cos | Is Congress crazy?

Is Congress crazy?

Problem: A lot of banks, insurance companies, and other financial institutions are in trouble, and if a bunch of them fail the economy will suffer severely. They're in trouble through a chain of stuff that starts with a lot more mortgages failing than were expected, and a bad housing market. When someone can't make their mortgage payments they may be forced to sell the house, but in a bad housing market, their house may not be worth enough anymore to pay off the mortgage by selling it, so they can't do that. Glossing over a lot of the stuff in between, and ignoring for a moment the legal changes that let this happen, that's basically where the problem begins at the moment, yes?

Now, assuming that we decide that we can't afford to let all these financial institutions fail, and assuming we decide it's worth spending several hundred billion dollars on it right now - rather than argue the merit of those two points, let's take them as a given - assuming all of that... why would Congress even consider using that money to bail out the financial institutions directly?????

We could take the same money and spend it on bailing out homeowners who can't make their mortgage payments.

We could get more bang for the buck at first pass because we wouldn't have to buy all of the "bad" debt, only enough to make it possible for each homeowner to keep on paying, perhaps with lower payments over a longer period of time. Banks would be stronger simply because all this debt would no longer be poised to fail, and confidence in the banks would recover as soon as the plan was passed, even before actual homeownwers were bailed out, because people would know that a lot of these loans would no longer fail completely, because they'd qualify for the bailout plan. Not only would we save banks, but we'd save jobs, neighborhoods, and families. By preventing mass dislocation of people we'd be saving lots of other pieces of the economy at no extra cost.

I've heard some arguments against the "moral hazard" of bailing out people who took risks that didn't work out... every single one of those arguments applies to a much greater extent to bailing out financial institutions who took vast amounts of irresponsible risk, who risked not just themselves but everyone around them, who were paid to understand finance and to know better than to do this, who lobbied for laws to make it easier for them to do this...

In what bizarre reality does it make any sense to even consider bailing out the financial institutions instead of the homeowners in trouble?

I'm going to call my members of the House and Senate and I hope you call yours.

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So very, very much agreement (not to mention that argument shows a shocking lack of understanding of the argument of moral hazard - no one in foreclosure today expected any government bailout at all on their loans, why would they? Moral hazard very much does not apply here.) The root of the problem is bad mortgage debt. Fix some of the bad mortgage debt, don't just swallow it up in government coffers.

Edited 2008-09-22 13:55 (UTC)

Thank you. It is helpful to have some alternative arguments to "well, we have to give Wall Street all our money!"

"We could get more bank for the buck"

Deliberate or a thinko?

One possible answer is that the administrative costs of giving a large number of people money to pay their mortgages (even if done by giving the money to the banks on their behalf) is likely going to be hugely greater than just bailing out the financial institutions. The latter is likely a lot quicker as well.

One possible answer is that the administrative costs of giving a large number of people money to pay their mortgages (even if done by giving the money to the banks on their behalf) is likely going to be hugely greater than just bailing out the financial institutions. The latter is likely a lot quicker as well.

Yup. The number of affected banks is trivial compared to the number of mortgages outstanding right now that would have to be audited to see if the mortgage holder deserved an individual bailout or not.

On the other hand, when bailing out someone who wants to stay in their home, you only need to apply enough money to make it possible for them to do so, which is almost always going to be much much less than the whole amount.

sure, to pay this month. probably the only thing that would save the mortgages would be for the government to undertake to pay them, or a portion of them, if the original homeowners couldn't.

even ignoring administrative costs, i suspect that would cost orders of magnitude more than buying the securities from the bank for pennies on the dollar. then when you add administrative costs on top of that...

i suspect the answer to your question is that no one in the financial sector could possibly believe that the u.s. government could afford to do what you're suggesting even given that it can print money.

And printing money comes with its own liabilities, like driving inflation up even higher.

the only thing that would save the mortgages would be for the government to undertake to pay them, or a portion of them, if the original homeowners couldn't.

If that happens, does it make the Federal Government, effectively, landlord to those people? Holy cow, talk about administrative overhead...

Edited 2008-09-22 15:42 (UTC)

If they can afford $700 billion to buy the banks' debt, they can certainly afford less than that to make mortgages not fail. The total cost of making most mortages not fail is less than the lost value on the bad debt. I was absolutely NOT looking at just "to pay this month" - that's utterly ridiculous. The TOTAL has to, by definition, be less, because otherwise it wouldn't cost that much to deal with the bad debt.

