McCain’s mortgage-buying proposal

Great Debates
1

McCain’s mortgage-buying proposal
Pragmatics of the programme aside, is this idea something that is going to help or hurt him in the general election? While I can see many people favoring it, his base is composed of people who generally dislike large-scale government involvement like this.

Where did the plan come from? I thought I heard it is based on a couple Republican economists’ work, but I also heard they worked for Columbia and (?). Any links to the original paper?

As he proposed it, could this possibly work? All we have is a threadbare description so far, but the unintended consequences seem astronomical. That is, this seems to be a huge incentive to consider defaulting on a mortgage payment. Even if there were some magic formula or other freeze to limit the programme to just mortgagees in “real” trouble (who defines that?), how much has the national housing market dropped dollar-wise?

Thoughts?

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A couple of posters have mentioned this solution in other threads. I saw it posted by different people on different blogs. So, I don’t know the original author. I, too, am surprised that McCain would spout something so obviously and blantantly populist, and I’m surprised that Obama’s UChicago econ team didn’t pounce all over it.

In theory, it sounds nice, but it won’t work-- well – effectively. As I understand it, the problem is largely liquidity, fueling a credit crisis, because no one knows how to value the underlying securities/assets (homes and property) from which these bonds/mbs/cdos/etc. were derived. So, the government is saying, let’s negotiate at fair market value with homeowners so that they can afford their homes.

The first problem is logistical. Joe Sixpack’s mortgage has been sliced and diced in any number of derivatives, sold and re-sold. We won’t know where that payment is going to. We won’t know who’s security is now stable.

Second, if the government is going to negotiate at FMV, what does the government know about the housing prices? A massive, inefficient bureaucracy will have to be established to accommodate this endeavor, further decreasing the value of the transaction. The money they’re (or rather, we, as taxpayers) investing is already at a loss.

Thirdly, speaking of FMV and depreciated values, we are in a housing slump now. FMV is going to be low, which means that these securities are now going to be lower than previously thought, which again puts the whole idea of value of the security in jeopardy. I haven’t thought this point out that thoroughly, but perhaps this can be relieved by a one-time tax write-off.

Fourth, if Joe Sixpack couldn’t afford the subprime mortgage (or otherwise didn’t qualify), he’s not going to qualify for a 30 year fixed, or be able to make payments. It also rewards, unfairly, risky behavior. Not everyone who took out a subprime loan is a victim of predatory loans (however loosely that is defined). People should realize the consequences of their risky behavior.

Lastly, home values are based on comparables. Home values will be lower now because people were lucky enough to be saved by the government in an otherwise stable neighborhood. Those responsible homeowners should not have to suffer depressed home values because someone took out a risky loan and failed.

3

The provision to do this is actually in the bailout as it was passed. McCain is simply taking a stand and saying ‘Yes, I will do this!’.

AFIAK, the projected $300B isn’t the total expenditure, but rather the direct, nonrecoverable loss. The total money to buy the mortgages would be much more. In other words, the fed would buy $1T in mortgages, and rewrite the mortgage with the homeowners for $700B.

I think it’s rather interesting, politically. It’s like the parties have switched sides with the recent bailout. First it was Republicans who opposed a Wall Street bailout, and now McCain is pledging to use a good chunk of that money not for Wall Street, but rather the people directly in trouble. Obama either has to aknowledge being beaten to the punch, or stand up and oppose bailing out troubled middle class people with bad mortgages.

4

I took a massive loss on my previous house earlier this year- as a result, it’s going to be two-to-three years before I can buy another one. In the meantime, I’m helping someone else pay for THEIR house, since I’m renting.

If something like McCain’s plan goes through, I’m going to be PISSED. You mean I have to help a whole bunch of other people pay for their houses, too?

5

In some cases, Joe was sold a worse mortgage than he could have afforded because of lender incentives to sell these higher interest loans. In others, he could afford the original rate, but not the rate when it reset.

I think the proposal to let bankruptcy judges reset mortgages is the minimum that should be done, since they already have access to the financial records. It might not be enough. I agree with most of your points - I don’t see how paper that can’t be valued now will be better if a small percentage of the loans making up that paper get reset. In fact it might almost be worse, since any mortgage security might have its value changed at any moment.
I wonder if there is decent traceability from loans to mortgage bonds.

6

Can you help us find it?
He seemed to be saying that I could go to the Government, fill out paperwork that essentially says: I bought my house for X. Houses around me are selling for Y. I can’t afford to pay a mortgage for X, but I could pay for Y. Need help fast.

Then, the gov’t would … would buy(?) the mortgage or lean on my bank for them to renegotiate the loan. Perhaps acting as a guarantor?

I’m really eager to find the original paper, because it must have been written by some people who actually have an understanding of economics (or hopefully at least put in front of an undergrad who got a C+ in macro). Until then, there’s something missing here, unless this was just a Hail Mary attempt to woo voters. But even then that doesn’t make sense – won’t he end up losing more support from small government conservatives?

7

I think it’ll never happen and he knows it’ll never happen.

