that means you've been palling around with domestic terrorists. Or something.

[Bill]

If the McCain plan prevents losses by irresponsible lenders, that does seem like a new low in this policy debate. But I also don't like bailing out irresponsible borrowers, which is part of both McCain's plan and that of Paulson-Dodd-Frank. Foreclosures, while ugly in a lot of ways, are necessary to get housing prices back down to reasonable levels.

I've read that most foreclosures related to subprime loans have already occurred, and as a result many less-desireable areas have already seen house prices adjust back to more-reasonable levels (e.g., the Central Valley in California). Most of the Alt-A mortgages like teaser-rate ARMs for those with better credit have yet to reset to higher interest rates, which has perhaps delayed major price adjustments in pricier areas like Berkeley, where my family hopes to buy a house one day. According to Zillow.com, Berkeley prices averaged about $400K in 2000, got up as high as $800K, and are still above $750K. Meanwhile, the mutual fund where we kept much of our down-payment money for a future home purchase has lost 25% in recent months thanks to the mortgage crisis.

If we bail out people who never could have afforded their homes without crazy mortgages, won't we just stabilize home prices at artificially-inflated levels? That's great for those who made a stupid purchasing decision a few years ago, but quite bad for those of us who resisted buying in recent years, as well as young people who will want to buy in coming years. The latter groups will be stuck paying more to become homeowners while also paying higher taxes to support the bailout of those who foolishly purchased homes in the recent past (not to mention those who took home-equity lines of credit to buy new cars, vacations, etc).

[mary]

I'm so confused by all these plans. But here's a basic question. In a mortgage buying scenario (like McCain's or like Hillary's HOLC proposal) where the govt purchases the mortgage, the purchase price is paid to .... not the bank that made the original loan? Right? Because that bank long ago sold the note and related mortgage and those now reside with a trustee who holds them as collateral for a series of bonds. So the money goes where? To the bond trustee to be invested and held as collateral for the bonds? In which case if the purchase price is less than face value the original lender shouldn't be harmed at all because it is out of the picture. If anyone is harmed it would be the bondholders. And I'm not clear that they are hurt that much - depending on the aggregage value of the collateral pool securing their bonds. Is that right? I'm trying to get my head around how the concept of buying actual mortgages would work in practical terms.

[Peter Principle]

All I can say is thank God John McCain and his economic advisors have a plan to save us from the creeping socialism of Barak Obama and the Democrats -- by buying up every impaired mortgage in the country and forgiving the difference.

Now THAT'S free market capitalism we can believe in!

[Ken Houghton]

renato - What Dan Said. If McCain is elected in November, my bank has seen the final mortgage payment they're going to receive from me, because John W. McCain promises to Make Up the Difference.

Oh, you mean that's NOT what he means? But it's what he said...

[yoyo]

Ed:

8-1 is the leverage ratio (loans to capital). Brad points out that when you clear away bad MBS/loans, you're improving the denominator (loans), whereas when you recapitalize, you're improving the numerator.

The reason you can't apply 8-1 to McCain's "plan" is because this would not increase bank capital positions, but instead would simply erase (at face value) their outstanding loans. I.e., it improves the denominator, like the Paulson plan.

[Charles]

Brad, consider this: we want to (a) keep people in their homes, paying as much as they can on their mortgage, which will (b) support the underlying value of the paper that has been written on that mortgage. If everyone pays their mortgage, all the CDOs and CDO^2 and CDO^3 are worth full value; end of crisis.

The problem is mortgage resets (as well as unemployment and health crises) which make it impossible for homeowners to pay. It is possible for the Feds to pay for all or at least some fraction of the resets for the space of several years at a far lower cost than paying for either the full mortgage or for the derivative paper. After a few years, normal inflation reduces the burden of the mortgage payment.

My ideal solution is that the homeowner pays one-third of the reset, the Feds pay one-third, and one-third comes out of the hides of the investment banks.

McCain's proposal is a very expensive way of accomplishing this. However, it's better than the Paulson plan, because at least it is addressed to the underlying mortgages rather than the derivatives.

What do you say to that analysis?

[tegwar]

and if home values were to continue to fall? would they do further re-negotiations?

[Barkley Rosser]

I am not sure I agree with Charles's proposal, but I must say that I am not nearly as shocked or disgusted by this proposal as Brad or most of the other commenters here. There is the problem that it is unclear what it is (the disjuncture between the website and statements by Holtz-Eakin), and also the hypocrisy noted by many of calling for a spending freeze while pushing this spendthrift plan. But, I must agree with Charles that it actually looks better than some of the plans that are out there, at least the version that keeps people in their homes and is not just a giveaway to the "bad lenders."

[Not Really]

The existing bailout is $700 billion. As a reference, keep in mind the program where Los Angeles buys up old used cars that emit a lot of pollutants as part of their clean air program. Then note that $100 billion would pay for an order to GM for 2,857,000 Chevy Malibu Hybrids[1]. Think about that for a bit.

Not Really

[1] Or any combination of vehicles of equivalent interior volume and fuel economy built in the USofA regardless of manufacturer. And yes, I know that GM buys hybrid cores from Toyota; I also know that Toyota and GM pay each other patent licensing revenues on all hybrids.

[lboyd]

I have a question. I read somewhere that about 40 percent of these distressed ARMS were leant to people who could have gotten a fixed thirty year rate. They were essentially sold a loan on a nearly fraudulent basis, housing prices will rise, you can refinance, low monthly payments etc. So my question is for these people why not put them back into loans they can actually afford. The moral part of moral hazard assumes that knowledgeable parties entered into these agreements. If that isn't this case aren't we looking at something like we have currently, "immoral" hazard. While I agree that McCain's plan is absurd why not redo these mortgages. Everyone wins.

[D. Malcolm Carson]

McCain's plan is horrible, but really no worse than the bailout passed by Congress. At least in his plan, the homeowner gets something. In the Paulson-Dodd plan, the banks and investors who made/invested in the bad loans, get all of the money (with almost no loss to their own equity positions I might add), while the homeowners get nothing because in buying these "assets" the feds will not be in a position to actually work out better terms for the homeowners. The interests they will be buying are distinct from the servicer, who alone has the power to work with the homeowners.

Bankruptcy is the logical solution to all of this. The clause allowing the bankruptcy courts to alter the terms for homeowners should've been passed, and all of the Wall Street firms with these loans on their books should've been forced to come clean with their true financial position, and the insolvent ones forced into bankruptcy, where they could get their debts forgiven and get a fresh new start.

[Sarah Brand]

Trying to fix the economy but avoid "socialism" is like trying to do surgery with a ten-foot pole.

[Tom Heiden]

I am puzzled by those whose response to any plan that "rescues" individual homeowners (see above comment and responses about banks simply giving foreclosed homes back to customers) is "That's not fair to me, because I was responsbile and got a loan I can afford."
There is no "fair" solution here. Well, Bills of Attainder for the entire Bush Administration and most Wall Street corporate officers would be fair, but are illegal. About the only thing to be sure of is that since we find ourselves with NO good (read "fair" in this case) alternatives, we have made some extremely poor choices prior to the one facing us at the moment. "Duh", I realize, but...
The only real issue is who is going to be treated MOST unfairly.

[J Thomas]

D. Malcolm Carson, the impression I get is that these various financial institutions have very large amounts of debt that's woven into a complicated net, so that nobody knows who's solvent and who isn't. It's quite possible that the system as a whole is insolvent.

It appears the system was built with no thought to its members going bankrupt.

So now, say that corporation A has a lot of bad debts and is declared bankrupt. Then institutions B and C that A owes a lot of money to, now have bad debts from A and are declared bankrupt. Then institutions D, E, F, and G that have bad debts from A B and C are also bankrupt, and so institutions H, I, J, K, L, M, N, and O go bankrupt due to their bad debts from A B C D E F G.

And the more of your capital that's tied up in bankruptcy court, the less you have to work with. So there's a point to doing "speed bankruptcy". But if it's done sloppily then we get problems from that.

A complex interconnected world economy that does not work. Remember the time when one small electrical failure almost shut down electric power to the whole east coast? The electric grid was set up so if one section failed it could make everything else fail?

[Neal]

The politics of this proposal are good for McCain and hard to argue against in a season of high politics and in the face of hundreds of billions if not trillions committed to Wall Street firms. This proposal is easily explained and has an understandable outcome. One out of 6 mortgage holders are now underwater according to WSJ estimates.

Dangerous for Obama.

[Dan]

To clear something up: "moral hazard" has nothing to do with people having Morals. (Don't just trust me on this, ask Wikipedia.) It refers to the phenomenon of how insulating someone from risk may have the perverse effect of incentivising that risk.

So, an example...let's take a homeowner who purchased a $800,000 house in Irvine, CA, in 2006, using a stated-income alt-A loan (with a "teaser" rate) and a second mortgage...$0 downpayment. Let's also assume, in order to qualify for the loan amount, the purchaser misstated their income.

From the start, the homeowner couldn't really make the payments. But that's OK, because he took out Home Equity loans--$300k in total, justified because the appraised value of his home kept going up. That was enough money so that he could also lease BMWs for himself and his wife, go on nice vacations, and so on...and he wasn't concerned, because housing values only go up!

