The horizon is not so far as we can see, but as far as we can imagine

How To Bail Out Ordinary Mortgage Holders And Not Just Banks

I wrote this post originally in September of 2008.  It appears that Fannie and Freddie are getting their unlimited line of credit because underwater mortgages are sharply up, and they are expecting foreclosures to go through the roof next year, as well as the commercial real-estate market to collapse.  So, here’s what should have been done for homeowners well over a year ago.

I have received multiple e-mails today suggesting that instead of the bailing out banks at the expense of taxpayers, the government should give mortgage holders money to pay off their mortgages.

Both ideas are bad. But there is a better solution.

Why the Government Shouldn’t Just Bail Out The Banks

The government is talking about setting up a Trust to buy distressed debt then sell it again. The problem is that the Trust company will simply bail out banks at taxpayer expense without helping mortgage holders much. The mortgages it sells will still be underwater, or too expensive for many people to service, especially as their houses lose value.

The other proposal, just giving money to people to pay for their mortgages, is bad also. Housing prices are actually dropping, most mortgages issues were bad mortgages with horrible penalty clauses, based on assumptions about housing values which are just wrong. House prices are going to keep dropping.

What the government should do instead is set up a Trust to buy mortgages at a discount, then reset them to 20, 30 or 50 year fixed mortgages with a reduced face amount. If the house is later sold, half of the increase goes to the government, so that taxpayers make a profit. The mortgage cannot be paid off before the end of its term so that financial scavengers cannot come around and, as they did over the last ten years, say “get rid of that mortgage, and take ours. It’s better. Honest!”, because we know that when they say better, they don’t mean better for the mortgage holder. The mortgage is attached to the property and is transfered to any new buyer. And the mortgage cannot be removed from the property, and any new mortgages attached to the property are junior to the government mortgage.

End results:

a) a floor is set for mortgage prices. (Whatever discount the government is buying at. Probably 60% to 70%, but it should be based on what the long run price was in the area before the housing bubble.) This ends the confidence crisis in these securities, because there is now a market price—what the Trust will pay.

b) It helps homeowners stay in their homes.

c) It gets rid of overly complex mortgages and puts in their place a dead simple mortgage that anyone can understand.

d) It punishes lenders, which they deserve, for making loans they should never have made.

e) While it does keep homeowners in their homes, it doesn’t let them off scot-free either. In exchange for a good mortgage they can service, they give up some of the future profits on sales in their houses.

f) The government will almost certainly make a long term profit on this. This is important, because it’s not fair for people who aren’t underwater on mortgages to spend hundreds of billions or trillions bailing out those who are without some expectation that in the end it won’t be more than just a transfer of wealth to them and to investors and banks.

This bailout can be done right. It’s up to Democrats, who appear to be in danger of stampeding into a hasty decision, to stand firm and make sure it’s done right. The last two times they didn’t stand firm and do things right, we got the Patriot Act and the Iraq War. This is too important for Democratic fecklessness. Too important for them to just give the Bush administration whatever it wants.

If they do give the administration what it wants, then Wall Street and the Banks just got bailed out, no help goes to ordinary people and you get stuck with a trillion dollar bill. Taxpayers get all the toxic assets, but Wall Street, who paid themselves more in bonuses in 2007 then 80 million Americans got in raises, keeps the profits.

Democrats need to stand up for ordinary Americans and do the right thing.

Update December 2009: Well, obviously they did give the Bush administration what it wanted, then they gave the banks everything they wanted in 2009.  The result has been as predicted, except the bill may be even larger than I thought at that time.  It is not too late (in theory) to do the right thing.  If the Obama administration can spend unlimited money without Congressional approval to bail out Freddie and Fannie, then they can spend the money instead to set up a Housing Trust which helps everyone but also spreads the pain so it isn’t only ordinary people taking it on the chin for once.


A fundamental cause of healthcare costs exploding


More Notes on How To Help Homeowners


  1. anonymous

    Great idea! I haven’t heard anything like it yet. Too bad good ideas are anathema in these parts.

  2. And what should be done to help those of us who don’t own a home? Why should people who got caught up in the greed frenzy be saved?

  3. Ian Welsh

    Enlightened self-interest. And they aren’t entirely being saved, they’re taking a hair cut. Plus, in my plan, the government would probably actually make a profit. It hasn’t overall, money has just been shoveled over to TARP repayments to make it look as if it has.

  4. Ed

    I prefer the government just taking over the mortgages (probably best to have state governments do this, I don’t really care but its important for some people), then negotiate rents with the new public housing tenants, who would have the option of buying their houses outright for a set price.

    In other words, end the charade that paying mortage instead of rent (well rent to a bank instead of rent to a landlord) means that you own their home. This is probably completely politically unfeasible.

  5. Lex

    Ian, you’re a one man think tank. If i can find you a real good Larry Summers mask and my voodoo doll works, would you consider taking over as head economic adviser for my nation?

  6. It is more easy for the government to bail out individuals than banks.

  7. Great mortgage article for all.
    This is the “ought-to-do” intervention.
    This is what should be done.

Powered by WordPress & Theme by Anders Norén