Mismanaging the Mortgage Mess

COMMENTARY Markets and Finance

Mismanaging the Mortgage Mess

Mar 28th, 2008 3 min read

Former Distinguished Fellow

Ernest served as a Distinguished Fellow at the Heritage Foundation.

Bad decisions travel in pairs. Worse, they sometimes travel in mobs.

Consider how government is overreacting to our mortgage mess -- proving the adage that nothing is so fouled-up that Congress can't make it worse:

  • Taxpayers could be hit with a $300 billion-plus tab to help homeowners who filed false loan applications as well as those just struck by bad luck.
  • Mortgage rates could go up and their availability go down if Congress rewrites laws to shift the losses from individuals to companies -- which will want to recoup those losses through stiffer terms for future borrowers.
  • There's an effort to have Congress provide money for communities to convert these foreclosed homes into public housing.

Lawmakers are rushing to act and claim credit quickly -- before people realize that the private sector has already made major progress toward relief. Few know that the mortgage industry has been working aggressively to refinance troubled subprime loans through initiatives that include the "Hope Now" program announced in October. That's going as unnoticed as positive news from Iraq. Yet the Financial Services Roundtable reports there were 300,000 mortgage do-overs in the last quarter of 2007 and almost 100,000 more in January, with similar February and March numbers expected.

And contrary to a plethora of media reports, the Fed didn't really spend $30 billion on the Bear Stearns matter. But even if it had, would two wrongs make a right? (More on these later.)

Good intentions abound. But by protecting financial markets from a Bear Stearns bankruptcy, the Federal Reserve may have invited worse problems. A Hillary Clinton speech demonstrates the political consequences that this provoked:

If the Fed can extend $30 billion to help Bear Stearns ... the federal government should provide at least that much emergency assistance to help families and communities address theirs. That's why I'm calling for the creation of a one-time emergency $30 billion fund that would go directly to cities and states to address the housing crisis.

This money could be used to purchase foreclosed or distressed properties, which cities and states could then resell to low-income families or convert into affordable rental housing.

Where to put public housing is always controversial. Imagine the stir if every neighborhood were forced to deal with bringing public tenants into each troubled home. Not many residents would consider this an improvement!

As Congress returns to Washington at the end of March, leaders plan to fast-track companion bills by Rep. Barney Frank (D-Mass.) and Sen. Chris Dodd (D-Conn.) to "address the mortgage crisis." Actually, "fast-track" is intended to be "warp speed."

Since they chair their respective banking committees, these liberal lions expect to push their packages through quickly, and the Bush Administration hasn't acted to stand in their way. Under their plan, as described in a paper by The Heritage Foundation's David C. John, it's a buyout disguised as a refinancing plan:

  • The Federal Housing Administration (FHA) would get $20 billion from Congress, using it to capitalize $300 billion in bonds -- secured by the full faith and credit of the United States (i.e., with taxpayers' money).
  • FHA would pay a cash fee to lenders who would then reduce the amount a borrower owed and refinance the mortgage at a reduced interest rate.
  • FHA would fully guarantee the loan, promising to pay in full if there was a default.
  • Another $10 billion would go to states and communities to buy and fix-up foreclosed houses, then re-selling them or using them for public housing. (See Clinton plan!)

And how about that Bear Stearns action that Clinton and others claim is a "bailout" creating moral justification for giving taxpayer money to defaulting homeowners? The $30 billion guarantee is being mischaracterized. As noted by J.D. Foster of The Heritage Foundation, the guarantee would reach $30 billion only if a designated group of that firm's assets turns out to be totally worthless. The Fed is actually only on the hook for the "difference" between the value and $29 billion, as determined within six months. If the value ends up being $25 billion, then just $5 billion would be spent on the guarantee. If the assets are worth $32 billion, the Fed will reap a $2 billion profit.

And let's not forget the rest of us -- we who didn't overextend ourselves, didn't file false loan papers, but who are being prodded to be guarantors of those who did? We all want to be good neighbors. Let's find a better way to prove it, without having to pay off their mortgages.

Ernest Istook is a distinguished fellow in Government Relations.

First appeared in Human Events