But now, housing prices drop, and lenders have decided that "stated income" loans are no longer a good idea. The value of his house is now $650,000...which means he owes $450,000 more than the house is worth. Now, he can't refinance (he'd have to pay the $450,000, plus 20% of the $650,000, to do so), he can't open up another home equity line, and he can't sell the house at a price that covers his debt...and into foreclosure he goes.

Let's review, though: on the plus side, for two years he got to live in a nice house, drive nice cars, go on nice vacations...at no cost to himself ($0 down, remember?). On the negative side, he now has to deal with the ignominy of being kicked out of his home, and his credit rating is trashed for seven years (but hey, no jail time!).

Now, the moral hazard of this story is...per McCain's plan (and some of the others suggested in the comments), this person gets to keep his house and credit rating. Quick quiz...does that ENCOURAGE or DISCOURAGE the behavior that caused the problem in the first place? And if it ENCOURAGES the risky behavior, shouldn't we actually expect the problem to get worse?

Yes, I understand that not everyone acted like this. But the point is--under McCain's plan, the people who did would be financially rewarded.

Also, if you're the type who believes the homeowners were the victims here, you can build the parallel scenario from the loan originator's or financial institution's point of view...and in all cases, simply paying off the delinquent loan results in those involved being financially rewarded for their behavior.

Finally, yes, the example here is a realistic one. There are blogs out there dedicated to documenting this very thing.

[Bill]

LBoyd writes "... 40 percent of these distressed ARMS were leant to people who could have gotten a fixed thirty year rate. They were essentially sold a loan on a nearly fraudulent basis ..."

Buyers were presumably told "you can pay $2400 a month for a fixed 30-year loan, or $1500 a month for an interest-only ARM that could reset in 3 years; but don't worry about the reset, since by then you'll have so much appreciation that you'll be able to refinance on even better terms." Yes, the promise of a "free" lunch surely fooled some buyers. But I trust most of these people knew the ARM involved real risks, but chose it anyway because they had a high rate of time-preference and liked having that extra $900 a month to spend on other stuff.

I'm a lefty, but can't find much sympathy for the these people. If we're going to spend a lot of money buying housing for people, I'd rather we build modest homes for poor people rather than subsidize suburbanites who gambled to get a plus-size house with a 3-car garage.

[joel hanes]

The only real issue is who is going to be treated MOST unfairly.

While I agree with everything else in Tom Helden's comment, I'd like to suggest that the only real issue should be :

Which of the alternatives produces the best outcome for the nation as a whole, regardless of its fairness to some individuals?

Any plan that works will be patently unfair to a whole bunch of people like renato. If we veto any plan that outrages their sense of virtuous fair play, we will do nothing.

It's roughly the same moral problem as welfare. The solution depends on convincing the responsible and the fortunate that their own outcome will be better if help is provided to persons that the responsible and fortunate believe to be undeserving.

[D. Malcolm Carson]

J. Thomas: The thing is, this structure was built with bankruptcy in mind. I'm a lawyer who's worked on financings, corporate formation, etc., and I guarantee you there are literally million of pages of documents covering all possible eventualities. The buyers of the various investment instruments in question are presumed to have done their "due diligence" and priced such eventualities into the expected rate of return on their investments.

Yes, there is the question of the domino effect and of the time it takes to work through a bankruptcy. But as you can see from what's happening now, the current situation where everyone just goes into their corner with every bit of cash they can get their hands on and waits is far worse. These things need to be unwound and everyone knows it. The longer we put it off, the worse the damage.

The bankruptcy can also be done quite quickly, if the government pushes it. WaMu and Wachovia were essentially forced into bankruptcy, but the buyers were found before they had to unwind stuff.

The WaMu and Wachovia examples indicate what I suspect to be the true reason why this is not being allowed: the bondholders, creditors, depositors, etc., of those institutions lost not one single penny. There has not even been an inconvenience of time or delay. I have an account at WaMu and the only thing different so far is that when I went into my local branch the other day, there were free cookies under a poster celebrating the marriage between JP Morgan and WaMu.

But there were some big losers in that case: Upper management and the shareholders. Upper management was fired, and the shareholders received a small amount for their shares. These bailouts are being brought about because upper management and large shareholders have the power to get the government to prevent them from suffering the losses that they otherwise would have to in a bankruptcy. There's no policy behind it, it's just people with power using it for their own benefit.

[Bill]

Joel says this is roughly the same moral problem as welfare, and I'm certainly no enemy of the public safety net. But I support welfare programs because they target their assistance to poor people. These homeowner bailouts have no such targeting. Homeowners are, on average, better off financially than those who rent.

While some people who are underwater with their home loan are living in poor areas, the publicly-subsidized benefits will flow equally to people who bought more McMansion than they could afford or cashed out too much equity for fancy toys. Many of the latter people can do fine without the aid, and as Dan writes, they may not be much worse off after foreclosure than they would be if they never bought.

If we are going to bail out people who might lose their homes, I would hope the program could be targeted toward those how most need it.

[ArtL]

At the Post, economics columnist Steven Pearlstein observed that McCain's proposal was just an "expansion" of the previous Congressional bill on helping homeowners avoid foreclosure. Did he miss the point, or is he accurate in describing it this way as a part of a critique of both candidates proposals as not addressing the current crisis:

"The only departure from the standard script last night came from McCain, who said he'd direct the Treasury Department to buy up troubled mortgages and refinance them with new loans reflecting the diminished value of houses and the ability of homeowners to make their monthly payments. A McCain campaign spokesman said the program, which could cost up to $300 billion, should be financed with the $700 billion economic bailout plan passed by Congress last week.

"McCain's plan appeared to be an expansion of a proposal he made earlier in the year, based on similar legislation crafted by House and Senate Democrats. Despite the initial opposition of the White House, that legislation was passed by Congress and signed by the president.
McCain acknowledged that such an open-ended program would be expensive, but he argued that no economic recovery could begin until home prices are stabilized, and that was the quickest way to do it...

"Obama's campaign labeled the mortgage idea "old news," noting that a similar program is already part of the economic rescue package and that Obama supports it."

But your argument is that McCain's proposal is fundamentally different from the previous $300 billion legislation, and would enrich bad lenders and loot taxpayers, correct?

Why isn't that clearer and more widely known to other economic experts and political commentators? Are they missing something important?

[Maynard Handley]

Surely, AT THE VERY LEAST, if we are going to giving houses away, we, the US taxpayer, ought to get some stake in that house? WTF give the house away? Let the US govt take ownership and provide refinancing (but not debt forgiveness).
Refinancing might take many forms, but how exactly is giving away houses to (some small fraction of) the middle class going to improve the existing situation? Not only, as has been pointed out, will it lead to perverse incentives, I suspect it will lead to a heck of a lot worse. How long do you think it's going to be before Americans who paid for their houses, and who now have to pay through their taxes for someone else's free house, decide, WTF, you know, I'm going to burn that asshole's house down?

[Michael S. Schreiber]

Sen. McCain proposed that the treasury purchase $300 billion of bad loans from the failing banks and investment companies that hold them, and then renegotiate those bad loans with the individual homeowners.

Sen. McCain has called for an across-the-board spending freeze. What currently non-existent government agency is going to do the job of actually renegotiating these millions of bad mortgage loans? What rules are they going to apply to the job?

Sen. McCain (unlike Obama) has consistently opposed chapter 13 bankruptcy relief for homeowners. However, a change in one sentence of chapter 13 (the section 1322(b) homeowner exclusion) would manage the renegotiations suggested by McCain without the need for a new federal bureaucracy. the Bankruptcy Courts are already there and already paid for, they have the knowledge and experience, the rules are already in place, and they are ready to go tomorrow, not six months to a year after a new set of regulations are proposed.

I don't believe that buying up $300 billion in bad debt at face value is a good idea for all of the reasons already cited.

But if Senator McCain supports real relief for homeowners, all he has to do is support the bankruptcy amendment proposed by Sen. Durbin and Rep. Frank and supported by Sen. Obama.

[lboyd]

Bill wrote:
"But I trust most of these people knew the ARM involved real risks, but chose it anyway because they had a high rate of time-preference and liked having that extra $900 a month to spend on other stuff."
And Dan writes: (After using an extreme example of irresponsible borrowing)
"Yes, I understand that not everyone acted like this. But the point is--under McCain's plan, the people who did would be financially rewarded."

These are assumptions about behavior, rather than looking at actual behavior. If people truly understood the risk, and theory tells us that people are risk averse, then why in the world would we see such a mass phenomena. The very fact that people were acting so far out of the behavioral norm would suggest that something systemic was going on.

