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W'S DISASTROUS MORTGAGE 'FIX'
Paulson: Seeking more bad borrowing.
December 7, 2007
PART of the Bush administration's "mortgage-bail out" plan
would make it easier for cities and states to conduct their own
mini-bailouts alongside the feds. Should Congress go along, the
proposal would imperil the fiscal, economic and credit outlooks of
municipalities across America.
would make it easier for cities and states to conduct their own
mini-bailouts alongside the feds. Should Congress go along, the
proposal would imperil the fiscal, economic and credit outlooks of
municipalities across America.
The centerpiece of Bush's plan is to encourage lenders,
investors and their agents to freeze interest rates for up to five
years on tens of thousands, and perhaps hundreds of thousands, of
mortgages issued during the last three years at below-market "teaser"
interest rates.
investors and their agents to freeze interest rates for up to five
years on tens of thousands, and perhaps hundreds of thousands, of
mortgages issued during the last three years at below-market "teaser"
interest rates.
Yet this plan, bad as it is, has little chance of helping most
of the people who face the possibility of foreclosure - after all, 1.5
million Americans will see their mortgage rates "reset" to higher rates
next year.
of the people who face the possibility of foreclosure - after all, 1.5
million Americans will see their mortgage rates "reset" to higher rates
next year.
So Treasury Secretary Hank Paulson will propose to Congress to
let cities and states issue tax-exempt debt to bail out even more
borrowers.
let cities and states issue tax-exempt debt to bail out even more
borrowers.
Cities and states would borrow billions and lend the money to
"homeowners" (in fact, these borrowers don't actually "own" their
homes; they only own the mortgage). The "homeowners," in turn, would use the money to pay off the mortgages they can't afford - and take out new,
more affordable mortgages with their city or state government. (Not all
tax-exempt debt is guaranteed by the city or state that issues it, but this debt would have to be - no private investor will touch this risk right
now for an interest rate that would be "affordable" to these
borrowers.)
"homeowners" (in fact, these borrowers don't actually "own" their
homes; they only own the mortgage). The "homeowners," in turn, would use the money to pay off the mortgages they can't afford - and take out new,
more affordable mortgages with their city or state government. (Not all
tax-exempt debt is guaranteed by the city or state that issues it, but this debt would have to be - no private investor will touch this risk right
now for an interest rate that would be "affordable" to these
borrowers.)
The whole idea is disastrous - and not simply because it is
massive government interference in the private markets. The problems
are almost too painful to describe:
massive government interference in the private markets. The problems
are almost too painful to describe:
* It's a mass-scale payment from city and state taxpayers to
banks and big investors - institutions that should have known they
risked a huge loss from lending on such an unsustainable basis.
banks and big investors - institutions that should have known they
risked a huge loss from lending on such an unsustainable basis.
Consider: Many people are in trouble right now because they
expected housing prices to keep rising and rising; thus, they expected
to either sell their house for a quick profit or refinance their loan
easily. But they can't do either in this market - hence, the "mortgage
crisis."
expected housing prices to keep rising and rising; thus, they expected
to either sell their house for a quick profit or refinance their loan
easily. But they can't do either in this market - hence, the "mortgage
crisis."
When the bank forecloses, though, and finds it can only sell the home for a fraction of its last purchase price, it's the investors in the mortgages who take the loss. But if state and city money lets
homeowners pay back that mortgage, it saves those investors from that
loss - while you, the taxpayer, wind up paying for someone
else's investment mistake. (Sure, maybe local governments would
negotiate with banks and mortgage investors to share the pain - but the
government is often a bad negotiator.)
homeowners pay back that mortgage, it saves those investors from that
loss - while you, the taxpayer, wind up paying for someone
else's investment mistake. (Sure, maybe local governments would
negotiate with banks and mortgage investors to share the pain - but the
government is often a bad negotiator.)
* By encouraging people to stay in homes they can't afford, the
plan keeps the housing market artificially high. When a bank forecloses
on a home, conversely, someone else can buy it at a much cheaper price.
plan keeps the housing market artificially high. When a bank forecloses
on a home, conversely, someone else can buy it at a much cheaper price.
