## 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.