The point is that if "moral" hazard means "insulating people from risk" and thereby "incentivising that risk." Then wouldn't "immoral" hazard be unnecessarilly, or fraudulently, exposing some people to risk and thereby "incentivising that risk" to the system as a whole, thereby greatly increasing systemic risk, and even destroying the financial system. That we had a system of borrowing, purposely set up that allowed these loans to occur without even the simple warning you see when investing in a mutual fund, "past performance does not indicate future returns," means that "Immoral" hazard would be a fairly precise antonym of moral hazard. People were "sold" these loans with little or no detailed explanation of the risk. And even if that was required the explanation would have been deficient because the ARMs were based on some future LIBOR rate which would have been impossible to predict, other than to say it will fluctuate. We have set up an "immoral" and hazardous situation in both the technical and colloquial definition of the term. Correcting the situation by redoing the mortgages would reduce the risk to the system by reducing the risky loans in the system and given that we would regulate the system would hardly "incentivize" risky behavior. The actual roblem with the McCain plan is that it does not correct this "immorality" but simply keeps price of these worthless assetts high, thereby creating further "systemic" risk.
Cheers

[lboyd]

Bill wrote:
"But I trust most of these people knew the ARM involved real risks, but chose it anyway because they had a high rate of time-preference and liked having that extra $900 a month to spend on other stuff."
And Dan writes: (After using an extreme example of irresponsible borrowing)
"Yes, I understand that not everyone acted like this. But the point is--under McCain's plan, the people who did would be financially rewarded."

These are assumptions about behavior, rather than looking at actual behavior. If people truly understood the risk, and theory tells us that people are risk averse, then why in the world would we see such a mass phenomena. The very fact that people were acting so far out of the behavioral norm would suggest that something systemic was going on.

The point is that if "moral" hazard means "insulating people from risk" and thereby "incentivising that risk." Then wouldn't "immoral" hazard be unnecessarilly, or fraudulently, exposing some people to risk and thereby "incentivising that risk" to the system as a whole, thereby greatly increasing systemic risk, and even destroying the financial system. That we had a system of borrowing, purposely set up that allowed these loans to occur without even the simple warning you see when investing in a mutual fund, "past performance does not indicate future returns," means that "Immoral" hazard would be a fairly precise antonym of moral hazard. People were "sold" these loans with little or no detailed explanation of the risk. And even if that was required the explanation would have been deficient because the ARMs were based on some future LIBOR rate which would have been impossible to predict, other than to say it will fluctuate. We have set up an "immoral" and hazardous situation in both the technical and colloquial definition of the term. Correcting the situation by redoing the mortgages would reduce the risk to the system by reducing the risky loans in the system and given that we would regulate the system would hardly "incentivize" risky behavior. The actual roblem with the McCain plan is that it does not correct this "immorality" but simply keeps price of these worthless assetts high, thereby creating further "systemic" risk.
Cheers

[Cranky Observer]

> To clear something up: "moral hazard" has nothing to
> do with people having Morals. (

I am sorry, but if this is so then why is the word "moral" in there? In fact every discussion of "moral hazard" in the public discourse (which admittedly only occurs in the WSJ, Economist, and forums with similar outlook) has an undertone of "the underclasses who succumb to this behaviour are immoral and weak".

To me this is similar to the way the overloading and debasement of the word "risk" from about 1995 on has contributed to our current situation. Words have meanings, and those meanings come to be generally accepted in both public discourse and our collective subconsciouses. When people with agendas start overloading those words and subtly shifting their meaning they are usually trying to hide something. When they succeed, as they did with the word "risk", bad consequences generally follow.

Cranky

[ami f]

Aimai -

I think we can point fingers all around, but it is important for us to look in the mirror. Yes, the greedy bankers and mortgage brokers are guilty, and I think they should all be investigated on an individual basis and arrested for any illegal activity such as falsifying credit reports, W2's, etc. Yes, the politicians are greedy, and we need some big changes in Washington. But most importantly, we as a society and as individuals are the most guilty. This all happened under our watch, and we are the ones who signed the mortgages on homes we couldn't afford.

It sounds harsh, but I think we all need to learn an important lesson about morals and ethics, and most importantly, PERSONAL RESPONSIBILITY. I don't care if you bought your second home, you bought a home in an economically challenged area with no credit or good income, or you signed a variable interest rate or interest only loan, they were bad choices, and we must pay the consequences.

The AIG party where they spent over $440,000 has shown that even when we get in trouble, if we get an easy bail out, we have learned nothing, and continue to piss money away and live on debt and credit. I know it sounds harsh and darwinian, but our society has to stop encouraging irresponsible and reckless behavior and choices from the top to the bottom, equal for everyone.

Maybe if people lose their homes they will learn an important lesson. If you don't know about mortgages, finance and investing, educate yourself. There is tons of free information online, in books and journals. There is no excuse for stupidity. Harsh, maybe.

A girlfriend of mine bought a home in November 06, here in NY, RIGHT before the market crashed. They could not afford the home in the first place (they are a married couple in their late 20's purchasing a home for $580,000), and their combined income in NY is barely over $110,000/yr. Not only that, but they put very little down, and got an interest only loan for the first year. They actually have two separate mortgages on their home. We all warned them, and they HAD to have their house, and of course, real estate is such a great investment (ONLY if you can afford it and then some, and it's only a true investment if it is a rental bringing in income). Now they can barely pay their mortgage, and they are struggling, but I do not feel bad for them, nor do I feel that I should have to bail them out.

We shouldn't reward stupidity, recklessness, irresponsibility or greed, but if we go and just buy up bad mortgages, or just do a flat bail-out of the banks, that is exactly the message we are sending and exactly what we will be doing. This WILL happen again if we do not look in the mirror and change our values. Put down the celebrity magazines, stop trying to buy the big house and fancy car you cannot afford, and stop buying overpriced designer clothing so that you can feel trendy and popular. This problem is pervasive within ALL levels of our society, from greedy big business to unethical bankers to greedy government to irresponsible, money-hungry Americans who have become lazy and live beyond their means.

No, I am not bashing the average hard-working American, but I feel that those of us who are responsible, hard-working, good people have been screwed over by the rest of this gluttonous country, and it is a shame. The American dream became the assumed right of too many. If we do not wake up, it may be too late. Rome fell, and so shall we.

[Nicole]

I wonder if they even understand moral hazard. So much could be fixed if politicians just had to take (and pass) an undergraduate level public finance course. McCain's health care plan shows an ignorance of adverse selection as well... is the next big idea going to show a lack of understanding of externalities or public goods? Public policy doesn't have a whole lot of easy solutions, but it really doesn't have to offer stupid ones.

[Bill]

LBoyd says "If people truly understood the risk, and theory tells us that people are risk averse, then why in the world would we see such a mass phenomena. The very fact that people were acting so far out of the behavioral norm would suggest that something systemic was going on."

I totally disagree. Most people are somewhat risk averse, but that doesn't keep us from investing in stocks. If potential homebuyers thought that they would probably profit quite a bit on their house, but that there was say a 10% chance that they'd lose their down payment, it might look like a better bet than the stock market.

Like I mentioned in an earlier comment, in the last month my wife and I lost >20% of the mutual fund dollars that we've been saving for the down payment on an eventual house purchase. I now feel stupid for having put so much of our savings in a risky stock market. Yet nobody had to trick me into taking this risk -- I just gambled and lost. And I certainly don't feel that anybody owes me assistance in rebuilding a down payment so that I can become a homeowner sooner.

[joel hanes]

Maybe if people lose their homes they will learn an important lesson.

If a lot of people lose their homes, we will all learn an important lesson about the interconnectedness of things.

An economic contraction like that of the 1930s will deeply wound even the prudent, responsible, and fortunate. Be careful what you wish for.

[Dan]

Cranky,

I agree that the term "moral hazard" creates confusion; that's actually why I wrote that comment. It's financial jargon that refers to a specific phenomenon, and in that context the meaning is quite different than the common understanding of the words. If you want to try to convince the finance world to use different jargon, that's fine by me--but it's the phenomenon, not the terminology, that economists are concerned about.

lboyd,

Three things: first, like Cranky, I think you're mistakenly getting hung up on the jargon.

Second, the example you give (of bad behavior on the lender's part) is also an example of moral hazard, and is just as valid as the one I gave. To slightly rephrase your example: consider a mortgage broker, who's compensation is based on the value of the loan he sells. Assume, in his portfolio, he has "stated income" alt-A loans that offer a neg-am teaser rate. After the loan is closed, it's packaged in a CDO, and sold off to an investor...at which point, all risk of loss is transferred to the investor.

So then: the broker makes more money if he originates a larger loan. For the same monthly payment, the "stated income" alt-A loan with a teaser rate can pay for a more expensive house. Since the loan is "stated income", it really doesn't matter to the broker if the homebuyer can actually afford the loan; there will be no audit.

So there you have your moral hazard: the broker has a financial incentive to get the homebuyer to pay more for a larger house, and use an alt-A loan...and there's no risk to him; that's all transferred to the CDO investor.

In fact, you could even make the argument that the introduction of the alt-A loan--and the moral hazards it introduced (both for the homebuyer and the broker)--is in large part responsible for causing the housing bubble. Because if you look at the data, it's not like people's incomes doubled in the past 5 years...so why did home prices?

Third, the example that I used is less "extreme" than you suspect. I was trying to avoid this (as it's bad form to pimp someone else's blog in comments), but go find the Irvine Housing Blog. The author has literally profiled hundreds of cases like the one I used...just in Irvine, CA.

Nicole,

I totally, completely agree. :)

[Cranky Observer]

> It's financial jargon that refers to a specific phenomenon,
> and in that context the meaning is quite different than the
> common understanding of the words. If you want to try to
> convince the finance world to use different jargon, that's
> fine by me--but it's the phenomenon, not the terminology,
> that economists are concerned about.

