Consumer Law

Of Bailouts and Rescues

By Alan White

By Alan White

Today's Wall Street Journal reports that Treasury Secretary Paulson, on behalf of the Bush Administration, categorically rejects any plan to "bail out" homeowners facing foreclosures with federal dollars, displaying a remarkable blind faith in the unregulated market in the face of an unfolding catastrophe. While it would be foolish to write Treasury checks to pay off inflated mortgage balances on depreciating homes, no one is suggesting such a plan. Several rescue proposals would provide loans to homeowners, not handouts, and would require investors to absorb losses, not reward their recklessness.

As my colleague Jeremy Telman points out on the ContractsProf blog, there is little coherence to the Administration's position on "bailouts" -- they also call the bankruptcy strip-down bill a "bailout", although it would actually force investors to absorb more losses in Bankruptcy court, and require homeowners to repay their loans.

The savings and loan bailout of the 1980s required payment in full, ultimately by taxpayers, of the (mostly commercial) mortgages involved, because the capital came from S&L depositors, whose deposits were FDIC and FSLIC insured. In contrast, the investors in subprime mortgages bought mostly uninsured securities (although the private bond insurers who backed some subprime deals are now in trouble, creating problems for other parts of the economy and prompting proposals to bail out the insurance companies.) Sensible rescue plans call for mortgage balances to be reduced to the current deflated value of the home before being refinanced or restructured, either by a Federal lender like the old HOLC or Federally-insured lenders under the FHA program. The haircut on the mortgage balance will result in losses to the investors, not a bailout. Properly managed, a rescue program would mitigate investor losses by avoiding the cost and delays (and further home value losses) of foreclosures, and would stabilize home values, by preventing more foreclosed homes from coming on the market and driving prices down further. While some rescue plans would leave investors with their losses, others would provide investors some upside recovery if the homes' values went back up and homeowners eventually sell at a profit. Obviously, the devil is in the details. The announcement of the plan, and the negotiation of mass mortgage buyouts, will have a significant effect on home values.

The alternative, doing nothing, means that we will continue to see 10 foreclosures for every loan modification, that the homes with brown grass and for sale signs will continue proliferating, and that the financial system's downward spiral will continue.

Full post as published by CL&P Blog on February 28, 2008 (boomark / email).