Bankruptcy

More on the McCain Plan

By Adam Levitin

Now it appears that the McCain plan is to pay 100% of the outstanding balance on distressed mortgages (and, presumably prepayment penalties if applicable). What isn't clear is whether the government refinancing will be for fair market value or at the old outstanding balance. If the later, it really won't help folks with negative equity.

If the McCain plan is going to buy mortgages at 100 cents on the dollar and then replace them with, say, 80 cents on the dollar mortgages, there's good news and bad.

The good news is that this will work at stopping the foreclosure crisis. To be sure there are some inevitable foreclosures--some folks won't be able to pay their mortgages even with a low-rate 30 year fixed mortgage, but those will be manageable levels.

The bad news is that this is a terrible business deal for the government (buy high, sell low...). Now that may be an acceptable price for stopping foreclosures. But it is a true bailout of both investors in questionable loans and the borrowers of them. And the bailout is financed by the taxpayers in general.

This could be made fairer by offering everyone a low fixed-rate government mortgage, as R. Glenn Hubbard and Chris Mayer have argued. Whatever one thinks of that idea, it's of little comfort to those who (1) own outright or (2) rent and either have no interest in owning or don't have downpayment funds.

My own take is that the McCain plan is a bitter pill to swallow, but that it would be worth seriously considering if we didn't have a far better alternative. Why spend taxpayer dollars bailing out some homeowners and a lot of investors when permitting modification of mortgages in bankruptcy would cost the taxpayer nothing and force the loss spreading among lenders (mainly) and borrowers?

It's a strange world we live in where a year ago bankruptcy modification looked so radical and now it looks like the moderate option.

[As a sidebar, let me note that the confusion about whether the McCain plan was going to pay 100% of the outstanding balance or only fair market value or the like did not just stop with the McCain press statement. It also extended to the media call by his top economic advisor, Douglas Holtz-Eakin, who spoke about paying 80% of outstanding balances. (I don't have the transcript in a linkable format yet.) It makes me a little uneasy about what the plan really is. At 100%, it's workable if problematic; at 80% it just isn't workable.]

Full post as published by Credit Slips on October 10, 2008 (boomark / email).