I am well aware of financial jargon, having been exposed to it in two different graduate programs. Your clarification goes against how this term is used in public discourse by the same people who also use the financial jargon, and is very similar to similar discussions about "risk" in the same channels (and here) in the 2002-2006 time frame. Of course what happened in that case is that the various technical overloadings of the word "risk" suddenly converged on the colloquial meaning with disastrous results.

And I really am not in the mood for more moralistic simpering from the self-proclaimed "lions" of Wall Street who see "hazard" in every progressive policy proposal but no hazard at all in $40 million termination bonuses.

Cranky

[Jonni Good]

Why not just stick with the idea of changing the bankruptcy laws and allow bankruptcy judges to lower the principal owed on a mortgage? No additional government agency, no taxpayer's dollars given to unscrupulous lenders, and no additional national debt. If keeping people in houses they can't afford is so important to the national interest (and I'm not convinced that's true), then why not do it the easy way?

Lenders know, with a reasonable certainty, if a borrower can repay the loan or not. If they chose to loan money to people who couldn't pay it back, thereby destroying the companies they work for along with the US and global economy, they should expect to suffer the consequences for their actions. A candidate who suggests that we hand these crooks some unearned money from the US treasury (and without raising taxes, thereby passing the bill to our grandchildren) will not get a vote from me.

[Jonni Good]

Why not just stick with the idea of changing the bankruptcy laws and allow bankruptcy judges to lower the principal owed on a mortgage? No additional government agency, no taxpayer's dollars given to unscrupulous lenders, and no additional national debt. If keeping people in houses they can't afford is so important to the national interest (and I'm not convinced that's true), then why not do it the easy way?

Lenders know, with a reasonable certainty, if a borrower can repay the loan or not. If they chose to loan money to people who couldn't pay it back, thereby destroying the companies they work for along with the US and global economy, they should expect to suffer the consequences for their actions. A candidate who suggests that we hand these crooks some unearned money from the US treasury (and without raising taxes, thereby passing the bill to our grandchildren) will not get a vote from me.

[Bill]

Joel writes: "Maybe if people lose their homes they will learn an important lesson. If a lot of people lose their homes, we will all learn an important lesson about the interconnectedness of things."

While I don't want to bail out people who made bad bets, I'm very aware of the risks of depression. I totally support the idea that we have to inject capital into the banking system to keep it from freezing up. (Hopefully the TARP will be used in a way that actually does this!)

I don't like having to pay to save banks that took dumb risks, but I understand that bank failures have huge negative externalities on all borrowers and thus merit saving. It's like if one neighbor ignites his house by being very careless with fire, but it's a windy day and the other houses are susceptible to fire, then it's in everyone's interest to fight the fire at the careless person's house.

I know that foreclosures temporarily hurt the value of neighboring homes, and this argues for some action. But policies that aim to maitain bubble-level home prices hurt everyone who doesn't yet have a home, and this too needs to be considered in choosing public policy.

[Pilgrim]

It's important to realize how cynical McCain was in proposing this plan. It panders to homeowners, but - as he knows - the chances of his proposal being supported by his own party make a snowball's chance in he11 look like great odds.

[dmh00000]

The following has been sent virtually every member of the Senate banking committee. At least 100 times this email was sent as early March 2008. (Obviously, John McCain never read it):

For those of us who played by the conventional rules for buying a home – saved money for the appropriate down payment and borrowed an amount that did not exceed our salaries’ ability to service – we look at the current housing crisis and wonder how foolish we were as lax lending standards permitted unqualified borrowers to ultimately devalue our primary asset and as irresponsible lending practices by regulators and bankers fueled the bubble without regard to the disaster they were creating.

Right now politicians are sitting around either talking about ways to save the irresponsible borrowers or devising plans to bail out the banks that recklessly inflated this bubble.

Our politicians are pandering to the foolhardy and mindless instead of searching for solutions that seek the following outcomes: preserve the home values of responsible investors (by far the vast majority of homeowners in this country), recover tax dollars from those responsible for the inevitable bailout currently underway and construct the right regulatory framework so that future profligacy will be avoided.

Painful as it is to say, to protect responsible borrowers’ primary asset, politicians must bail out reckless borrowers. In the absence of this assistance the responsible parties will continue to suffer as their property values unjustly fall as the supply of homes from defaulting sub-prime borrowers floods the market.

Politicians must collect taxes from the irresponsible parties. To do that they need to design a special federal real estate tax (SFRET) whereby “qualified” sub-prime borrowers (i.e., those who can continue paying their mortgages at their current rates) will be permitted to keep their homes and maintain their mortgage payments but accumulate tax liability payable within 20 years or when the property is sold or transferred, for example, to family members. The SFRET payable will be a percentage of the borrowed funds and will grow each year but be capped at 50% of the funds borrowed and be payable within 20 years. (After 20 years SFRET homeowners can still own their SFRET properties but will have to refinance and pay taxes due.) The longer those SFRET home owners hold their homes the greater the percentage they will pay. Thus there is an incentive for SFRET homeowners to get their financial house in order quickly, sell their SFRET properties and purchase properties unfettered by SFRET tax liabilities.

(In the immediate term the SFRET solution will stifle the over-supply of homes on the market -- because SFRET owners will keep their homes instead of defaulting on their mortgage obligations -- which will restrain further downward pricing pressure on home values. SFRET property owners will have to wait till their properties appreciate enough to repay their loans and pay their SFRET taxes. In the intermediate term as home values start to move up in value SFRET property owners will undoubtedly try to sell their properties tempering another potential real estate bubble from developing. In the long run when property values have appreciated to the point where SFRET properties can be sold and SFRET taxes repaid in full without any risk to the financial system, property values will reflect the current demand and supply conditions for real estate.)

The treasury coincident with the introduction of the SFRET program should float SFRET bonds based on the present value of future SFRET receipts. Wall Street firms who helped fuel this bubble and who are now enjoying the current Federal Reserve bail out should be obligated to purchase these bonds which will carry an interest rate 100 basis below current treasury bond rates.

As with any program that holds accountable the responsible parties, borrowers who are right now counting the days, weeks, and months before they face their inevitable default and bankruptcy will still find this SFRET program unfair even though it bails them out of bankruptcy, permits them to retain their homes and gives them the opportunity to enjoy the appreciation of their home in the long run. Essentially, those that find the SFRET unfair are looking for a free-ride – a bailout without consequences. Those that find the SFRET solution unfair have two choices, declare bankruptcy or sell their homes quickly to get out from their growing SFRET liability.

[Bill]

Pilgrim says McCain is cynical, but maybe he's just being Mavericky. So much so that he's proposed something that Senator McCain wouldn't have had a snowball's chance of supporting back before he became candidate McCain!

[David desJardins]

As I understand the McCain proposal (at least, this is my optimistic interpretation), the government would buy underwater mortgages at market value (which reflects a statistical possibility, but not certainty, of default), and then would restructure those loans further to reduce the likelihood of default.

[That would make sense. But unfortunately making sense does not appear to be an attribute of the McCain campaign...]

This means that the government would take a loss also (because restructuring the loans reduces their market value; if that weren't true the banks would already have done it), but the benefit is going to the homeowners, not to the bankers.

[dmh00000]

The McCain plan would result in one of the greatest redistributions of wealth in our history.

Here's why:

Let's say in 2005 I paid $500k for a house, putting down $100k and financing $400k with a 30yr fixed mortgage at 5.5% and on the same day my (new)next door neighbor bought the identical house for $500k putting 0% down, financing $500k with a 3% teaser loan that resets in 2008. In 2008 (the year my neighbor's teaser loan will reset at the LIBOR +5%) our homes are worth $425k. There's no impact on me because I have a 30 yr fixed mortgage. My neighbor, on the other hand, has a problem. He can't afford to pay LIBOR + 5% and he can't afford to refinance elsewhere because either other lenders would require some type of downpayment which my neighbor can't afford (hence the reason for no downpayment in the first place), would not agree to finance a $500k loan at the teaser rates b/c (a) the home is only worth $425k now, (b) the Loan to Value (LTV) would be greater than 100%, and (c) my neighbor's credit score is no where near high enough to qualify for that kind of loan.

John McCain, my friends, would allow my neighbor to refinance with a new $425k loan (my neighbor's new cost basis for his house) wiping out $75k of debt he originally took on. Stupidly, on the other hand, because I bought a home with a downpayment and can continue to make payments on the $400k I financed, no one is eliminating any of my debt obligation. But why isn't the government giving me $75k(the responsible guy in the story who took out a loan I could service with a downpayment that kept equity in my house even when the market declined)?

What's the moral (hazard) of the story? Live way above your means and the responsible guy next door will bail you out by paying more taxes.

So what happens down the road? In 10 years my neighbor and I both go to sell the house that originally cost us $500k. But because the house lost value and the goverment bailed him out in 2008, the house really only cost my next door neighbor $425k. We each sell our houses for $700k. I make $200k in capital appreciation and he makes $275k.

That's a pretty good deal for him since he put nothing down, got a bailout and had the goverment reduce his cost basis.

How is it possible that we're actually going to reward my next door neighbor? How is possible that my next door neighbor makes more on the sale of his house than I do?