At worst, for example, the government could put in enough money to buy the house at current market value, losing whatever the difference was from its former value. That's not the best solution, but it is the limit of how much it should cost. If someone can continue to make payments for that much house value, they can continue to make payments, putting the right percentage of those into interest to make it at least break even. If they can't, they can "sell" and break even that way.

The TOTAL has to, by definition, be less, because otherwise it wouldn't cost that much to deal with the bad debt.

i don't think that's true.

say i've taken out a loan to buy a house, that i still have $100,000 in payments left on. the market just crashed and now the bank thinks they'll probably only ever see 20% of that money from me. with that understanding, it'd be a fair trade for them to sell the mortgage to someone else for $20,000. but if the bank's right, it would cost another $80,000 for someone to "make my mortgage not fail."

i gather that in the current situation, the problem is that nobody really knows how to guess how much of the money they expect to see again. that mortgage could only be worth $1,000, or $100. faced with the choice of paying $1,000 each for millions of crappy mortgages like this one or paying a million homeowners $99,000 each to save their mortgages, which do you think the government should do?

i do see complaints that those aren't the only choices, coupled with the fear that the government is really going to pay $50,000 for that $1,000 mortgage because the bailout is run by people who like bankers. those complaints make some sense to me.

Someone living in that house, however, who doesn't want to move, gets a lot more value out of it than the $20k it's worth to other people, and would therefore be willing to make payments to stay in that house that are higher than what you could get if you took the house from them and resold it. As long as they can make payments they can afford, to stay in the house.

In other words, there's a lot of value out there in the difference between what a house is worth on the market, and what it's worth to the people who have been living in it and don't want to move. There are probably a huge number of houses in that situation, and if you add up all of that value, it's probably a very very large number. Foreclosing on all of them makes all of that value simply disappear from the economy.

Edited 2008-09-22 19:15 (UTC)

I can't fathom how my statement implies yours. No logical connection from one to the other comes to me.

You stated that "Someone living in that house, however, who doesn't want to move, ... would therefore be willing to make payments to stay in that house that are higher than what you could get if you took the house from them and resold it."

So having just stated that the current homeowner will always pay more than the bank could make on a foreclosure sale, I think you did, indeed, just argue away the existence of foreclosure.

Of course, some people would probably just as happily default, because they're not compelled by sentiment to stay in a place when they could move somewhere cheaper in a time of falling markets, so any bailout plan for individuals would have to address a way to compel those people not to move.

Edited 2008-09-22 20:34 (UTC)

"So having just stated that the current homeowner will always pay more than the bank could make on a foreclosure sale, I think you did, indeed, just argue away the existence of foreclosure. " Huh? How?

Banks do lose money on foreclosures.

Also, I did not state that the current homeowner is always willing to pay more than the bank could make on a foreclosure (though that is very often the case), I stated that the current owner is (on average) willing to pay more than other people would, if they can afford to, and if they want to stay there.

I did misstate one thing: payments "that are higher" isn't necessarily it, only that over the long term they'd add up to more for the bank. That is, the individual payments may not be higher, the value of what's paid over time is higher, is what I meant.

This is particularly true in a situation where this is happening to a lot of houses all at once: the more foreclosed & re-sold, the lower the value of all houses, to everyone, so everyone loses out.

Banks do lose money on foreclosures.

hm, i think that's a different issue. i'm wouldn't be surprised if on average, loans that go into foreclosure wind up losing money for the bank.

but here we're not talking about the loan as a whole. here's a bad loan, the bank has already decided it's a loss, the question is not "are we going to get our $100,000 back plus interest?" the question is "are we going to get any money at all? and how do we maximize the pittance that we do get?"

it sounds like you're saying that, at least if only there were some way to keep pressure on the homeowner to continue making payments as best they can, that would always produce more money than foreclosing. and i'm saying that, if that were true in the general case, the rational bank would never foreclose; it would always opt for the "figure out how to keep pressure on the homeowner while keeping the loan from defaulting" method. because (you say) that would yield more money.

perhaps you mean that there are some special market conditions that make that true right now, which do not generally hold? or, perhaps, that the government is uniquely positioned to keep pressure on the homeowners to make payments despite separately arranging for the loans not to default?

