The emerging mortgage bailout plan

Yesterday, the NY Times ran an article titled, "Mortgage Plan May Aid Many and Irk Others". The story described the federal proposal to assist homeowners who are at risk of foreclosure. It's great that the Feds are finally turning to the problem underpinning the crisis; however, it's unfortunate that the Bush administration continues its focus on keeping lenders whole as opposed to helping borrowers. To that end, their plan tries to assess whether it benefits the lender to let a home foreclose versus negotiate easier terms with the borrower. And, of course, if the bank chooses to work out the loan, then the federal government will guarantee it. Unfortunately, this approach, which is far more bank-friendly than consumer-friendly, raises a number of questions:

• Will banks work in good faith with consumers? To date, they haven’t. As Joe Nocera observed in a recent article, even after the Fed invested billions in them, banks have shown greater interest in new mergers than using the funds for their intended purpose - making loans
  
  
• The loan servicers tend to operate on auto-pilot when it comes to the foreclosure process. Can we trust the loan servicers to really help borrowers? Here's a clue - most of the loan servicing in the country is conducted by three banks: Chase, Bank of American and Wells Fargo. These are, of course, the three largest institutions who have capitalized on the financial crisis to grow even larger.
  
  
• Millions of loans are in jeopardy now. The federal proposal entails considering each loan separately which promises to be an enormously time-consuming process. Will this approach address the crisis quickly enough to make a difference to at risk homeowners?
  
  
• To qualify for the program, it appears that borrowers have to miss several monthly payments. As your article notes, this will incentivize many borrowers to stop making monthly payments. Others will feel they are being punished for their continuing to make payments.
  
  
• Last, the proposal ignores borrowers who were illegally or unethically prompted to refinance their homes and will continue to face foreclosure. Consider the elderly individuals who owned their homes outright but were "persuaded" to take on a subprime loan.
  

If this or the future administration can leave ideology behind (isn't it past time to do so?), there are other simpler, broad-stroke approaches to resolving this crisis. Several have been discussed in the Times, such as the proposal to refinance all residential mortgages on primary residences into 30-year fixed-rate mortgages at 5.25 percent and place those mortgages with Fannie Mae and Freddie Mac. At a minimum, the government could institute a foreclosure moratorium and then lock in payments at a lower rate and then permit them to rise (or fall) very slowly over several years. This would stabilize housing prices and permit a softer landing. The real story behind this economic crisis has been the costly triumph of ideology over common sense. The ideologues have been proven wrong and it's time to do what works. To that end, we have to stop feeding the Frankenstein institutions that created this mess and focus on the human beings who are at risk of losing their homes. Failure to prevent them from going into foreclosure will certainly lead to a cascade of declining home values, great human suffering and a longer, deeper recession for all of us.

The City on the Hill - A Fairy Tale for Our Times

Once upon a time there was a prosperous city high in the mountains. The reason the city was prosperous was that the surrounding hills had deposits of precious gems and gold. The people of the city were greatly admired from afar for their prosperity and the wisdom of their rulers. Many people would try to venture through the dangerous mountains to live in the city; other cities sought to emulate their advanced ways.

Of course, the wealth of the city resulted, in part, from miners who worked the rich veins of precious metals in the surrounding hills. And ordinary citizens benefited greatly when miners returned home and bought things in local stores and paid taxes. With a steady, reliable stream of wealth flowing through the city, citizens found that they could safely buy on credit, knowing that their prosperity would not abate.

Alas, no good thing lasts forever and that was the case for the city on the hill. Over time, a few of the miners grew ever wealthier and began to buy out small mining outfits. After a few years, there were just a few very large, and very powerful, mining companies left. And these companies came under pressure from their owners to generate ever more profits. Some of these profits were spent locally and so everyone was happy.

However, eventually the veins of gold were exhausted and the companies had to start looking elsewhere.

So imagine their surprise and delight when they discovered rich, untapped veins directly beneath their city. At first, the companies mined the veins on the margins of the city and didn't tell anyone what they were doing. However, inevitably the easy veins were tapped out and they had to probe deeper under the city. It was only a matter of time before citizens became aware of the growing sounds of tapping beneath their feet.

A town meeting was convened and some citizens argued that the mining companies should be prohibited from mining below the city. “They'll destroy the city!”, they argued. Others suggested permitting limited mining that wouldn't endanger the city.

The mining companies had a different perspective. They pointed out to everyone that their employees spent their earnings in the city and that the companies paid taxes* to the city government. If the city restricted their activities, they would have to move their operations . . . and money . . . elsewhere. Besides, didn't everyone know that the mining companies had a great safety record and hadn't had a major accident in nearly 80 years. This was true, but the companies didn't mention, and people had forgotten, that the city council had imposed strict safety standards after that tragic accident.

What do do? The city elders were perplexed. They didn't want citizens to get mad at them (especially with an election coming up); but they certainly didn't want to “kill the goose” that provided so much prosperity. Also, over the years, the mining companies had quietly given city elders a share in their companies and had helped them retain their lofty positions through periodic gifts.

So, the city elders sat the mining company owners down and explained the situation.

“Not to worry!” replied one owner. 'Our engineers are the best and they will make sure that our mining operations won't jeopardize the city.”

“Trust us!”, declared another. “We live here too and we would never do anything to endanger the city we love.” The speaker saluted the city's banner to punctuate his point.

And so the city elders explained to the public that the mining companies could be trusted and that government efforts to limit them would only muck things up and, in fact, might make matters even worse, because everyone knew how incompetent government bureaucrats were. And since no one really wanted the wealth to stop flowing, most everyone decided not to push the issue further.

But an odd thing happened. Over the next year or two, many of the mining company owners sold their holdings and moved far, far away (actually, they purchased some rather large islands in the Caribbean – but that's another story).

Meanwhile, back at the city on the hill, strange cracks showed up in the walls of buildings, floors began to tilt and the sounds of drilling grew ever closer.

And, one day, it happened. A section of the city collapsed into the cavern that had grown beneath it. While most of the city was intact, all mining operations had to be severely restricted. Suddenly, the survivors had to contend with the fact that the money coming into the city had declined precipitously. Making matters even worse, many of the citizens who had bought on credit couldn't pay their bills and several merchants went out of business. The merchants' employees who had lost their jobs stopped spending money and this in turn hurt the remaining merchants. The city's economy steadily spiraled downward. A formerly prosperous people were forced to live in reduced circumstances and over time, the city on the hill looked more and more like a dilapidated slum.

The citizens were furious with their leaders and forced them out of office and elected new leaders – some of whom were the same people who had warned about the dangers of mining under the city. But it was too late. Even thoughtful and competent leaders could only moderate the damage that had been done and the city continued its decline.

And the former city elders? Well, they still had their shares in the mining companies and they weren't forgotten by the mining company owners who provided them with very nice homes in their new island havens.

Epilogue

Not surprisingly, the people in other countries who had admired the city on the hill realized their folly. “That whole city was built on a bed of sand”, they declared. The once beautiful city became a laughingstock and, eventually, a cautionary tale about greed. But eventually, even the cautionary tale was forgotten.


*Actually, the mining companies paid less and less in taxes over time. They successfully persuaded the city elders that taxes reduced their profitability and that they would move elsewhere unless they were lowered.