It happens because John McCain has redistributed wealth. Thank you John.

[CommonSense]

If this were such a good idea, McCain should have mentioned it when he "rushed" to Washington 2 wks. & $700B ago!!

[JS]

Quote:

"Right now politicians are sitting around either talking about ways to save the irresponsible borrowers or devising plans to bail out the banks that recklessly inflated this bubble.

Our politicians are pandering to the foolhardy and mindless instead of searching for solutions that seek the following outcomes: preserve the home values of responsible investors...

Painful as it is to say, to protect responsible borrowers’ primary asset, politicians must bail out reckless borrowers. In the absence of this assistance the responsible parties will continue to suffer as their property values unjustly fall as the supply of homes from defaulting sub-prime borrowers floods the market."

I'm sorry, no.
The only "responsible" parties in this kind of bubble are the parties who refrained from buying the overpriced assets, i.e. those of us who remained renters.

Anyone who purchased a home at these insane prices was simply another contributor to the bubble. People love to pat themselves on the back and declare themselves responsible, but if you want to consider your house an investment (and not a place where you live), then you have to accept the fact that you bought a grossly overvalued asset, and now you have lost the money you put into that investment. That is not the fault or responsibility of lenders or subprime borrowers or people who are currently defaulting; it is simply your own fault, because you bought into a bubble. And the government is not obliged to step in and protect your bad investment decision.

If you want the government to shore up your home values, the best you can hope is for it to last until you find a Bigger Sucker (tm), and good luck to you. This financial mess will not be solved until home values return to normal, whether we take the long or the short road; that will require that a lot of people will see a lot of equity go up in smoke, but the least they could do is not protest about how responsible they were to have paid so much for a bad asset to begin with.

Those who couldn't afford the bad investments they made will be forced into foreclosure. Short of instituting debtor's prison (and wouldn't that do lovely things to the labor market), there's nothing that can be done to get those loans paid off. "Responsible" house investors have the same option as anybody else -- walk away from the house, give up whatever equity you have, and there's the limit on your exposure. I doubt you'll take me up on it, but there you go.

But to worry about somebody else getting a free ride, well -- you still have your house, you just overpaid, and that's the real reason for your loss. By buying into that bubble market, you gave up a claim to be acting responsibly, so let's have no more whining.

Now, if you want to swear off the view that a house is an investment, and instead think of it as a home that children shouldn't be driven out of, or worry about where all these foreclosed folks are going to be living over the next couple years, etc., then we can talk about any theoretical bailout of homeowners from a productive perspective.

[schadenfreude]

Poor poor responsible borrowers. You have it so hard with your good credit, house and 30 year fixed. I look forward to purchasing the foreclosure down the street for about 80% of what your house is valued at.
Did I mention it is a nicer home and has a larger yard?

[Steve]

Some mortgage lenders are already doing this (e.g., Countrywide)-- renegotiating loan amounts and terms for troubled mortgages. It's a win-win, since the homeowner keeps the home and the lender gets more than they'd get if they foreclosed and sold the house. Why get the government into that? To me, this proposal came across as a desperation play decided on at the last minute that went against McCain's other strategies (balanced budgets, earmarks, wasteful spending). Maverick, I'm coming to appreciate, simply means impulsive.

[Bowl 300]

I am sick of the same old bullcrap. Who is telling the truth in this campaign. I sure do not know. God help us if we elect who we think is right and it turns out wrong. CANDIDATES STAND UP AND START TALKING TO US STRAIGHT ALL THIS NONSENSE OF ATTACKING EACH OTHER TELL US WHAT YOU ARE GOING TO DO TO MAKE THIS COUNTRY BETTER AND HELP THE LITTLE GUY LIKE ME.

[J Thomas]

The thing is, this structure was built with bankruptcy in mind. I'm a lawyer who's worked on financings, corporate formation, etc., and I guarantee you there are literally million of pages of documents covering all possible eventualities. The buyers of the various investment instruments in question are presumed to have done their "due diligence" and priced such eventualities into the expected rate of return on their investments.

It appears their presumption was wrong.

The bankruptcy can also be done quite quickly, if the government pushes it. WaMu and Wachovia were essentially forced into bankruptcy, but the buyers were found before they had to unwind stuff.

Suppose that the government pushes quick bankruptcy on some corporations that are not actually bankrupt? Could they do that? Could they raid corporations they don't like, and give their assets to corporations they do like? And maybe years down the road they get some criticism for it....

There's no policy behind it, it's just people with power using it for their own benefit.

That's how it looks to me. People believed that it was vitally important to do something quickly, within the week, so they gave Bush $350 billion (and another $350 billion unless they decide to take it back) to reward his friends and punish his enemies.

[Frederik]

I just wanted to make three points:
a.) I am reluctant to thrust those $700 billion in the hands of the same people who caused this mess - Barney Frank, Chris Schumer, Nancy Pelosi, Harry Reid, Christ Dodds and yes even Barack Obama - he was No.2 recipient from Fannie Mae.
b.) McCain at least has a plan and is engaging the problem. Obama only talks about "hope that their good fortune trickles down" and "Bush". Well, his Godo fortune sure did trickle down in good favour in his case. He became in the last eight years a very rich man and lives in a $1.5 million mansion in Chicago.
c.) No matter which option we will select the American taxpayers will pay a very heavy price. There is no magic hand with which we can solve this financial mess and as usually we the taxpayers will carry the heavy burdain.

Addendum: How come nobody in the Congress is making any inquiry about Fannie Mae and Freddie Mac, which caused all this? They talk about AIG, Lehman Brothers, Disneyland etc. but nothing can be seen, heard or read about Freddie Mac and Fannie Mae???

[J Thomas]

"The thing is, this structure was built with bankruptcy in mind. I'm a lawyer who's worked on financings, corporate formation, etc., and I guarantee you there are literally million of pages of documents covering all possible eventualities. The buyers of the various investment instruments in question are presumed to have done their "due diligence" and priced such eventualities into the expected rate of return on their investments."

It appears their presumption was wrong.

"The bankruptcy can also be done quite quickly, if the government pushes it. WaMu and Wachovia were essentially forced into bankruptcy, but the buyers were found before they had to unwind stuff."

Suppose that the government pushes quick bankruptcy on some corporations that are not actually bankrupt? Could they do that? Could they raid corporations they don't like, and give their assets to corporations they do like? And maybe years down the road they get some criticism for it....

"There's no policy behind it, it's just people with power using it for their own benefit."

That's how it looks to me. People believed that it was vitally important to do something quickly, within the week, so they gave Bush $350 billion (and another $350 billion unless they decide to take it back) to reward his friends and punish his enemies.

[ccsail]

you people are so far out of touch with reality.. sure .. go ahead.. attempt to bail the mcmansions.. now everyone underwater will walk away. take it one step further.. anyone who can't sell their house will just walk away.. if the government attempts to force the prudent to stay and pay for the imprudent .. you are talking a civil war. don't waste another second on any ideas about bailing out the imprudent homeowners.

[Matthew H]

Fannie May and Freddie Mac didn't cause this. They don't originate risky loans- they're not even allowed to. The definition of a "subprime" loan is "a loan that Fannie and Freddie won't buy or insure".

It's certainly true that, by insuring prime loans and injecting more capital in the market, they allowed the market to continue to expand instead of collapsing in 2006 or so. But that's what they were designed to do- inject more capital into the market so that more people could get home loans. How can you complain when you design a business to make it easier for banks to create mortgages, and then it makes it easier for banks to create mortgages? They've got a liquidity squeeze now because the foreclosure rate jumped higher than anybody thought possible while the prime mortgage market collapsed (so they can't sell their mortgages to make money), but their books are basically sound.

I don't buy any blame going to Fannie or Freddie. It's like teaching a dog to fetch a stick, throwing the stick, and getting upset when the dog fetches it. Ain't the dog's fault.

[Cat]

My comments pertains to whether or not folks knew they were going into bad home loans and did it anyway, or whether something systematic was going on behind the scenes...

I grew up in the DC metro area, left for 20 years, and came back in the late '90's. My husband and I saved for years for a down payment, but housing costs kept climbing beyond anything we could save for. The average price of a McMansion rose to just shy of 500k. Not only did we not want a 4000 square foot house after our kids moved out, but we knew we didn't want the upkeep burden. Suddenly the inventories for new homes began to dry up. Investors were buying multiple homes and flipping them at an alarming rate. Which kept making the housing prices increase. We watched from the sidelines, terribly depressed that a house in the area was out of our reach.

Fancy new terms were introduced on the market to make getting a loan easier... But still we resisted. Still, everywhere you looked from the President on down told consumers to buy buy buy... ARMS were encouraged as a way to beat rising costs - buy now, reset in 3 years, and make a bundle on appreciation...

My husband and I sensed something was terribly wrong. We began to look at other areas of the country and eventually settled on picking ourselves up and buying a nice house with a reasonable size (just shy of 2000 square feet), relocated, and bought a wonderful home for a reasonable price ($170k - if we could have found the same home in N.VA it would have been a miracle!).

Now we're feeling like geniuses for getting out of that crazy market and the housing market remains stable here in Austin, TX.