Okay, I see what you mean now. Yes, I think that legislation can change the balance on that decision, converting a lot of what would've been foreclosures into restructured mortgage payments, by applying only a relatively small amount of money - enough to make it possible for the owner to continue. This would add more to our economy because it's not just the bank that benefits, but also the people living in the house (and their employers, their family who might otherwise have to help them out, etc.)

In other words, there's a lot of value out there in the difference between what a house is worth on the market, and what it's worth to the people who have been living in it and don't want to move.

Yes, and that's often a negative number. Let's take a sample jingle mail case.

If a homeowner took out an $800,000 loan to buy a place, and can replace that house for $500,000, what's the point in staying in the $800,000-mortgaged property, other than to make sure that homeowner has an additional $300,000 debt burden (or, in your scheme, that the Fed takes on some or all of that debt burden.)

Foreclosing on all of them makes all of that value simply disappear from the economy.

So driving home prices down to the level where they might be affordable again? Is that a problem?

And, more to the point, you're once again conflating the issue of foreclosure with the issue of the liquidity of mortgage backed securities. The issues may be related, but they are not the same thing.

I don't see the logic in what you're saying.

In your example, the owner of the formerly $800k place has more of a "point" to staying in that place than anyone else does, so the amount of money you'd have to apply to let them stay is less than the loss that happens if you don't, and someone else buys the place. If that place is worth $500k on the market now, the homeowner already has that extra $300k of debt burden. You don't make it go away by declining to help them keep the house: one way or another, that money is gone. However, if the house is worth $500k on the market, it's likely worth more to the owner, let's pretend $600k. So if they can't afford it and someone else has to buy it, it gets sold for $500k and $100k worth of value goes *poof* - nobody gets it.

Obviously this only applies to people who want to stay in the home they're in now, and help ought to be structured that way.

I don't see the conflation either. In this subthread we're talking about the mortgages themselves.

If "liquidity" were the only issue, banks could just sell the securities they have no for whatever people are willing to pay for them - there are people willing to buy them cheaply. It's not the only problem. A plan that would obviously prevent a lot of foreclosures would give all of those securities a lot more value, which is the real problem.

Applying the same money directly at the financial institutions can possibly solve that same problem (though I'm skeptical), but it does so without the benefits of applying the money to the root of the problem.

In your example, the owner of the formerly $800k place has more of a "point" to staying in that place than anyone else does, so the amount of money you'd have to apply to let them stay is less than the loss that happens if you don't, and someone else buys the place. If that place is worth $500k on the market now, the homeowner already has that extra $300k of debt burden.

Sure, but if the Owner can walk away from the debt burden, then he doesn't have it any more. If I pay $800 for a suit, and I see the suit next week marked down to $500, nothing changes - I'm already out the $800. If I promise to pay $800,000 for a house, but then find out I can have the same house for $500,000, that's $300,000 worth of incentive for me to wiggle out of my current promises.

You don't make it go away by declining to help them keep the house: one way or another, that money is gone. However, if the house is worth $500k on the market, it's likely worth more to the owner, let's pretend $600k. So if they can't afford it and someone else has to buy it, it gets sold for $500k and $100k worth of value goes *poof* - nobody gets it.

While cognitive neuroscience has some fascinating things to say about the ownership effect, I think assuming it has a 20% price value for everyone is a poor basis of policy. Likewise, If we take the case of the $800,000 mortgage, I fail to even understand what you're trying to get at. Is your argument that if I write down $200,000 of that fellow's debt, that he'll stay? In that case, I haven't saved $100,000, I've lost $200,000 - unless you're presupposing I take that money away from you and me and give it to this fellow's banker? And the last $100,000 is a non-number anyway. If the fellow can sell the house for $500,000, that's its market value, regardless of how sentimental he is about the place.

If "liquidity" were the only issue, banks could just sell the securities they have no for whatever people are willing to pay for them - there are people willing to buy them cheaply.

Oh? Whom, and how cheaply, and how much?

A plan that would obviously prevent a lot of foreclosures would give all of those securities a lot more value, which is the real problem.

