Is Congress crazy?

[cos]

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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Comments

[cos]

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.

[mrf-arch.livejournal.com]

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.