The way I see it, the pressure in the market was to buy if you didn't want to be an idiot, and all the banks and mortgage lenders offered products that were just too attractive to say "no" to.

[dmh00000]

I always regret responding to these trackbacks because it's obvious that no one really read my proposal. I have no sympathy for the imprudent. But failing to assist them will cause more damage to the prudent. The strawman I proposed (above on Oct 8 at 7:01pm) , while permitting the imprudent to keep their homes, would require the imprudent to pay for their profligacy. In other words, the cost causer pays. My proposal just permits them to delay that payment until the future. Read the whole proposal.

[JanWN]

From a blogger on POLITICO" QUOTE-UNQUOTE
The McCain plan would result in one of the greatest redistributions of wealth in our history. Here's why: Let's say in 2005 I paid $500k for a house, putting down $100k and financing $400k with a 30yr fixed mortgage at 5.5% and on the same day my (new)next door neighbor bought the identical house for $500k putting 0% down, financing $500k with a 3% teaser loan that resets in 2008. In 2008 (the year my neighbor's teaser loan will reset at the LIBOR +5%) our homes are worth $425k. There's no impact on me because I have a 30 yr fixed mortgage. My neighbor, on the other hand, has a problem. He can't afford to pay LIBOR + 5% and he can't afford to refinance elsewhere because either other lenders would require some type of downpayment which my neighbor can't afford (hence the reason for no downpayment in the first place), would not agree to finance a $500k loan at the teaser rates b/c (a) the home is only worth $425k now, (b) the Loan to Value (LTV) would be greater than 100%, and (c) my neighbor's credit score is no where near high enough to qualify for that kind of loan. John McCain, my friends, would allow my neighbor to refinance with a new $425k loan (my neighbor's new cost basis for his house) wiping out $75k of debt he originally took on. Stupidly, on the other hand, because I bought a home with a downpayment and can continue to make payments on the $400k I financed, no one is eliminating any of my debt obligation. But why isn't the government giving me $75k(the responsible guy in the story who took out a loan I could service with a downpayment that kept equity in my house even when the market declined)? What's the moral (hazard) of the story? Live way above your means and the responsible guy next door will bail you out by paying more taxes. So what happens down the road? In 10 years my neighbor and I both go to sell the house that originally cost us $500k. But because the house lost value and the goverment bailed him out in 2008, the house really only cost my next door neighbor $425k. We each sell our houses for $700k. I make $200k in capital appreciation and he makes $275k. That's a pretty good deal for him since he put nothing down, got a bailout and had the goverment reduce his cost basis. How is it possible that we're actually going to reward my next door neighbor? How is possible that my next door neighbor makes more on the sale of his house than I do? It happens because John McCain has redistributed wealth. Thank you John.

Posted By: dmh00000 | October 08, 2008 at 11:58 PM

[dmh00000]

JanWN, that was my post. I posted the same message above on this blog at 8:55pm Oct 8. It's very sad that the preponderance of responsible homeowners (94% of homes, i believe fall into this category) will suffer b/c of irresponsible borrowers (i.e., people who assumed that property value appreciation would indefinitely outrun income or salary growth) purchased properties they couldn't afford with a variety of horribly designed and insufficiently vetted mortgage products like interest only loans, teaser loans, etc.

Taxpayers need to let their congressmen and congresswomen know that a bailout for irresponsible homeowners paid for by the responsible homeowners is just not acceptable. As i say in my 7:01pm Oct 8 post above Congress needs to make sure they are designing solutions with the following outcomes: preserve the home values of responsible investors (by far the vast majority of homeowners in this country), recover tax dollars from those responsible for the inevitable bailout currently underway and construct the right regulatory framework so that future profligacy will be avoided.

Absent that future moral hazard risk is almost certain.

[Gayle]

Remember what Joe Biden said in the his debate? He stated that their campaign wanted to reduce the principle on the bad mortages. Actually the language is in the bailout bill that passed a week ago. Look under Relief for Homeowners section in the bill. It should be on about page 35 under adobe reader, Section 110, (2) modifications. The section gives authority to "reduce principle amounts" and adjust the interest rates on the mortgages by "federal property managers." So Obama campaign and McCain campaign have virtually said the same thing. They both voted for this in the first place.

[JS]

Again, dmh, "responsible investors" don't buy things that are priced tens of times above their actual valuations. The housing market has been ridiculously overinflated. We ALL knew it was coming. I've been talking about the bubble for FOUR YEARS. Admittedly I'm more informed than most, but by two to three years ago, everyone should have realized that something was wrong with this market, which means anyone who bought a home in the last three years (whether they could pay it off or not) was acting foolishly and irresponsibly.

The last thing we need is a government bailout to shore up artificially high housing prices and shut the younger generation out of the market permanently. You people who bought stupid need to accept your loss and move on. If you're wiped out, I'm sorry for you, but thank God we didn't privatize social security, right?

@ Frederik, 10/9/08@5:49--
"a.) I am reluctant to thrust those $700 billion in the hands of the same people who caused this mess - Barney Frank, Chris Schumer, Nancy Pelosi, Harry Reid, Christ Dodds and yes even Barack Obama - he was No.2 recipient from Fannie Mae."

You have no idea what you're talking about. The bad loans came from private industry. FNMA only exists to buy and resell those loans so that lenders can stay liquid and make more loans. Yes, these agencies did encourage subprime lending by trying to increase their holdings of those loan varieties; but the ultimate cause of this lending mess is banks' desperate search for better returns and more markets, coupled with their reliance on stiffened bankruptcy laws ("Who cares if they default, we can force them to pay now!") and ultimately the (necessary and obviously-coming-since-2003) collapse in housing prices -- if housing prices weren't dropping, then banks wouldn't worry too much about foreclosures; they'd just foreclose, cash out, and move on.

Anyway, think about it: if it had been mostly FNMA at fault, the bailout of FNMA would've been sufficient to fix it, right?
Beyond that you're just echoing conservative talking points.

"b.) McCain at least has a plan and is engaging the problem."

McCain has a plan to pander to people who realize their housing values are declining, now that the subprime mortgage crisis has become a prime mortgage crisis. That's all this is -- a poorly-thought-out pander that he knows his own party would never pass, even if he wins in November.

"Addendum: How come nobody in the Congress is making any inquiry about Fannie Mae and Freddie Mac, which caused all this? They talk about AIG, Lehman Brothers, Disneyland etc. but nothing can be seen, heard or read about Freddie Mac and Fannie Mae???"

Because FNMA and FHLMC weren't chiefly at fault; they were at worst enablers, doing the same thing that AIG did (in the sense of insuring loans on banks' books).

[Kenneth Almquist]

The politics of this proposal are good for McCain and hard to argue against in a season of high politics and in the face of hundreds of billions if not trillions committed to Wall Street firms.

Under the recently passed bailout plan, the U.S. government is expected to pay considerably less than face value, meaning that Wall Street firms and banks will take losses. If the U.S. government buys worthless paper for 20 cents on the dollar, the seller has lost a lot of money in spite of the bailout.

In contrast, McCain is proposing buying mortgages at face value, meaning that the sellers lose no money whatsoever. I don't see how that can possibly be good politics. My impression is that the public wants people who made bad loans to pay a price.

[dmh00000]

JS, i don't disagree that people overpaid for their homes. That's not my point. The point is that we should not be redistributing wealth. If someone overpaid for their home but can afford to make the payments, that's fine. No problems. Shame on them, live and learn. (I'm sure you're a genius and profitted handsomely from your forecasting skills. I congratulate you.) I have no problem with home values regressing to the mean as all asset classes do over the long-run. What has exaserbated the problem is lending money to people who couldn't afford the homes they purchased UNLESS THOSE HOMES CONTINUED APPRECIATING AT AHISTORIC RATES. Remember, the justification for the subprime market was home values were appreciating at 10%-20% annually in many markets. So in 3 years or 5 years when the teaser rate ended a subprime borrow would have a house that was worth 40% more than what they paid for it. The logic was flawed because salary growth did not keep pace with house appreciation growth. (You seem smart enough to figure out why salary growth was an imperative to keep the bubble going.) Consequently, home values had to regress to the mean and they did. When that happened, subprime borrowers had mortgages that exceded their then current home values (LTV). This meant that they couldn't refinance their loans because the original loan, let's say $500k, was greater than the home's new current value, let's say $425k. The subprime borrow had 3 choices
(1) pay the post-teaser rate which would increase the mortgage payment by 25% which the subprime borrow couldn't afford;
(2) refinance with a $425k loan and pay off the original mortgage by coming up with $75k which the subprime borrow didn't have; or
(3) walk away and declare bankruptcy.

We're seeing #3 play out in the marketplace. Consequently, we see an oversupply of homes. And if we remember our econ 101, we know what happens to prices when there is a supply curve shift to the right and demand curve shift to the left, prices go tumbling down.

All good so far. Problem i have is we're now talking about bailing out these subprime borrowers with taxpayer money.

Now, as far as the impact on the rest of the economy, you have to ask what impact does the declining home values have. If you look at Nobel winning economist Franco Modigliani's Life Cycle Income Hypothesis (maybe Econ 201) you would know that people spend today based on their expected long-term wealth. Since the housing crisis has taken away a huge chunk of people's expected long-term wealth, spending is reduced. The reduction in spending costs jobs and economic growth. From this we all suffer.

