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Slippery Slope

At last night's Presidential Debate, John McCain said that he would order the Treasury Department to purchase up to $300B of consumer mortgages at the original value of the mortgage and renegotiate them down to the new diminished value of the home.  The idea is to get people into a loan they can afford so they don't lose their house.  It sounds like a nice idea to help out homeowners, but I think that it is an incredibly slippery and expensive slope.

First of all, the taxpayer will be taking the loss on all of these mortgages.  That seems like one of the biggest government handouts ever.  Secondly, this loan will bail out banks who overextended credit, falsified appraisals to inflate home values, or engaged in other practices to over-mortgage properties.  These banks will be made whole.

However, the most complicated part is bailout out the homeowners who over-mortgaged their property and spent the money on something else.  There are plenty of people who mortgage their homes to the hilt and spent the money on new cars, vacations, etc.  This was encouraged by banks.  Now, the taxpayer is going to pay for this profligate spending.  And, McCain calls Obama a liberal!

The worst is that this rewards all the people who took advantage of the easy credit at the expense of those people who lived conservatively and didn't end up in trouble.

I'd prefer a program where the level of debt that the homeowner owes isn't reduced.  Perhaps some level of debt has to be moved to a soft second mortgage that is only paid out when the property is sold (or is possibly forgiven if the homeowner stays in their home and pays their mortgage for 10 years).  Mortgages will be restructured so that homeowners are given 'prime' terms even if they are subprime borrowers (30 year fixed rate mortgages only).  The banks will have to take a write-down for the diminished value of the loan, but that will be cheaper than doing a foreclosure.  And, perhaps, the government can provide some sort of tax credit proportional to the value of the writedown that a bank does to encourage this and soften the blow.

Homeowners who can't afford their mortgage even with the terms above should be required to pay whatever they can towards a restructured 'prime' mortage in order to get a six-month moratorium on foreclosure.  This gives them time to move to something they can afford.  It keeps some cash flowing to the lender during the foreclosure process, softening the loss from the foreclosure.  A tax credit for restructuring the loan as described above is also a possibility.

I prefer this type of approach because the homeowner doesn't get to wriggle out of their responsibilities.  I think that the very large majority of homeowners subjec to foreclosure knew that they were borrowing more money than they could afford.  Shame on the banks for making this loan available, but shame on the homeowner for getting in over their head.  This approach also limits some of the losses of the banks, but the banks will certainly take some losses (somewhat offset by some tax credits).

Minimizing foreclosures will help the banks financial situations and will help stop the drop in home prices from foreclosed homes flooding the market.  There are probably still many challenges with this approach as the restructured loans are securitized and may be difficult to change.  Part of the government rule would be allow these changes to happen without making the banks liable for changing the terms of the loans.

We have to do everything we can to make sure the money we spend during this time bails out the economy, not the individuals or companies who took advantage of the easy credit environment.  Individuals and companies can survive, but they'll have to give up a lot financially in order to do so.  Unfortunately, I don't know how we can reclaim the profits and bonuses that were legally made during the runup before this crisis.


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