Here is what is wrong with McCain’s new housing proposal: It can’t improve on current law without rewarding an unacceptable amount of bad behavior.
Under the Frank-Dodd housing bill that was signed into law last summer, borrowers qualify for a federally subsidized workout only if they meet the following criteria:
1) The borrower must live in his house — no investment properties.
2) The borrower must show that he has been spending at least a third of his income on mortgage payments since March of this year.
3) He must also show that he can afford to make lower payments if his lender agrees to a write-down.
This is obviously a narrow slice of borrowers — around 400,000, according to most estimates. It excludes people who borrowed to buy investment properties in order to flip them for a profit. It excludes people who are hopelessly in over their heads and simply cannot afford the homes they’re in. And it excludes people who could afford to pay their mortgages if they wanted to but have instead decided to mail the keys to the bank rather than continue making payments on a house that is worth less today than when they bought it.
McCain’s campaign says his plan would help “millions” of borrowers stay in their homes without authorizing any new spending. But he has not said how he plans to accomplish this without lowering the standards set forth in the Frank-Dodd bill. And if he does lower the standards — by, for example, letting people who can afford their current payments get a write-down just because their property value has fallen — then he would be offering taxpayer assistance to “ruthless borrowers,” which is an industry term for borrowers who default on their obligations not because they can’t pay but because they’ve decided it’s not in their interest to pay.
McCain’s plan would also be a gift to lenders who abandoned any sense of prudence during the boom years. Under the Frank-Dodd bill, lenders must agree to “take a haircut” — slang for writing down the value of a mortgage — in order to qualify for federal insurance on a distressed mortgage. The lender bears an initial loss but is protected if the borrower eventually defaults. McCain would transfer that initial loss to the taxpayers. Under his plan, the government would buy mortgage loans at face value and then reduce the principal and interest on these loans to accommodate distressed borrowers. Taxpayers would take so many haircuts we would all look like Britney Spears after a three-day bender.
Defenders of McCain’s plan argue that the lenders are already getting a bailout through the Treasury Department’s purchase of mortgage-backed assets from banks and other financial firms. They argue that McCain’s plan actually saves taxpayers money by preventing foreclosures and preserving the value of the assets the Treasury Department is about to buy.
There is a big difference between Treasury’s plan to buy mortgage-backed assets through a reverse auction and McCain’s plan to buy the mortgages themselves at face value. It gets complicated, but here’s the bottom line: There must be a limit to the level of reckless behavior we are prepared to reward in a given bailout, especially if we are only improving on previous bailouts in a marginal way.
The Frank-Dodd housing bill has only been in effect since Oct. 1. It gives lenders who own mortgages ample incentive to work out deals with distressed borrowers and avoid costly foreclosures. It also provides liability protection for loan originators who sold their mortgages to Wall Street. These lenders are authorized to work out deals on behalf of investors in mortgage-backed securities (of which the U.S. government is soon to be the biggest). Most important, Frank-Dodd sets reasonable limits on what kinds of borrowers will be eligible for taxpayer assistance.
We never thought we would defend the Frank-Dodd legislation, which we bitterly opposed last summer. But it looks downright prudent compared to what McCain has proposed. McCain’s plan is a full bailout for lenders, and it cannot do much more than the Frank-Dodd bill without letting “ruthless borrowers” and other reckless types off the hook. It is time to acknowledge that the government has gone as far as it can without creating a level of moral hazard that is unacceptable. Give Frank-Dodd — and the Paulson plan — time to work.