That's not the problem. The problem is that most of the key players are so heavily leveraged (or were, until the fed took over the last two survivors) that there's no way to unwind their positions in those securities without bringing in a new counterparty. If it was just a matter of taking a paper loss, it'd just be a balance sheet write-off, and everybody goes about business as usual, no different from when the stock market tanks. THe difference being that stock market price discovery is almost instant, and the price discovery mechanism for these securities is being written even still.

Applying the same money directly at the financial institutions can possibly solve that same problem (though I'm skeptical), but it does so without the benefits of applying the money to the root of the problem.

Just to be clear, (because I realize there are some different implications in your previous comment) how do you propose to do that? Write down the value of existing mortgages to market? Pay them off with Federal dollars? Something else?

there are people willing to buy them cheaply.

it's possible that i've just missed something in the analyses of the problem that i've read. but my understanding of what i've read so far is that this isn't actually true; and that that is the problem.

Yeah, I think you have missed one of the threads in the public debate. Basically, what people want to pay for this stuff is less than the holders have it written down as being worth, so unless they write down even more than they already have, they don't want to sell at the prices people want to buy at. It's not a lack of willing buyers that's the problem, it's a lack of belief in the value of these things, and the fact that their holders still have them on the books as worth more than buyers are willing to pay.

That's actually one of the most common criticisms of Paulson's public remarks on the bailout: He says the government would buy "at fair market value" and lots of people are pointing out that he must mean "well above market value", otherwise there'd be no point: there are already willing buyers, and "market value" is what those buyers are willing to pay, and if we could solve the mess by having all the banks sell at those prices, there's no need for the government to buy any of it.

(fixed, thanks) When my fingers get used to typing a certain letter combination a lot, they get to doing it automatically.

The other thing I don't get is why, even if we are bailing out Wall St, we would give a $700 billion blank check to one organization, with accountability strictly forbidden ("Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.") This seems like a perfect recipe for unbridled corruption.

Oh, and just one question on your question: is it the case that we could actually rescue anything by bailing out the homeowners? Lots of them have been foreclosed already, so there are lots of houses sitting around empty and losing value rapidly, that the banks need to get some sort of value out of or they'll lose even more money. Would a homeowner bailout be too late at this point? I don't actually know, I'm just curious.

It's not a recipe so much as it is unbridled corruption.

Bankers figure out they could take more risks and make more profits if they get some laws change, so they lobby to change the laws, and take lots and lots of risk and make huge profits. Risks fail and now they're in trouble, so they go back to the government and get the money. They got to keep the profits, of course - those are long spent or invested in other things, or paid to individuals.

A homeowner bailout would make the value of existing mortgages more certain. That would definitely be enough to stave off this financial meltdown. It wouldn't save banks from the stuff they've already lost, but nobody's talking about doing that anyway AFAIK. If they are, that's even crazier.

A homeowner bailout would make the value of existing mortgages more certain.

The "value" of the existing mortgages is already known. It's the value of the mortgage-backed securities that's at issue. Of course, if you can guarantee there'll be no defaults, you can probably guarantee the total value of the mortgage-backed securities too, but the scope for abuse there is mind-boggling.

Now, assuming that we decide that we can't afford to let all these financial institutions fail, and assuming we decide it's worth spending several hundred billion dollars on it right now - rather than argue the merit of those two points, let's take them as a given - assuming all of that... why would Congress even consider using that money to bail out the financial institutions directly?????

First, let's understand the terms: The plan would allow the Treasury to buy up mortgage-related assets from American based companies and foreign firms with a big exposure to these illiquid assets. The aim is for the government to buy the securities at a discount, hold onto them and then sell them for a profit.

So, in effect, the government would be swapping T-bills (or the like) which are a known value for these mortgage backed securities of questionable pedigree, (which right now are not able to be sold for love or money) and then sitting on the latter until they can be sold. Or possibly until they expire, since I think the CDO basically runs out of life when all the underlying mortgages are paid off.

This is a better potential bet for the taxpayers, since if I give money to every homeowner, 100% of that money is basically gone from government coffers, not to return. If I buy the mortgage backed securities, to whatever extent the underlying mortgages don't fail, I retain value. And, in the latter scenario, I've also added some liquidty back into a banking system that won;t function without it. In the former, I haven't, since giving a bunch of homeowners cash does jack for setting a solid market value on mortgage-backed securities, even assuming the homeowners use the money to pay off mortgage debt.

