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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"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.

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