Part of this plan sounds like an unambiguously good idea. But most of the coverage I’ve seen is ignoring what should be the key questions.
Yesterday President George Bush and Treasury Secretary Henry Paulson announced a plan to prevent the interest rate from rising on adjustable-rate mortgages for a particular class of borrowers. The first question I had was the same as Yves Smith: by what authority could a declaration of the President, or even act of Congress, alter or rescind the terms of existing mortgage contracts?
The Wall Street Journal’s answer to this question appears to be that the President and Treasury Secretary were in fact announcing a voluntary agreement on the part of some lenders:
Under the deal, formally released yesterday, the industry would voluntarily help as many as 1.2 million homeowners who are heading for trouble paying their subprime mortgages but aren’t yet lost causes. For some homeowners, loan-servicing companies will agree to freeze mortgages at their low introductory rates. In other cases, credit counselors or loan servicers will walk mortgage holders through refinancing processes.
The natural question is then, Why did lenders volunteer to receive a lower interest rate than that to which borrowers had previously committed? And why was the announcement coming from the government rather than the creditors themselves? There unquestionably can be a benefit to the lender to renegotiating the terms of a problem loan– better half a loaf than none. And there is a profound problem coordinating such renegotiation in the modern world of mortgage-backed securities, as Paul Krugman explained last August:
Consider a borrower who can’t meet his or her mortgage payments and is facing foreclosure. In the past… the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home….
Today, however, … the mortgage was bundled with others and sold to investment banks, who in turn sliced and diced the claims to produce artificial assets that Moody’s or Standard & Poor’s were willing to classify as AAA. And the result is that there’s nobody to deal with.
In such a setting, there may be a very useful role for someone– perhaps the Treasury Secretary– to coordinate this process, and help arrive at an arrangement that collectively is in everyone’s interest, but nobody could have implemented on their own. To the extent that this is what has happened, surely no one could object to the plan.
Tanta has an interesting alternative explanation of the role of the government in facilitating this coordination, noting that certain details of the tax treatment of real estate mortgage investment conduits invite clarification from the U.S. Treasury on the conditions under which the terms of a mortgage could be altered and still qualify as not being “actively managed” by the trust. Again, to the extent this is the story, such clarification from the government is surely most welcome.
But I wonder if the Secretary did more than just clarify and help coordinate. Bloomberg provided this curious detail:
The agreement addresses homeowners unable to afford higher interest rates once starter rates increase, and offers help in one of three ways, a White House official said. The options are freezing rates or refinancing into either a new private mortgage or a Federal Housing Administration-backed loan, he said on condition of anonymity.
We announce with great fanfare that we’re “doing something”, though details of that something can only be described by an official insisting on anonymity? It’s that third option mentioned by the anonymous official that could be the potential stinker here. To what extent did lenders perceive this agreement to be in their interest because the government is offering to absorb some of their capital loss?
And this gets to the heart of the policy discussion that we need to have, but have not yet engaged in. My reading is that there are substantial capital losses that must be absorbed by somebody– some creditors must take a loss on their investments, some borrowers must lose their homes, and all home-owners must see a decline in the value of their asset. The worry that these events could become so large as to cause huge problems for all of us is in my mind very real, and it might be that some commitment from the taxpayers could help mitigate some of these problems. But I’d prefer that we discuss openly and up front how much we’re willing to spend, and how much we realistically expect those expenditures to accomplish.
This is too big a problem for us to pretend to have found an easy and painless fix.