As you yourself point out, there's a moral hazard issue, too - why do I want to reward people who signed for a mortgage they couldn't pay, again?

You can "give" a lot less money to homeowners than the value lost in the securities, because they will want to keep making payments they can afford in order to stay in their houses.

Now, why would I want to reward companies and executives that irresponsibly made huge amounts of bad transactions when they were supposed to be the ones who knew better, and put not only their companies but all the rest of us at risk? Talk about moral hazard.

You can "give" a lot less money to homeowners than the value lost in the securities, because they will want to keep making payments they can afford in order to stay in their houses.

They will? How many of the threatened homes are owner-occupied right now? How many people would take the money and run, particularly given the falling market? How does a lump sum payment help with future unaffordable payments, or are we arbitrarily re-writing the terms of everyone's mortgage while we're at it?

Now, why would I want to reward companies and executives that irresponsibly made huge amounts of bad transactions when they were supposed to be the ones who knew better, and put not only their companies but all the rest of us at risk?

Companies have no personality, no humanity, and no conscience. "Punishing" a company is a convenient fiction - it means nothing and all that happens is that the costs of the "punishment" move down the line to shareholders and customers. As for punishing individual responsible actors, I'm all for it, and I think

crouchback's suggestion of a decimation for the senior management of the investment banking sector would be a lovely idea. But it's a complete aside to fixing the problem, and conflating the two things isn't helping your thinking.

You could give the money to the debtors in a form that could be used only to pay the creditor banks.

Which gets us right back to baling out the creditor banks, except instead of swapping mortgage based securities for t-bills, you've swapped the underlying mortgages, and had to set up a bureaucracy to figure out which mortgages are worthy of being paid off. And probably not solved the liquidity crisis, since some portion of the underlying mortgages are still going to default, unless you go to a plan of paying off any mortgage no matter how irresponsible its origination.

"Companies have no personality, no humanity, and no conscience." - which is exactly why the Supreme Court's decision giving them rights as if they were "persons" is possible the worst legal precedent in our history. But it's also irrelevant to this discussion, because the "hazard" can translate easily from "moral" to "expected value". If companies expect that once they're big, they can take on irresponsible risk without actually being at risk, that encourages them to do so as long as there's short term profit in it. If they can't expect that, boards would be more likely to stop such behavior even if it's profitable.

Given that this bunch of clowns call themselves strict constructionists the right wing of the SCOTUS's pro-corporate attitude is both baffling and infuriating, particularly since several of the actual framers we dubious about the personhood of corporations precisely because of the accountability issue.

If companies expect that once they're big, they can take on irresponsible risk without actually being at risk, that encourages them to do so as long as there's short term profit in it.

This is an issue regardless of the size of the company - in smaller firms it simply occurs in the form of siphoning profits off as quickly as possible, while leaving the lenders and stockholders holding the bag if the company fails.

If they can't expect that, boards would be more likely to stop such behavior even if it's profitable.

Unlikely, at best, since the stock market is a very efficient vehicle for creating an ethical race to the bottom - if companies A and B can generate a 10% return at the risk of socializing some of the losses if they go bust, and companies C and D refuse to go there and so take less risk and generate a 5% return, who's going to be in business when it comes time to pay the paper? Probably A and B will have bought C and D outright. But that too is far afield from the original point.

I'd expect the stock market to price in people's expectations about what would happen to a company if it failed, given enough transparency (which needs to be mandated).

As you yourself point out, there's a moral hazard issue, too - why do I want to reward people who signed for a mortgage they couldn't pay, again?

Are you talking about people who a priori knew that they wouldn't be able to afford their house, but wanted the thrill of buying something large?

Are you talking about people who were responsible, knew their limits, and made their payments on time every month, but $BADTHING happened, and now they can't move or sell, while getting hit with an adjustment they never thought they'd have to face (due to moving before then)?

I think that there are remarkably few of the former, and a whole bunch of the latter.

Using the power of 20/20 hindsight to retcon people into being deadbeats doesn't sound like "moral hazard" to me.

I think the larger group is in the middle: People who didn't really know they might have trouble with this mortgage in the future. It seemed like a house purchase that made sense at the time, and then circumstances changed; or, they thought if they got in trouble they could sell the house, but surprisingly their house is now actually worth less than when they bought it, something a lot of people didn't realize was possible.

