In a major speech on the economy last month, John McCain correctly diagnosed the mortgage crisis. “A sustained period of rising home prices made many home-lenders complacent, giving them a false sense of security and causing them to lower their lending standards,” he observed, adding, “Some Americans bought homes they couldn’t afford, betting that rising prices would make it easier to refinance later at more affordable rates.”
“I have always been committed to the principle that it is not the duty of government to bail out and reward those who act irresponsibly,” McCain explained, “whether they are big banks or small borrowers.” But it was a very different John McCain who showed up in Brooklyn last week and outlined a plan that appears to offer precisely the sort of bailout he had rejected. After these two performances, we’re left wondering: Which John McCain will show up Tuesday in Pittsburgh, where he is scheduled to flesh out his plan in more detail?
McCain has protested that his latest plan is not a bailout. “I said that there shouldn’t be a broad government bailout,” he told a Wall Street Journal reporter who challenged him on the plan’s details. “I said very clearly and I’d be glad to get the record of what I said.”
Whether he defines it as a “broad bailout” or not, what McCain said last week is disturbing. He proposed something he calls the HOME plan, under which distressed homeowners could apply to the government for help. If they qualify under the terms of the plan, their mortgage servicers would be required to write down and retire their current mortgage, and they would be given a new loan backed by the Federal Housing Administration.
The new, federally guaranteed loans would constitute a bailout for borrowers and lenders who knew or should have known the risks inherent in gambling on housing prices. The structure of McCain’s program would create a perverse incentive for those homeowners whose homes are currently worth less than the value of their mortgages to default on their payments in order to qualify for a write-down. Lenders who put people into loans they could not afford would be spared the burdens of foreclosure.
Investors, meanwhile, would see the contractual terms to which they agreed when they purchased mortgage debt rewritten by the government. The reputation of American debt-backed securities would suffer accordingly. Taxpayers would also lose out on the deal: They will be on the hook if the distressed borrowers who qualify for new FHA-backed loans can’t pay those back, either.
McCain has defended his plan by arguing that it is much better than the one the Democrats in Congress and on the campaign trail have proposed. That is not an especially high bar to clear. McCain has pointed to the fact that, under his plan, homeowners rather than lenders would work with the government to write down problem loans, reducing the likelihood that taxpayers will wind up backing the riskiest loans in the lenders’ portfolios. McCain says the strict standards he would apply to borrowers also would prevent taxpayers from backing too much risky debt.
But this raises the question: Whom is this plan intended to help? According to the fact sheet that accompanied the speech, eligibility for the new plan is restricted to holders of a sub-prime mortgage taken out after 2005 who live in their home and can prove creditworthiness at the time of the original loan, but cannot meet their current mortgage obligations. Most borrowers in default or foreclosure would not meet these criteria — sub-prime mortgages, by definition, are held by borrowers with poor credit — but the campaign claims that 200,000 to 400,000 borrowers would qualify at a cost of between $3 billion and $10 billion.
In Pittsburgh Tuesday, McCain has a chance to return to the spirit of his original speech by providing more detail about whom his plan would help — and by making sure that his final plan does not reward imprudent lending and borrowing while punishing investors and taxpayers. The plan he outlined last week is unwise, but the very lack of detail leaves him some room to refine it. As it stands, the plan looks a lot like the kind of bailout McCain has pledged to oppose.