Bailout: Could Government Actually Be Part of the Solution?
Thoughtful reader Robert Roth sent in some cogent comments in response to Saturday's entry on renegotiating mortgages. He raises many important issues about the mortgage crisis which tend to get brushed aside by blanket condemnations of any bailout.
I am not predisposed to any bailout, but intellectual honesty requires me to recall that the much-maligned "bailout" of Chrysler in the early 1980s saved the company and tens of thousands of jobs at modest (or according to Lee Iacocca, zero) government funds.
Though it was obvious the Savings and Loan collapse in the 80s was caused largely by Reagan-era deregulation of an industry which simply requires some regulation--that is, the crisis was predictable and easily avoidable--the horrendously expensive bailout did resolve a financial crisis which could have festered for years. Though the government covered depositor's money, the primary tool used to clean up the mess was auctioning of/ liquidating all the impaired properties--thousands of buildings around the country.
So all the bailout ideas require an honest analysis. Let's start with Robert Roth's commentary:
"L.S. recommends that people under threat of foreclosure try to work it out with their lenders. I have read in several places that that approach is problematic because in many (most?) cases, the people who collect the payments don't even know who holds the mortgage -- that precisely the complexity and opacity of the securities backed by these mortgages makes impractical the old-fashioned way of addressing the problem that L.S. suggests. If I'm wrong about that, I'd love to hear it, and wish someone would say so and why.
And while I agree folks in trouble shouldn't wait for a government bailout, I also think that to save everything from the homes of a great many unfortunate (even if some profligate) people to the global financial system and real economy, we should demand a government bailout commensurate with the size of the problem.
Today (12/15-16)'s WSJ cites the proposal of "Center for American Progress, a liberal think tank ... that the government buy some mortgage-backed securities and create a new agency, the Family Foreclosure Rescue Corp. [to] issue new, more affordable fixed-rate mortgages for those facing foreclosure whose homes are worth less than what they owe," and that of Alex Pollock, a resident fellow at the American Enterprise Institute, who says take a look at the history of Home Owners' Loan Corp, a now-defuncy federal agency created in 1933 that "acquired distressed mortgages from banks at a discount and refinanced them on easier terms."
Both ideas sound promising to me. So do preemptive tax cuts implemented by reducing payroll taxes immediately so as to put some cash into the hands of consumers, who carry two-thirds of the economy and seem to be sagging under its weight and quite likely about to drop it.
Perhaps it would be worth adding another point: I recall reading in the WSJ years ago that the French government, to combat an economic slowdown, was offering interest-free mortgages to first-time homebuyers. I suspect there are many more potential solutions if we were able to transcend the democracy deficit as a result of which relief is targeted to the Big Boyz (as I believe Jim Kunstler calls them) rather than the rest of us.
Paul Krugman's December 10, 2007 piece entitled Henry Paulson's Priorities argues that the Paulson proposal is intended only to create the appearance of action -- while helping some investors, but not families losing their homes -- "thereby undercutting political support for actual attempts to help families in trouble," in particular, probably, "legislation sponsored by Barney Frank that would give judges in bankruptcy cases the ability to rewrite mortgage loan terms. ... 'Bankers Hope Bush Subprime Plan Will Scuttle House Bill,' as a headline in CongressDaily put it."
Properly empowered, by the way, the bankruptcy courts may have considerable potential to examine transactions in more detail than would otherwise be possible. Then there's your own blog entry The Unintended Consequences of the Housing Bubble Bursting citing the December 10th SF Chronicle article which suggested the Paulson proposal is intended to shield Wall Street firms from lawsuits by foreign investors challenging the basis of the interests they'd been sold in CDOs, etc. as fraudulent in origination."
Any bailout is a complex thicket, so let's start with what we can safely surmise:
1. The political process will be slanted toward major contributors, i.e. the banking, real estate and lending industries. This should not surprise us in the least. Nonetheless, history suggests (i.e. the Depression-era Home Owners Loan Corp. mentioned above) that occasionally some political "interference" may have some value beyond helping the Big Boyz preserve their capital and profits--though of course any bailout must accomplish this first.
2. There will be political action of some sort because "we have to do something." Former Fed Chairman Greenspan has come out in favor of tax cuts for the imperiled borrowers, a proposal which is essentially meaningless because most of those borrowers probably wouldn't save enough in any such proposal to make a dent in their mortgage payments.
In this sense, the proposal will be largely ineffective but also relatively harmless.
3. We can safely assume about 25% of distressed buyers were speculators who never occupied the house, i.e. "flippers." A recent San Francisco Chronicle study found Investors own about one-fifth of Bay Area homes in foreclosure but the methodology was extremely conservative and so 25% seems fair. but the methodology was extremely conservative and so 25% seems fair.
Let's guesstimate that another 50% of distressed properties were purchased by buyers with little or no "skin in the game," i.e. down payment. The S.F. Chronicle study found that about 70% opf subprime buyers in 2005-2006 put no money down. Thus, these people will lose virtually nothing in foreclosure because they brought nothing to the party in the first place.
So when the mess is settled by market forces, i.e. auctions etc., the primary losers will be speculators (whom no one expresses interest in saving) and the lenders and buyers of CDOs, SIVs, mortgage-backed securities, etc. (ditto).
4. The primary lesson of the 1980s S&L bailout is: move quickly to liquidate bad debt via market auctions of distressed properties. In extremely overbuilt, investor-fueled markets like California's Central Valley and Las Vegas (to name but two of many), there may be no buyers at lender-run auctions; but the market solution is simple: lower the price until buyers emerge, even if the price is $1.
In extremely depressed areas such as certain neighborhoods in Detroit, houses don't sell even for $1. In these cases, Nature takes over the neighborhood and/or the city bulldozes the vacant, decrepit homes. This is sad, but you can't force people to live somewhere, or artifically inflate prices or economic vitality.
If we set aside these outliers, most distressed property in economically viable areas can be sold, albeit at huge discounts. Thanks to a steady flow of "on the ground" intelligence from readers all over the country, I can report that buyers--not just professional investors, but wage-earners looking for investments/places to live--will come out when the price is right.
Within the last few days I have heard from readers who are planning to bid on properties which are being auctioned off (foreclosure/REO auctions) or considering buying a home in areas which never experienced the bubble rise and therefore aren't experiencing the bubble popping.
Since readers of this site are a priori fiscally conservative and savvy, :-) I think these potential buyers are evidence that not everybody is an underwater owner of a negative-equity home. One reader is considering paying the 10% penalty to extract some 401K money which is limited to stock market mutual funds in order to purchase property. If the stock market tanks as severely as many of us expect in 2008-2011, this will be seen in retrospect as a very savvy move.
5. As Mr. Roth suggests, the courts could step in and make a substantial contribution to rapid resolutions of bad debt and distressed properties. The courts are a wild-card because the Supreme Court could always step in and protect lenders and investors (domestic and foreign alike) from losses, but the bankruptcy laws have quite a bit of case history and may yet serve as a "clearing house" of sorts.
6. From one view, it can be argued that since government enabled the entire bubble via lack of lending/investment banking oversight (once again), it should be part of the solution. Again, I am not talking about using tax money to bail out hopeless mortgages, I am talking about a government-sponored auction of debt and properties along the lines of the Resolution Trust Corporation which cleared up the S&L mess in the late 80s/early 90s.
It's certainly something to consider, especially when we recall what happens when the government colaborates with lenders to cover up the losses, as the Japanese government has done for the past 17 years: you get 17 years of stagnation and deflation, and ballooning government deficits.
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Tuesday, December 18, 2007
Bailout: Could Government Actually Be Part of the Solution?
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