So if you believe economic growth is important and you believe Modgiliani's hypothesis is right, then there is a desire to keep peoples' wealth higher than lower.

Finally, as for Fannie and Freddie, i agree there should be investigations, but the management of those institutions are hardly the sole source of blame. Rating agencies deserve a huge portion of the blame. As does the SEC for changing 4 years ago the leverage requirements.

I'm not making this political because the blame should go to both sides of the aisle. There is a desire among stalwarts from both parties to blame the other when in fact they both bear the burden of blame along with countless others.

[Richard Mason]

"The Paulson Plan: Have the government buy up distressed securities at market value"

I do not agree that that was the Paulson Plan. (Supposing that market value means something like "the best price that can be obtained" or "similar to prices that other people are willing to pay." One could sophistically argue that whatever price the government pays is the new market value, but then the words lose their meaning.)

Bernanke testified that under the Paulson-Bernanke plan, the government would not buy securities at "fire sale" prices, a.k.a. market prices. They would buy securities at "reasonable" hold-to-maturity prices, i.e., more than anyone else would pay, but where they hoped (or claimed to hope) the government might break even by holding to maturity.

I see the Paulson plan and the McCain plan as similar in being an unjust giveaway of the taxpayer's money. The McCain plan adds a moralistic element of not to reward fraudsters and speculators; the Paulson plan is to help bankers, so fraud and speculation is okay (semi-joke).

[RC]

How in the world could anyone but an avowed socialist support reducing the pincipal amount owed on a mortgage to facilitate the irresponsible, stupid or unlucky to remain in a home they could never afford?

If a lender (bank, gov., whatever) wants to take a further chance on somebody and give them a good interest rate, fine, whatever, for the team I'll risk the moral hazard of that.

But forgive principal while the responsible people (like us) on the same block just keep on paying....no way, no way, no way.

[JS]

DMH--
You're making sense here, and I'm also not expressing myself as well as I should.

I oppose bailouts to individual home-owners (in the manner McCain has suggested). I would support giving bankruptcy judges the ability to restructure failing mortgages as an alternative to foreclosure; I understand that the general terms involve reduction of principal, though I suspect that changing the interest rates of the loans might be more appropriate; the financial institutions can have their liquidity requirements met through government-based capital infusions (in exchange for equity).
The goal of this is to make complete bankrupty (getting foreclosed and walking away) harder, by resetting terms so that people who overbought can (irrationally) pay to stay in their houses, even as those house values depreciate. That's the only way I can see to actually salvage as much of the value of the bad loans as possible. The economic effects of pouring money into that hole, trying to repay that loan, instead of putting it into consumer spending, will be bad... but I don't see any way around that, because it's just as bad if those loans all go completely sour as the market crashes. Anyway, this sort of facility would probably result in a slower deflation of the housing bubble than the do-nothing approach (where people can't pick the irrational choice to keep the house even though loan balance - market value > equity), while the bailout approach would be at least in part an effort to prop up artificially high housing prices. That bubble needs to deflate in order to bring movement back to the housing market, but a slow deflation will be less traumatic to the market than a sharp one.

Action to prop up the insane housing prices will render reasonable home ownership essentially out of reach for the majority of future buyers, because the core of the bubble problem, as you've noticed, is that:
Housing prices increased at a rate that far outstripped flat wages.

Otherwise put, the problem is something no one has ever dared to mention:

People were getting loans for homes they couldn't afford because there no longer are affordable homes.

Banks should never have made the loans, and people should never have taken them, but the bankers figured it'd be Someone Else's Problem when the bubble burst and the defaults happened, and people always make irrational decisions when it comes to Their Homes.

"(I'm sure you're a genius and profitted handsomely from your forecasting skills. I congratulate you.)"

Sadly, it's kind of hard to short the housing market. If I'd worked out a way, I'd have a free-and-clear McMansion right now (though of course, if there were such a facility, the bubble would not have grown to the extent it did.) Anyway I'm not trying to proclaim myself a genius, just an informed party; if I could see the problem, so could others, but they didn't act on it. More shamed them.

"[ARMs on overvalued homes reset, so people were foreclosed upon, deflating the bubble rapidly.] Problem i have is we're now talking about bailing out these subprime borrowers with taxpayer money."

I agree with you there -- we sure shouldn't be doing that, if you approach it as an investment. If we want to use squishy arguments about providing people with housing and not forcing children onto the street and all that, then under that perspective it's maybe something that could be considered, but that's a separate mental model that doesn't take the financial side into account. I don't subscribe to it, though.

"Now, as far as the impact on the rest of the economy, you have to ask what impact does the declining home values have. If you look at Nobel winning economist Franco Modigliani's Life Cycle Income Hypothesis (maybe Econ 201) you would know that people spend today based on their expected long-term wealth. Since the housing crisis has taken away a huge chunk of people's expected long-term wealth, spending is reduced. The reduction in spending costs jobs and economic growth. From this we all suffer."

Here you're getting to something interesting, but the problem is the choices are either 1) attempt to prop up the bubble, or 2) restructure the economy so a house is no longer the major chunk of people's long-term expected wealth. The former is very hard, because people (or at least lenders) are smart enough not to respond to government efforts to do this; those efforts are obviously finite, and thus only beneficial if the propped-up owners can all find Bigger Suckers before the bubble support ends. And when the support ends, we're back to square one.
Regardless, Boomers are going to retire. If the majority of their assets are their homes, the bubble was going to burst without the subprime crisis, because there wouldn't be enough younger folks with the money to buy into that overvalued housing market anyway. So in ten years, when Joe McDadFoughtHitler retires, he still won't be able to find a buyer, you have your oversupply again, and we're back to house values regressing to the mean. And we *still* have the problem of people's major asset's value being wiped out.
So the bubble was going to pop; now we "just" have to restructure the economy so that a house is not the repository for the majority of a family's assets. A lot of people will be wiped out by this process. That is really an awful thing, but I just don't see any alternative.

The *real* answer has to be an increase in wages; as you already said, that's the only thing that could sustain the bubble in any sort of meaningful way. That means we need to promote some form of wealth redistribution, principally by reducing the outliers in the income distribution graphs. IE, average wages need to go up, and the kind of wealth extremes that substantially fueled the out-of-control increase in house valuations need to come down.
I'd also add that this up-and-coming generation of Americans, the first one that it's widely understood will not live as well as their parents -- their spending needs to drive the economy, now, once the Boomers are winding down. *Their* expected long-term wealth needs to be shored up, even more than their parents', if the economic engine is going to run after we've replaced the Boomer... spark plugs, or something. That simply will *require* some kind of wealth transfer, ideally in the form of policies that promote middle-class job growth and across-the-board wage increases and cost-of-living decreases. Bubble prices have classed them out of ever owning that wonderful wealth engine, the American Home... because ultimately, these years of prosperity were substantially built on imaginary money resting in artificial valuations.

All this is a completely separate issue from how we deal with the immediate crisis. In the short term, we're right boned.

And I agree there's plenty blame to go around; but given that I think a major part of the necessary solution is going to be reducing wage inequalities and revitalizing the middle class, I think it's obvious who I think would be better at fixing the whole thing.

[JS]

(cont'd)
"(I'm sure you're a genius and profitted handsomely from your forecasting skills. I congratulate you.)"

Sadly, it's kind of hard to short the housing market. If I'd worked out a way, I'd have a free-and-clear McMansion right now (though of course, if there were such a facility, the bubble would not have grown to the extent it did.) Anyway I'm not trying to proclaim myself a genius, just an informed party; if I could see the problem, so could others, but they didn't act on it. More shamed them.

"[ARMs on overvalued homes reset, so people were foreclosed upon, deflating the bubble rapidly.] Problem i have is we're now talking about bailing out these subprime borrowers with taxpayer money."

I agree with you there -- we sure shouldn't be doing that, if you approach it as an investment. If we want to use squishy arguments about providing people with housing and not forcing children onto the street and all that, then under that perspective it's maybe something that could be considered, but that's a separate mental model that doesn't take the financial side into account. I don't subscribe to it, though.

"Now, as far as the impact on the rest of the economy, you have to ask what impact does the declining home values have. If you look at Nobel winning economist Franco Modigliani's Life Cycle Income Hypothesis (maybe Econ 201) you would know that people spend today based on their expected long-term wealth. Since the housing crisis has taken away a huge chunk of people's expected long-term wealth, spending is reduced. The reduction in spending costs jobs and economic growth. From this we all suffer."

Here you're getting to something interesting, but the problem is the choices are either 1) attempt to prop up the bubble, or 2) restructure the economy so a house is no longer the major chunk of people's long-term expected wealth. The former is very hard, because people (or at least lenders) are smart enough not to respond to government efforts to do this; those efforts are obviously finite, and thus only beneficial if the propped-up owners can all find Bigger Suckers before the bubble support ends. And when the support ends, we're back to square one.
Regardless, Boomers are going to retire. If the majority of their assets are their homes, the bubble was going to burst without the subprime crisis, because there wouldn't be enough younger folks with the money to buy into that overvalued housing market anyway. So in ten years, when Joe McDadFoughtHitler retires, he still won't be able to find a buyer, you have your oversupply again, and we're back to house values regressing to the mean. And we *still* have the problem of people's major asset's value being wiped out.
So the bubble was going to pop; now we "just" have to restructure the economy so that a house is not the repository for the majority of a family's assets. A lot of people will be wiped out by this process. That is really an awful thing, but I just don't see any alternative.

