Not So Fast on Mortgage Solutions
A drumbeat is building for some form of federal takeover of troubled home mortgages. Sen. Christopher J. Dodd (D-Conn.) is leading the charge in the
Jul 31, 202013.3K Shares514.7K Views
Image has not been found. URL: /wp-content/uploads/2008/09/bernanke38.jpgFederal Reserve Chariman Ben S. Bernanke (WDCpix)
A drumbeat is building for some form of federal takeover of troubled home mortgages. Sen. Christopher J. Dodd (D-Conn.) is leading the charge in the Congress, while Bank of America has been lobbying hard behind the scenes. Respected economists like Paul R. Krugman and Alan S. Blinder, both of Princeton, have added intellectual heft to the bandwagon.
To construct new legislation, the two most cited precedents are the Resolution Trust Corporation (RTC) that cleaned up the mess left by the 1980s Saving and Loan bust, and the Depression-era Home Owners Loan Corporation (HOLC), Blinder’s favorite, that took over some four million mortgages in the 1930s.
Illustration by: Matt Mahurin
Neither precedent is fully on point. The RTC was a mortgage seller, not buyer. When the government paid off the depositors of bankrupt S&Ls, it automatically acquired a mare’s nest of dicey commercial and residential mortgages. The RTC then ran one of the biggest fire-sales in history, bundling up assets into big collateral pools that were sold off en masse to Wall Street and other big investors. Inevitably, many of the firms that made a bundle creating the crisis made a second one on the way out.
The HOLC actually did buy and hold mortgages, but it was intervening in a market where only the most solid citizens had qualified for mortgage finance. In the 1930s, less than half the housing stock was owner-occupied. Minimum down payments were typically high, and mortgage maturities rarely exceeded 15 years. All HOLC clients, in short, had a massive economic stake in their homes. HOLC rules forbade lending to anyone with less then 20 percent equity in the home.
Today’s subprime and“liar loan” mortgage holders are a different breed. Perhaps one-third are speculators; another third, reasonably well-to-do folks whose appetites for jacuzzi-ed McMansions got ahead of their incomes. Only the remaining third are the plausibly victimized lower middle-income families, that everyone wants to help. As economists are wont to do, Blinder assumes into existence a neo-HOLC able to sort out the speculators and fraudsters from the proper beneficiaries of government largesse. He might first check out the Small Business Administration’s experience in the wake of Katrina.
The real problem with any new HOLC-like initiative, however, is that it is almost certain to be a windfall for the custom-suit set. Dean Baker, co-director of the Center for Economic and Policy Research, is a careful researcher with a decidedly left-liberal bent. He calculates that the mortgage-subsidy plans now floating around Congress will actually work as a heavy tax on lower-income home owners.
The normal ratio of home prices to annual rental costs is about 14-1. Because of the credit bubble, they are now 20-1, a 43 percent premium. Most subsidy plans seem to contemplate mortgage principal reductions only in the 20 percent range. Keeping lower-income people in homes at that rate would entail a substantial wealth transfer from poorer people to bankers, while still leaving home owners little prospect of accumulating equity. Baker’s preferred solution is to amend the bankruptcy law, so judges can convert mortgages into market-rental leases. Tenants get a fair price for their housing, and the banks take the losses.
But that brings us to the real nub of the issue. Responsible officials, from Federal Reserve Chairman Ben S. Bernanke through Treasury Secretary Henry M. Paulson, fear that a true valuation of assets on bank balance sheets could bring down the world financial system.
The federal mortgage agencies — Fannie Mae, Freddie Mac and the Federal Home Loan Bank Board — poured hundreds of billions into dicey mortgages over the past year, and have now been authorized to spend $350 billion more. In just the last few weeks, the Fed has authorized some $400 billion in new finance, targeted at bank-held mortgages. And Bernanke took barely a heartbeat to sign off on a $30-billion credit to prevent a default at mortgage-heavy Bear Stearns. All those prodigious financings are almost pure waste — aimed solely at maintaining the charade that banks are correctly valuing their huge holdings of mortgages.
There is a better way. But it would set the possibly unthinkable precedent of allowing taxpayers to get full value for their money, instead of absorbing only the losses.
Economists have already reached a near-consensus that the required home mortgage writedown is about $400 billion. Add in commercial mortgages, highly-leveraged takeover loans, credit cards and the rest, the total tab will come to between $800 billion and a $1 trillion. About half of it, or some $400-$500 billion is at the banks. Subtract the $150 billion in writedowns to date, and there is $250-$350 billion to go.
The SEC and the Federal Reserve have the authority to require a full-scale revaluation of bank balance sheets — applying tough, consistent rules to force restatements to realistic levels. The capital losses would require an immediate infusion of perhaps $200 billion in new equity. That’s far more than we could, or should want to, raise from the Arab and Chinese sovereign wealth funds that have been the main recent source of new bank capital.
But Washington does do have a sovereign wealth fund of its own. The Social Security Trust Funds own more than $2 trillion of U.S. treasuries that, conservatives have long argued, earn too low a return. The trust funds could supply whatever equity shortfalls are left after true private investors have had their shot. At most, bank stocks would be 10 percent of trust fund holdings, and over the long term, would probably be quite profitable. Current shareholders, of course, will take it on the chin — but they will have the satisfaction of inflicting appropriate punishments on their executives.
A return to a world of solvent banks would allow us to focus, finally, on the far more serious business of repairing the real economy. It will allow us to take a long careful look at the kind of regulatory regime we need to reap more of the benefits of the new world of hyper-finance, with fewer of the cataclysms.
Charles R. Morris, a lawyer and former banker, is the author of “The Trillion Dollar Meltdown: Easy Money, High Rollers and the Great Credit Crash.” His other books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P. Morgan Invented the American Supereconomy” and “The Cost of Good Intentions,” about the New York fiscal crisis.
Paula M. Graham
Reviewer
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