We didn't lose the game; we just ran out of time. - Vince Lombardi

Thursday, February 19, 2009

Some commentary on the housing plan.  First, McArdle:

Well, the obvious point is that it represents a massive transfer to borrowers from lenders and the rest of us.  As far as I can tell, there is no penalty for having borrowed more than you could realistically afford to repay--not so much as a speck of dirt on the credit report.  The administration’s release talks a lot about “responsible homeowners”, but very few responsible homeowners have payments that amount to 43% of their monthly income.  There are exceptions, of course, such as people who have just lost their jobs, but most of the people being helped are, nearly definitionally, people who bought more house than they could afford in the belief that prices would keep rising indefinitely and they would make big bucks.

....

It’s hard to muster too much sympathy for lenders who made loans to these speculators, except of course for the fact that “borrower-friendly” rules like the ability of bankruptcy judges to cram down mortgages means that those of us who have not been speculating in real estate get to pay higher mortgage rates when we do buy.  Expect Chapter 13 bankruptcy to become extremely popular over the next year or so.  Also expect your own credit card lines to be cut and interest rates to rise as lenders attempt to minimize their exposures to those bankruptcies.

And Pethokoukis:

But it is certainly debatable whether we should even be trying a savior-based plan to prevent foreclosures. Do we need Uncle Sam to “save” homeowners who have sinned against the gods of financial prudence? Here’s how the folks at Weiss Research see things after examining the Obama plan: “Foreclosures are actually resulting in overpriced homes burdened with too much debt being moved into the hands of new buyers, who are paying drastically reduced prices. They can therefore purchase using a traditional mortgage. ... Delaying and dragging out the downturn by artificially propping up home prices will arguably work against the market healing.”

In the same vein, former Bush economic adviser Lawrence Lindsey has suggested an immigration program that would give a provisional green card to anyone who invested at least $10 million in residential property and held it for five years. And bond guru David Goldman of the Inner Workings blog relates that he’s been getting inquiries from Chinese investors interested in the U.S. housing market. He also highlights what is easily the worst aspect of the Obama plan, the “cramdown” provision which would allow judges to modify mortgages. “Allowing judges to show generosity to homeowners ... and keep them in their homes makes the core assets of the banking system uncertain. ... Cramdown probably is responsible for the deterioration of subprime AAA’s during the last few days.” That’s what happens when you toss 1,000 years of contract law out the window in the middle of a global financial crisis.

I’ve had a night to mull this over.  I do like the idea of creating incentives for banks to modify mortgages (provided that we have legal protection of the banks against the inevitable securities fraud lawsuits).  The limit of the program to those who owe 105% of the home value will keep it from bailing out people who made really bad decisions.  It essentially eases the pressure in home-owners who are almost, but not quite, able to keep up.

But the program has to be focused on that—on giving a very small cushion to the market.  Attempts to re-inflate the housing bubble are bound to backfire.  Restoring property values can not and should not be a priority.  Housing prices are down.  They need to stay there until the market picks up.  That’s the only way to signal to homebuilders and buyers that we have too many existing homes on the market.

I’m also not happy with the additional funds being poured in to Fannie and Freddie.  I would prefer those companies to be busted up and sold off.  I know little about banking, so maybe I’m talking out of my ass.  Buy I wonder if FM2 could just become a temporary repository for the toxic mortgages TARP was supposed to be buying up, swapping out its good mortgages for bad ones.  The taxpayers would take a bath, of course, but we’re going to take a bath anyway, so we might as well kill Fannie/Freddie while we’re getting hosed.

In the end, the proposal would be workable except for one thing—the “cramdown” bankruptcy provision.  I would never be able to support a bill that allows bankruptcy judges to lower loan principle.  Such a move would provoke a tidal wave of bankruptcies, freeze the credit markets completely and provide windfalls to home-buyers at the expense of banks.  It’s, by far, the stupidest idea in the proposal.  And so, given how Washington works, it’s probably the most likely to get passed.

That’s ignoring the moral issue.  Here are two scenarios:

1) The house is foreclosed on and sold to a new buyer at the market rate.
2) The loan is crammed down to the market rate.

What’s the difference between (1) and (2)?  The banks lose the same amount of money and the house has the same loan against it.  The difference is that (1) favors the responsible buyer while (2) favors the person who got in over his head.