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Mortgage Bailout

By pharrell

It is anything but a surprise that a mortgage bailout plan drafted by one of the nation's biggest lenders, Bank of America, amounts to little more than federal taxpayers buying lots of under-performing loans from the very banks that (foolishly) wrote them in the first place. This is a terrible idea. While we clearly need some kind of a plan to keep people in their homes and keep foreclosures from eroding the property values of neighbors who kept their own borrowing to sensible limits, any bailout needs to meet eight criteria:

1. It helps owner-occupants, not speculators. While I feel for people who foolishly used interest-only, zero-down loans in the hope of making a quick buck flipping a Miami condo, they don't need a bailout. Real estate speculators made bad investment decisions; they deserve no more of the public fisc than investors who bought overpriced internet stocks at the hight of the bubble in 2000. Only owner-occupants should qualify for mortgage relief.

2. Banks, not the government, should bear most of the losses. Banks wrote the bad loans; they should deal with the consequences. It makes sense to protect homeowners who were tricked or otherwise misled into taking on loans that they can't afford, and to shift losses from those homeowners to the banks--which, after all, knew or should have known that these people wouldn't be able to meet their obligations. An interest rate freeze, government-run adjudicative process, or other mechanism that gives homeowners debt relief at the banks' expense--not the feds'--would be far more appropriate than a program that basically leaves the government holding the bag for the banks' mistakes. Basically, any program should help homeowners' at the banks' expense, not banks at the taxpayers' expense.

3. Direct government aid should be limited. In certain circumstances, it may make sense to help out individual homeowners with subsidized government-backed loans or some comparable benefits. But these should be sharply limited, and given only to those who need them most--and who have a realistic change of repaying them.

4. Any program should distinguish between homeowners who will, ultimately, be able to pay for their houses and those who won't. Aid should be targeted towards those who are suffering temporary hardship, or who could afford their houses at existing interest rates but not if their interest rates reset. People who just can't afford their houses under any circumstances will have to move sooner or later, and the sooner they move the sooner the market will stabilize.

5. We should aggressively target institutions that mislead borrowers. A lot of borrowers really didn't know what they were getting into, and banks took advantage of that ignorance. Aggressive investigations of shady lenders and hefty fines will get the mortgage industry to clean up its act while generating revenue to support other programs.

6. We shouldn't bail out sophisticated borrowers who knew what they were getting in to. Like speculators, sophisticated borrowers did nothing more than make a bet they've now lost. We don't bail out the high-rollers at the Venetian; we shouldn't bail out high-rollers in the Vegas real estate market.

7. It matters why an individual got a loan they couldn't afford. Individuals who were tricked or misled into loans, who were told that they could afford loans they really couldn't, or who've suffered some adverse event through not fault of their own, may deserve relief. Individuals who got into houses they can't afford because they lied about their income or other financial details, or who simply acted like ostriches with their heads in the sand in the face of known financial realities, should face the costs of their own decisions. We can't create a quintessential moral hazard problem going forward.

8. Any bailout plan should be predicated on regulations that will prevent a comparable crisis from developing in the future. In other words, much as banks and borrowers alike will hate it, if we're going going to bail people out of the mortgage mess, we have the right to impose regulations to ensure that we won't be seeing this movie again twenty years down the road.

Full post as published by Harrell Blog on February 24, 2008 (boomark / email).