Politicians in New York and elsewhere have been complaining about
a lack of affordable housing for years now; you'd think they'd be happy
to have the opposite problem. Yet the bailout plans use government
money to keep the market from finding its true price. This, when
first-time homebuyers benefit immensely from falling home prices.
a lack of affordable housing for years now; you'd think they'd be happy
to have the opposite problem. Yet the bailout plans use government
money to keep the market from finding its true price. This, when
first-time homebuyers benefit immensely from falling home prices.
* The Bush plan encourages foolish local-level borrowing. City and
state have limited funds; they should raise bonds only for crucial capital projects, like building and fixing roads, bridges, tunnels, schools and
subway systems. Any money the government raises to bail out a homeowner
who made a bad decision is money taken directly from fixing a
pothole-scarred road or an aging bridge.
state have limited funds; they should raise bonds only for crucial capital projects, like building and fixing roads, bridges, tunnels, schools and
subway systems. Any money the government raises to bail out a homeowner
who made a bad decision is money taken directly from fixing a
pothole-scarred road or an aging bridge.
* Encouraging city and state governments to guarantee new
mortgages for precarious borrowers puts the credit ratings of those
governments at grave risk.
mortgages for precarious borrowers puts the credit ratings of those
governments at grave risk.
Consider: The banks will likely cherry-pick the "best" of the
worst borrowers under Paulson's rate-freeze plan - leaving the worst risks for cities and states. But many (perhaps most) of the borrowers so
"rescued" would still wind up defaulting on their new government loans.
(One study showed that 40 percent of borrowers whose private lenders
rework their mortgages eventually default anyway.) So municipal
governments, having put their own credit rating on the line on behalf
of risky borrowers, will be left holding the bag.
worst borrowers under Paulson's rate-freeze plan - leaving the worst risks for cities and states. But many (perhaps most) of the borrowers so
"rescued" would still wind up defaulting on their new government loans.
(One study showed that 40 percent of borrowers whose private lenders
rework their mortgages eventually default anyway.) So municipal
governments, having put their own credit rating on the line on behalf
of risky borrowers, will be left holding the bag.
They'll also be left holding residential property - since, by
rights, they'll have to take back all that defaulted property once the
borrowers prove once and for all they can't pay. Other cities, towns
and states may lack the experience to alert them to this risk - but New York just finished selling off all the property it ended up owning during tax defaults of the '70s and early '80s.
rights, they'll have to take back all that defaulted property once the
borrowers prove once and for all they can't pay. Other cities, towns
and states may lack the experience to alert them to this risk - but New York just finished selling off all the property it ended up owning during tax defaults of the '70s and early '80s.
Yet, city and state taxpayers would start paying for this risky
plan even before the defaults begin. Consider: Investments in the
riskiest mortgages have tanked in recent months, because investors
don't want to go near these overvalued homes and risky borrowers
anymore. What will happen when city and state governments (under the
Bush plan) take on the very same bad risks? Investors in those
goverments' bonds will insist on charging a premium to cover the
greater risk - meaning higher interest rates for cities and states.
plan even before the defaults begin. Consider: Investments in the
riskiest mortgages have tanked in recent months, because investors
don't want to go near these overvalued homes and risky borrowers
anymore. What will happen when city and state governments (under the
Bush plan) take on the very same bad risks? Investors in those
goverments' bonds will insist on charging a premium to cover the
greater risk - meaning higher interest rates for cities and states.
Investors are already more nervous about some municipal bonds
than they were a few months ago - because the private companies that
insure some municipal some bonds (so that investors don't have to worry
about default) also insured some of the riskiest mortgages. If a big
private insurer goes under, the municipal bonds it insured will face
some turmoil and municipalities could face higher costs.
than they were a few months ago - because the private companies that
insure some municipal some bonds (so that investors don't have to worry
about default) also insured some of the riskiest mortgages. If a big
private insurer goes under, the municipal bonds it insured will face
some turmoil and municipalities could face higher costs.
These risks, put together, spell higher payments on all municipal debt for any city or state that uses its own credit to back
risky new mortgage obligations - just when these municipalities, as
property taxes fall, can least afford it.
risky new mortgage obligations - just when these municipalities, as
property taxes fall, can least afford it.
Cities and states should beware of the Bush administration's sudden generosity. It comes with a prohibitive price tag in the end, just like all those risky mortgages did.
Nicole Gelinas is a City Journal contributing editor.
nicole@city-journal.org
OMG! We're going down a path that is going to lead to the cliffs where we'll all crash into the sea like a bunch of lemmings! This was a year ago? And, no one was listening... 