Solving the mortgage mess

Now that we have the subprime mortgage mess, solving it is inevitably going to create a sense of injustice in some quarters. During the second Obama-McCain debate, I was startled by McCain’s sudden revelation of a new plan to address the mortgage crisis:

“As president of the United States…I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes — at the diminished value of those homes and let people be able to make those — be able to make those payments and stay in their homes.

“Is it expensive? Yes. But we all know, my friends, until we stabilize home values in America, we’re never going to start turning around and creating jobs and fixing our economy.”

He emphasized that this was his very own plan, not Obama’s or Bush’s. But it turns out that Obama had said something seemingly similar in a speech given on September 23, saying:

“For example, we should consider giving the government the authority to purchase mortgages directly instead of simply purchasing mortgage-backed securities. In the past, such an approach has allowed taxpayers to profit as the housing market recovered.”

But while the broad details of the McCain and Obama plans appear similar, apparently the details McCain’s plan, released later, are different enough from his own that the of Obama camp is now criticizing the McCain plan as mainly benefiting the financial institutions that caused this mess.

What McCain seems to be suggesting is this. Suppose someone has a $200,000 mortgage on a home that is now worth only $100,000. McCain’s plan would purchase the mortgage from the banks at the full value ($200,000), and then renegotiate the mortgage with homeowner for $100,000. This enables the banks to be fully bailed out of the consequences of their reckless lending, and also bails out the homeowners. It is the taxpayers who foot the bill for the remaining $100,000.

Critics have argued that there is no reason that the banks should be bailed out this way by buying the mortgages at face value. Instead they should pay them the ‘real’ value of the mortgages. But determining the ownership and real value of individual mortgages is not going to be easy since they have been bundled and sliced and diced on their way to being transformed into easily marketable securities.

Clearly the banks want to get as high a price as they can. But they have no real leverage in this situation except for what they have by virtue of their influence with the government partly purchased through their lobbyists’ contributions to politicians.

The government should use its leverage to say that they will not bail out the banks but will instead take them over (partially or wholly) by purchasing their stock and thus gaining control. Then they will be able to benefit when home values eventually rise and the banks become more stable and their stock values go up. The government can then sell its stock and get out of the retail banking business. But in the interim, they will have effectively nationalized these institutions, the way they have already nationalized Fannie Mae, Freddie Mac, and AIG.

This is the model being practiced by the European countries led by England and is based on the Swedish solution to their 1992 crisis.

Sweden did not just bail out its financial institutions by having the government take over the bad debts. It extracted pounds of flesh from bank shareholders before writing checks. Banks had to write down losses and issue warrants to the government.

That strategy held banks responsible and turned the government into an owner. When distressed assets were sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies as well.

It now seems that the US government is adopting this very solution. Of course, this move smacks of socialism and adopting it will be a tacit concession that capitalism has at least partly failed. It will thus be anathema to those ideologues who do not see problems as requiring pragmatic solutions based on whatever realistic options are available but as requiring actions based on an ideological template. The true free-market believers will say that the government should do absolutely nothing and let the chips fall where they may, irrespective of however many banks go under.

But the people who run the US are neither socialists nor free-market capitalists. What the current crisis reveals only too plainly is that they are ‘state capitalists’, who think that the government should serve the interests of the big corporations and financial institutions.

But facing a real chance of public revolt over a blatant giveaway to the very financial institutions and people who created this mess, the government seems to be reconciling itself to the fact that it must adopt some variant of the Swedish/English model, and Paulson’s revised plan seems to reflect that.

However, the way the US government has been itself lurching from one plan to another does not inspire much confidence. As Josh Marshall points out: “[T]he fact that [Paulson] rammed through his bailout bill as absolutely essential to saving the economy, only to decide a few days later that we need something dramatically different, does not inspire me with great confidence in his grasp of the nature of the crisis.”

POST SCRIPT: Tone deafness by the McCain camp

McCain has been getting hammered by Obama for advocating policies that seem to ignore the middle class and cater to the rich. Presumably feeling the need to respond to this charge, the McCain campaign has produced a new tax proposal they say is aimed at the middle class.

What is it? They are proposing a capital gains tax cut!

What are they thinking? It is mostly the rich who worry about capital gains taxes or even know what it is. They are the ones who are constantly asking for cuts in the capital gains tax and even its elimination.

Second, with the current stock market and housing market downturns, people are facing huge capital losses, not gains, so they are unlikely to be paying any such taxes soon.

While this may be just another effort to use the crisis to ram through a policy that will eventually favor the rich when the economy recovers, it is another sign that the McCain has no sensitivity to what concerns ordinary people.


  1. says

    It seems like another real option the government could explore is, along with the lenders holding the notes, the government could authorize a low interest rate adjustment to these troubled borrowers, so that they could still pay on their mortgages, but at a low interest rate. This way, the principle payments are paid in full, and the lenders do not experience the levels of default and foreclosure they’re currently experiencing.

  2. says

    This is a very insightful post that I have shared with a few of my friends who supported McCain. It will be very interesting to see how President Obama solves this crisis!

  3. says

    I voted for Obama but for all I know, I believe it will take his policies a long time to show the results. He is not even in the office right now and things are getting worse by the minute!

    It’s getting extremely difficult getting a loan right now and I don’t like where we are heading. Obama will have to take some immediate actions to take care of the mortgage market and to stop lenders from defaulting.

  4. says

    The problem is lowering interest rates really doesn’t help home owners that owned their home before the crises started. Most people down have enough value in their home to refinance it or get a new loan at a lower rates and a more affordable payment. They need something to help these people out, thats why many of them are just leaving their homes and going into forclosure.

  5. says

    American business seems to only obey the stick and the money. Energy rules was relax you got Enron. Lending rules are relax you get subprime mess. The first one makes many trying to exploit the system think about what they do when they messed out. The last one makes them see that with enough capital and “friends” you can get out of it. subprime are known to be toxic and a buble since very long time in 2002 the 2 super trusts (fany mae and freddie mac) already makes the headline as been a time bomb. all the finace sector knew what was the risk they just say makes more now and don’t care what happen. just get the dirt evrywhere then no one can find anyone more responsible then others.

    Capitalism is if you fail you fail not use taxpayer money to save failing. Corporation makes the decision maker partly immune to risk (not fraud don’t mistaken me Enron is fraud). Then decision is made for the decision maker goal not the corporate goal and the common sense. I make big money now and rush out before it collapse. Decision maker should pay in case of failure not get bonuses! In Corporate bankruptcy all management level should pay part of they 2 years revenue from 75% at high management to 10% at lower. Make them responsible and make them pay for their mistakes

  6. says

    So back 2 years ago, politicians were pandering, but today record number of homeowners are still losing their homes. Oh, that bail out that was supposed to help all those homeowners who were in trouble? The statistics on loan modifications are appalling, and now that they are feeling stronger, lenders seem to have become more callous towards homeowners than ever before. Getting informed is a good place for an overwhelmed homeowner to start, especially when the authorities are advising homeowners to just enter the lions’ den and “talk” with their lenders. There’s a free 15 minute on-line class that will at least get a homeowner started in the right direction, by dispelling common myths and helping avoid common mistakes that get homeowners denied before they say “hello” to their lender. It’s at -- Loan Modification Explained in 15 Minutes -- free on-line class

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