One big difference between homebuyers, as a group, and bankers, is that homebuyers aren't expected to know finances and markets to nearly the same extent, and are much more at risk of making what turn out to be bad decisions, completely in good faith.

I agree that your second group (bad thing happened) is much larger than your first group (people knowingly taking on bad risk), but I think my middle group is the largest.

or, they thought if they got in trouble they could sell the house, but surprisingly their house is now actually worth less than when they bought it, something a lot of people didn't realize was possible.

The effective value of your house drops by 5% pretty much the instant you buy it - since Realtor commissions come out of the sale price, not out of the buyer. How much attention do you have to not be paying to miss something that basic?

I agree that your second group (bad thing happened) is much larger than your first group (people knowingly taking on bad risk), but I think my middle group is the largest.

What exactly is the difference? If the change in circumstances is "something bad happens" then they go in that second group. If they've got a payment they can't carry indefinitely, because they gambled on an ever-rising market... well, if they'd gambled on the stock market rising eternally too, would you bail out their 401K's?

The effective value of your house drops by 5% pretty much the instant you buy it - since Realtor commissions come out of the sale price, not out of the buyer. How much attention do you have to not be paying to miss something that basic?

The only people that's relevant to are condo-flippers, in which case I think we're all united in our lack of sympathy for them.

Most people don't expect a house (which they intend to live in) to go down in price over the time horizon in which they expect to keep it.

well, if they'd gambled on the stock market rising eternally too, would you bail out their 401K's?

Please explain how a mortgage instrument (typical holding time: 7 years) and an investment instrument (typical holding time: 35+ years) have anything to do with each other.

Edited 2008-09-22 15:09 (UTC)

Please explain how a mortgage instrument (typical holding time: 7 years) and an investment instrument (typical holding time: 35+ years) have anything to do with each other.

I'd say that the conversion of the former into the latter is rather close to the heart of the current problem. To wit, the idea that mortgages could be bundled, sold, re-sold, and (mis)valued en bloc as though they were investment-grade securities is pretty directly associated with the current mess.

As to the intermediate point in this thread: it will also be necessary to find and somehow qualify a third class of current mortgage holders: those who were simply flat-out lied to. There are good and well-documented stories in reputable press that I believe of people whose "current income" and other numbers on mortgage applications were fraudulent or otherwise manipulated to get larger mortgages. Some of the buyers were no doubt complicit in this fraud (either through omission or comission). It's unclear to me how we'd figure that out and to what degree we'd bail out this class of people.

And finally, as to the original point cos is making: the bailout of large financial institutions is only VERY indirectly related to the mortgage crisis. It's much more directly related to a business infrastructure in which people and companies must borrow vast sums to operate. This includes entities ranging from investment banks that borrow billions to pay for securities transactions that won't clear for 2-13 business days, all the way down to state-level institutions that borrow hundreds of millions of dollars every year so they can make student loans to kids going to college.

In this kind of infrastructure, the inability to borrow funds - at ANY interest rate - causes business to stop. The purpose of bailing out at the high end is to maintain the flow of credit that these businesses require in order to operate. The present situation is one in which the people who normally make such loans won't make them because they have little or no confidence of getting repaid.

well, if they'd gambled on the stock market rising eternally too, would you bail out their 401K's?

Please explain how a mortgage instrument (typical holding time: 7 years) and an investment instrument (typical holding time: 35+ years) have anything to do with each other.

Because so far, the only logic I'm seeing as to why homeowners should be bailed out is because (due to the fall in house prices) they can't simply sell. If we're going to propose a bailout of homeowners because their asset lost value, I want to know why we don't propose the same for other classes of assets. I dunno about you, but the beating my house price has taken in the last year is less than the beating my 401K has taken in the last month.

Are you talking about people who a priori knew that they wouldn't be able to afford their house, but wanted the thrill of buying something large

Not to mention people who a priori knew nothing, because they didn't, couldn't, or wouldn't read the fine print. Again, to the extent that there's an issue of predatory lending practices, there's a need for individual punishment of individual bad lenders, but that's also an aside to fixing the problem.

Are you talking about people who were responsible, knew their limits, and made their payments on time every month, but $BADTHING happened, and now they can't move or sell, while getting hit with an adjustment they never thought they'd have to face (due to moving before then)?

