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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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.

"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.

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.

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.

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'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.

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

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).

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.

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)

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.

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.

"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.

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.

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?

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.

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?

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.

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.)

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