Defying a White House veto threat, the U.S. House of Representatives passed a pair of housing bills Thursday that would reward foolish lenders and borrowers, weaken the reputation of American securities, and punish renters. Not bad for a day’s work.
The centerpiece of the first bill is a $300-billion mortgage-insurance fund that would allow the Federal Housing Administration to insure an estimated 500,000 troubled home loans, at a cost to taxpayers of $2.7 billion. Under this bill, lenders can get the FHA to insure a souring loan by agreeing to write down the loan’s value by as much as 15 percent. This works out well for those lenders who let their standards plummet as housing prices soared, as well as for borrowers who took out loans they couldn’t afford. It doesn’t work out so well for taxpayers who exercised better judgment.
It doesn’t work out well for investors in mortgage-backed securities, either. These investors enter into contracts that specify the circumstances under which loan servicers can work out deals with cash-strapped borrowers. These contracts allow investors to know approximately how much their investments are worth. But the Democrats’ bill would throw even this small measure of certainty out the window by providing broad protection from legal liability for loan servicers who write down mortgages in violation of these contracts.
The massive write-downs that would follow from the Democrats’ bill wouldn’t just hurt rich investors. As the Competitive Enterprise Institute’s John Berlau has noted, middle-class investors, who own mortgage-backed securities through their 401(k) accounts and mutual funds, would lose billions. What’s worse, giving loan servicers a free hand to alter the terms of these contracts would contribute to an atmosphere of uncertainty on Wall Street at a time when uncertainty over the value of debt-backed securities is fueling a credit crunch.
A separate housing bill passed Thursday would provide states with $15 billion in grants and loans to purchase foreclosed homes. The ostensible purpose of this bill is to allow states to prevent foreclosures from blighting neighborhoods and driving down property values. In reality, the bill is a massive subsidy to lenders who made bad loans and now find themselves struggling to find buyers willing to take foreclosed homes off their hands. What’s worse, the bill provides an incentive for lenders to foreclose on struggling borrowers rather than work out deals with them.
When foreclosures rise in a particular neighborhood, homeowners in that neighborhood are faced with a dilemma. Unless the empty houses are promptly purchased, property values in the area can fall to the point where these homeowners are paying more on their mortgages than their houses are worth.
This is unfortunate for them, insofar as it is not their fault. But the Democrats’ solution to this problem would have the perverse effect of increasing foreclosures. A lender who might otherwise have worked out a deal with a struggling homeowner would have an incentive to foreclose instead, because he would be safe in the knowledge that the state has the money and a mandate to buy foreclosed properties right away.
Nor should the government prop up housing prices that are still well above historical averages. The Democrats’ bill punishes renters by enabling the states to compete with them for foreclosed properties in the housing market. Furthermore, if the bill has its intended effect of stabilizing the prices of homes that are not in foreclosure, renters who were waiting for housing prices to fall before buying would be punished for their prudence.
President Bush has threatened to veto both of these bills, and he would be right to do so. Fortunately, neither passed the House with a veto-proof margin, nor would either make it out of the Senate with enough votes to override a veto. The Democrats will try to force the administration to veto the bills so they can accuse Bush of “doing nothing” to alleviate the housing crisis. But if “doing nothing” means preventing the Democrats from making the problem much worse, then it is by far the better alternative.