And have we historically ever bailed those people out? Traditionally, "I did my best planning but something went wrong" is what bankruptcy is for.

Traditionally, "I did my best planning but something went wrong" is what bankruptcy is for.

Which Congress made much more difficult a couple of years ago at the urging of Big Finance.

Absolutely. The primary pushers of the Bankruptcy act were credit-card companies and other holders of unsecured debt, rather than mortgage holders, but since both tend to live under the same roof, it doesn't actually change much. I haven't studied the 2005 bill in enough detail to know how bad it is, though my knee-jerk reaction is against it.

If the financial system is on the brink of collapse then you may prefer to blow $700 billion rather than allow the collapse. If the investment banking system entirely collapses it doesn't just take itself down the drain. It takes your 401K's with it. It takes pension plans with it. It takes investments by towns with it. It takes the ability of many non-financial businesses to simply do business with it.

Doing a bail-out may allow pieces of the system to fail slowly rather than dramatically. If they fail in a slow, controlled manner then they won't have to depress the assets of the rest of the system. Morgan-Stanley and Goldman-Sachs were both profitable and solid companies. They beat earnings estimates in the most recent quarter. Their stock, however, is down over 30% as a result of the failure of other large investment houses (Lehman Brothers). As you take apart Lehman Brothers, if you flood the market with their assets you depress the value of other investment firms and you can put firms which are still able to operate out of business in the process. If that happens you may be looking at the collapse of the entire sector.

I think that's something you want to avoid.

I am not saying that I believe the government's plan is a good plan. I don't know enough about it to have an opinion. I don't know enough in general to really formulate a useful opinion even given the details. And I don't think enough details of the plan are even solidified yet to say.

Try to rescue the system, punish the people who are responsible for its failure, not just limited to the people running the organizations but the people in government who let it happen as well, like the people at the SEC who decided it was acceptable to waive regulations that would have not allowed the major investment firms to take on too much risk. If not rescue, at least attempt to put it to rest in a controlled manner.

The consequences of the system failing are a lot more dire than the individual businesses involved collapsing.

Sure, I accept as axioms in this post that:
1 - we need to prevent the collapse
2 - it is worth spending $700 billion from the government's general fund to do so.

These points can be debated, but I'm not debating them here, I'm accepting them as starting points.

First, I'm at work and haven't had time to read all the responses. If anyone's already covered the gourns I will, I apologize.

The problem isn't martgages that have already defaulted, it's securities that have been bundled in such a way that the issuers will default at some time in the future, as some fraction of the underlying mortgages do default.

So I don't see how to accomplish what you want without eitehr guaranteeing the mortgage-backed securites (which is helping the debt-writers, not the home-owners) of guaranteeing in advance that home-buyers who degfault on their mortgages will have the tab picked up by the government so they can stay in their homes.

As bad of a moral hazard any other option is, I think telling home-buyers that there's no future consequence for not paying loans they currently have outstanding is a much more extreme invitiation to bad behavior.

Perhaps the govenment could pick up the mortgages and take ownership of the homes, grant the defaulting home-buyers a long-term lease, and sell the properties to an organization more suited to being a landlord.

You're right on the first part: the problem is mainly that nobody knows how many mortgages will fail and how many of them will turn out to be on houses that aren't worth enough.

What the government needs to do is pass a plan that clearly makes it much more likely that mortgages will not fail. It doesn't have to "guarantee in advance that buyers who default will have the tab picked up" - that's a pretty stupid strategy. Rather, it needs to put in place a plan that makes it possible for homeowners who are in danger of defaulting, to readjust in such a way that they can continue paying without failing. That would cost the government some money, but nowhere near the full cost of a default.

Furthermore, the money doesn't actually have to be spent right now: As long as a sensible plan is in place, the financial industry can look at it and say "aha, now we can predict that a much smaller percentage of these mortgages will fail, therefore we can recalculate the value of these mortgage-backed securities and be confident in that value, therefore companies that hold credit default swaps insuring those securities have a more measurable liability and we can see that some of them are going to survive ... " etc. Basically a cascading effect, starting from the root, and flowing through the entire industry, stabilizing it, based on the expectation that a lot of now-uncertain mortgages will survive, perhaps with some loss, but not as much as the risk they now seem to be.

