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.
no subject
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.