The *real* answer has to be an increase in wages; as you already said, that's the only thing that could sustain the bubble in any sort of meaningful way. That means we need to promote some form of wealth redistribution, principally by reducing the outliers in the income distribution graphs. IE, average wages need to go up, and the kind of wealth extremes that substantially fueled the out-of-control increase in house valuations need to come down.
I'd also add that this up-and-coming generation of Americans, the first one that it's widely understood will not live as well as their parents -- their spending needs to drive the economy, now, once the Boomers are winding down. *Their* expected long-term wealth needs to be shored up, even more than their parents', if the economic engine is going to run after we've replaced the Boomer... spark plugs, or something. That simply will *require* some kind of wealth transfer, ideally in the form of policies that promote middle-class job growth and across-the-board wage increases and cost-of-living decreases. Bubble prices have classed them out of ever owning that wonderful wealth engine, the American Home... because ultimately, these years of prosperity were substantially built on imaginary money resting in artificial valuations.

All this is a completely separate issue from how we deal with the immediate crisis. In the short term, we're right boned.

And I agree there's plenty blame to go around; but given that I think a major part of the necessary solution is going to be reducing wage inequalities and revitalizing the middle class, I think it's obvious who I think would be better at fixing the whole thing.

[JS]

RC-
"How in the world could anyone but an avowed socialist support reducing the principal amount owed on a mortgage to facilitate the irresponsible, stupid or unlucky to remain in a home they could never afford?"

What do you think happens to your house values when three houses on the block are available for fire-sale prices because they got foreclosed on?

That's right, they drop through the basement.

And then your neighbors realize that what they still owe on the home is EVEN MORE than the new sale value plus their current equity, and walking away from it starts to look like the only smart move there is... or they decide to cash out before the price falls to that point. What does that do to your responsible housing values?

Ask not for whom the bailout tolls; it tolls for thee!

[dmh00000]

JS, I think we're in much closer agreement than I thought. I agree that deflation was necessary. My SFRET solution was designed to create a softer and managed landing. In my scenario home values would have stagnated for many years. Over-Supply would have been mitigated. Incomes would have eventually creeped up. And eventually housing prices would start to move again.

I think the window for the SFRET may have passed, who knows. Policy makers right now are so busy trying to cover their ass instead of crafting long term solutions that it's hard to imagine a truly constructive long term plan that achieves the 3 objectives I identified in March:

(1) preserve the home values of responsible investors (by far the vast majority of homeowners in this country) [this is highly unlikely at this point. Minimizing further declines may be the most that can be attempted.]

(2) recover tax dollars from those responsible for the inevitable bailout currently underway. [with the right structure i still believe this is achievable]

(3) construct the right regulatory framework so that future profligacy will be avoided. [This is definitely still achievable.]

You should have bought Puts on LEAPS for housing industry stocks.

[stop subsidizing the real estate industry]

Time to end the mortgage-interest deduction

[J Thomas]

"What do you think happens to your house values when three houses on the block are available for fire-sale prices because they got foreclosed on?"

"That's right, they drop through the basement."

If you need to sell and move elsewhere, the result is that you get less money for your house, you pay less money for your new house, and you pay less property tax all round. Not so bad. Your new house will probably appreciate nicely in coming years, though we can hope it won't suffer another bubble like the last one.

If you don't need to sell then the concern is that the neighborhood might go bad. People might stop picking up trash, homeless people might break into the empty houses and live there until they get chased out, occasionally they might burn down empty houses -- either by accident or in anger at getting chased out. Your neighborhood might become a worse place to live. That can happen when there are lots of homeless people and houses that can't be sold or rented out. It could happen in many of the places you might move to, also. It's better for everybody when the economy does well. But there's a fair chance that your neighborhood will do OK, and if not there's a fair chance that it will improve later and not become part of a slum.

Of course, the closer we come to a third-world economy the more likely your neighborhood *will* become a slum. Since the big majority of the population will be poor people living in slums.

If you borrowed a lot of money on the value of your bubble-house, then you could be in trouble.

If you still owe more on your mortgage than you can pay, and you depend on your job to bring in that money, you could be in trouble.

If you have your money invested in the stock market, in bonds, or in gold you could be in trouble.

If you have your money hidden under your mattress you could be in trouble.

Even if it's a catastrophe, though, you personally might come out OK. Remember the story about the backpackers who see an angry grizzly bear that has seen them, and one of them gets ready to run.

"You can't outrun a grizzly."
"I don't have to outrun the bear. I just need to outrun you."

[B.B. Mills]

Gosh, it just amazes me still that the largest majority of people with political opinions consider "researching an issue" to be listening to soundbites off of whatever partisan news show they love most.

I've read at least 15 comments that say that McCain's plan is going to bail out "irresponsible homeowners." This is totally false. Eligibility for the HOME program requires the following:
-------------------------------------------------------------------
Holders of a sub-prime mortgage taken after 2005 who live in their home (primary residence only); can prove creditworthiness at the time of the original loan; are either delinquent, in arrears on payments, facing a reset or otherwise demonstrate that they will be unable to continue to meet their mortgage obligations; and can meet the terms of a new 30 year fixed-rate mortgage on the existing home.
------------------------------------------------------------------
This may not be ideal to some people, but it is definitely a far cry from the assertion that the McCain camp is just going to throw money at homeowners.

Also, it should be noted that McCain's plan is similar in many ways to the suggestions of Nouriel Roubini.

http://www.rgemonitor.com/blog/roubini/253739/home_home_owners_mortgage_enterprise_a_10_step_plan_to_resolve_the_financial_crisis

Although I don't fully support McCain's plan (if banks are to be paid full market value, then the gov't must maintain a stake in the shares in order to profit when the bank returns to profit.) at least I took the time to see what it was actually about instead of just sitting in front of the boob tube letting some media pundit fill my head with garbage.

I swear, it is the PEOPLE in our country that have caused this crisis because the largest majority of them are semi-educated, lazy, apathetic, know-it-alls who let their mouths run more than either their brains or their feet.

Some of you guys made some very valid, well thought out ideas based on actually THINKING about the problem and I'm sure doing some background research into the issue. Even if I don't agree with you, I respect the fact that you have formulated your ideas based on actual facts and logical conclusion.

The rest of you are a disgrace to the nation and you should all go hide your ignorant selves in shame. You are the bad "side-effect" of freedom of speech. Get back to yanking your crank watching internet porn and leave the thinking to the big boys.

[J Thomas]

BB Mills, I apologise. I got my understanding of McCain's real estate bailout entirely from what McCain said, rather than researching how it would really work (assuming it didn't get changed around). I should have known better than to listen to him.

One thing concerns me about his plan as you present it. Since it only applies to a small minority of homeowners, won't it be mostly irrelevant to the problem?

[roger dowdle]

If the gov't. buys assets at full value, restructures the loan to reflect current value, there will be a rush to get good loans to be rated as bad! If person a and person b both have houses in the same area, and person a is paying the mortgage, but person b is falling behind, the govt would step in and reward b for failure! A could then decide he can't afford the payments, fall behind, and apply for the same deal B got (and save the difference). Then the gov't would eventually end up paying for all property devaluation!

[Art Balog]

Below is the text of an email I sent to John McCain:

Senator - Your proposal to buy up mortgages and reconfigure at the new reduced property value for people about to lose their homes is insane. Lowering the interest rate and extending the loan period to 40, 50 or even 60 years could keep these people in their homes but, to have the American taxpayer pick up the diminished value of the properties is wrong, wrong, wrong. There is never a guarantee that real estate prices will go up or remain at the purchased price, this is the chance we take when purchasing real estate. Your plan make fools out of the responsible buyers that make a decent down payment and bought within their means. How does you plan compensate the buyer who is not in trouble but whose home is now worth so much less? Are these people who have actually put their savings into their home and due to decrease value have actually lost their money, at least on paper, going to be reimbursed for their reduce home value? Your plan rewards poor planning and judgement and penalizes the prudent buyer. Your plan sounds like an extreme Liberal plan not a plan of a Conservative we had so much hope in. What has happened to you to present such a liberal plan? Your plan needs to be rethought so prudent buyers do not feel like disenfranchised fools. Please, please take another look at your plan and rewrite in a Conservative manner so we can support you as the next President of our great country.

[dmh00000]

Art Balog, I love your note. What is so sad is that people like you and me (and the 94% of the people who have act prudently) seem to be in the wilderness as our politicians ignore our concerns about resdistributing wealth and advocate permitting those over-extended with mortgages to reset their priciple loan amounts.

I'm frustrated, angry and saddened that voices like yours and mine (and the vast majority of responsible homeowners not over-extended with mortgages) are being ignored while our politicians STEAL our wealth from us.

This is not a demorcrat or republican issue. Until we citizens stop letting politicians suck us into this vortex of divisive party politics they will control the dialog and our fate. We must insist that the voice of the majority be heard.

How do we change this debate?