Regarding the hazard:

1. It can be made to apply only to loans already existing at time of passage, which would address the current crisis without affecting people's future home-buying behavior, and could be coupled with re-regulating mortgages to prevent massive bad risktaking by banks in the future.

2. Whatever the government does to stabilize troubled mortgages to allow homeowners to stay, can still have "consequences". Government may gain some of the equity in their home; their mortgage terms may be extended to a longer horizon; in some cases if the government's loss is high enough the homeowner might have to file bankruptcy and lose access to credit for a time (as well as loss of face, which is significant to people). Economically, though, we're better off if people get to stay in their homes, and if mortgages now seen as having uncertain value gain a more quantifiable and higher value to the industry.

Rather, it needs to put in place a plan that makes it possible for homeowners who are in danger of defaulting, to readjust in such a way that they can continue paying without failing. That would cost the government some money, but nowhere near the full cost of a default.

What is the homeowners incentive to continue to pay, aside from sentiment?

More importantly, you cannot adjust the terms of a securitized mortgage without the consent of the security holders - so we're right back where we started. Either the fed takes those securities under its roof, (which would allow it to change the terms of a given mortgage, if it chose) or it does not, and issues periodic by fiat changes to the assets (mortgages) underlying the security. This is not, I suspect, an actual recipe for stability, especially since those changes can be pretty much guaranteed not to happen in a short time frame.

I think there's also a key question - are you proposing to support those mortgages at whatever dollar value they stand, or write them down to the asset value of the collateral? In the former case, you've still got the fed on the hook for the difference between the dollar guarantee and the underlying asset value - potentially huge given the number of mortgages out there, and basically a giveaway to the banks and security holders anyway. In the latter case, you're back to the current buyout strategy anyway, except instead of cramming an write down on the security holders and then taking away the securities, we cram a write down on the security holders and leave them with the securities, which they'll be forced to hold for even longer, since the payout periods of the underlying mortgages has on average grown. Might be more viscerally satisfying, but won't solve the liquidity issues underlying the freeze.

Now, assuming that we decide that we can't afford to let all these financial institutions fail, and assuming we decide it's worth spending several hundred billion dollars on it right now - rather than argue the merit of those two points, let's take them as a given - assuming all of that... why would Congress even consider using that money to bail out the financial institutions directly?????

Mercy's sake, you don't really need to ask that question, do you? We've had a kleptocratic, carpetbagger government in power for eight years. They've been utterly shameless in their use of their power to line their own pockets and the pockets of their cronies and ass-lickers. Why, when the opportunity presents itself, would they not choose the option that channels still more rewards to the wealthy?

You know that you and I have disagreed violently in the past about whether the answer to this country's real problems lie in a policy solution (and I ain't no libertarian, god forbid). In cases like this, though, where the people are being coerced to contribute to a policy solution whether they want one or not, we've got an obligation to bitch up a storm about the form that that policy solution takes. In fact, I tried to do just that thing a week ago when the AIG bullshit went down, only to find invalid email addresses for both John Kerry and John Olver. Perhaps your links will work better.

I've been calling on the phone, because I think it's more effective than emailing. When I call I can actually speak to the legislative aide working on the issue, and have a real conversation, if I'm conversational about it.

I heard something the other day that a large chunk of the failed mortgages are NOT folks who live in their homes, but folks who were buying up houses intending to flip them. Should they be covered?

I think that to the extent that stabilizing mortgages for people who live there is not enough to stabilize mortgage-backed securities, other things need to also be done. But keeping people in their homes should be the starting point, rather than the afterthought.

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If you look at it from a moral, "want to puke" point of view:
There are homeowners who "shouldn't" be bailed out.
There are bank/brokerage/etc. executives & stockholders who "shouldn't" be bailed out.

Percentagewise, the extreme "shouldn't be" bailed out set, by this standard, is much higher in the latter set than in the former.

Furthermore, by the same moral standard, there are those in both sets who *should* be bailed out.

I suspect that in the former set (homeowners), that "should" set is pretty large, and possible even a majority. In the latter set, it's vanishingly small. Most of those who aren't in the "shouldn't" set are in a middle ground: people who bought some stock, knowing it might fail, and able to accept the consequences.

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Is Congress crazy?

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