8

The problem becomes “who qualifies?”.
As he stated it’s not just getting them into a fixed rate loan, it’s also getting them a loan at FMV.
If Sue and Bob got in over their heads getting a subprime adjustable rate motgage on their $350K house which is now valued at $250K and have been paying the teaser rate for a few years, and now are allowed to get a fixed rate loan of the $250K FMV…
How are Mary and Jim who bought the house next door for $350K with a fixed rate and have been paying on time every month gonna feel about it?

9

The bailout plan was supposed to directly attack the mortgages. Somehow it turned into the banking and financial company bailout that it was originally called .
If the mortgages are the underlying problem, they have to be dealt with directly.
But now we find that credit swaps and exotic financial instruments may be the real culprits. Swaps are estimated to be around 60 trillion dollars. 60,000,000,000,000 .I wanted to see what it looked like with all the zeroes. That is a lot of money .
Our Financial gurus thought up these new ways of making money. They made a ton and sold them to all kinds of banks around the world. They just could not pass up what appeared to be free money. Iceland is in horrible financial straights right now. Europe and Asia are trying to save their banking systems. You think the world hates us for our warlike ways? Wait til they suffer through this mess. Who will look at America with any positive light.?

10

Most of sections 109/110 go into to further detail about what is allowed. Prinicipal reductions, rate reductions, etc.

11

This write-up from Politico is perhaps the most lucid analysis of McCain’s plan.

The “$300 billion” number McCain used last night comes from the bailout bill itself–Sinaijon is right that this authority is already part of the bill. But the bill requires lenders to take into account current home values and therefore to reduce the mortgage principal. The lender then takes part of the loss on the mortgage, not the taxpayer.

McCain’s plan–at least according to his spokesman–is to buy up $300 billion worth of mortgages at their face value–i.e. the full principle:

Taxpayers will therefore be on the hook for a larger loss. Both plans obviously help distressed homeowners, but McCain’s lets the lenders off with much less pain, which means less of that $300 billion is going to, you know, the homeowners it’s supposed to be helping.

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Oh, and I forgot: making these payments isn’t the problem. The problem is that there is a $200k mortgage on a piece of property maybe worth $145k, but no one really knows. No one really wants to wait the for the security to mature, especially if they need cash now. Regardless, even if people started paying on time and the already accounted for default rate were to become even lower, this, in of itself, is not enough money to get lending started again. It’s too slow.

13

Thanks for pulling all that stuff together for us, CJJ*. That’s been the main question I’ve had today - what McCain’s plan would pay for these mortgages.

Paying face value for the mortgages underlying the toxic securities that nobody’s willing to pay real money for is a giveaway, pure and simple, to the banks. It doesn’t surprise me at all that McCain would (a) invent such a giveaway program, and (b) try to pass it off as a populist measure.

What a scumbucket.

14

Update: Obama opposes the McCain plan because it will overpay for mortgages:

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How is buying the house underlying the security and different from buying the security itself?

Its not just a giveaway to the banks. The homeowners get to keep the house, but are essentially paying a lower price for it. They are profiting as well. And everyone else benefits too, because the number of foreclosure fire sales (which are spurring the market value drop of housing) go down.

Also, if you actual read the details, home owners that go this route will owe money to the government when they finally sell their house. The fed will get partial ownership of the house.

16

Do I have your position right?
If the government is going to give a $1 grant and a $1 loan to an entity to try and avoid national economic trouble, who is the better recipient: banks or homeowners? You’re saying the homeowner is, because if they make it through the downturn, they will end up with a tangible asset, shelter, etc. The homeowner will give the $2 to the bank anyway (to keep the house from foreclosure), so the bank is not assetless.

If the bank received the $2, they would be able to cover their own obligations (wider network of loans, interest on deposits, etc.), but they would still own the house and eventually foreclose, giving them another asset to sell.

17

In my reply, I’m assuming the ‘and’ was superfluous. It’s different in a bunch of technical ways that make unraveling this crisis more complicated, since the same house, or a single mortgage on the house (let alone second mortgages, HELOCs, etc.) can underlie parts of multiple securities. But still, what’s happening to those securities should give us a pretty good idea of what the underlying houses and mortgages are worth.

You remember all that stuff about tranches? If not, the quick summary:

  1. You’re an investment bank. You own a bunch of subprime mortgages.
  2. You divide the income stream from those mortgages into three tranches.
  3. The first tranche gets the first 1/3 of the income from those mortgages; the second and third tranches get the second and third 1/3’s of the income.
  4. You separately securitize the income flow from each tranche.
  5. The securities based on the third tranche are treated as practically worthless, and the second, junk-bond level. But the securities backed by the first tranche are rated AAA; everybody figures that even a bunch of subprime loans will yield at least 1/3 of face value, which would yield a solid income stream for the holders of the securities based on that tranche.
  6. ‘Everybody’ turns out to be wrong: even the top tranche turns out to be pretty crummy, and the bottom falls out of the market for those (now formerly) AAA-rated securities.
    Extra Credit:
  7. Financial institutions holding a (shit)pile of those securities have negative balance sheets. Particularly if they bought them in a highly leveraged manner. If you put $3 down to buy a security trading at $100, and now nobody will pay $50 for it, you have a debt of $97 that is backed by a security worth <$50. Oops.
  8. Pretty much all the big financial institutions are in the same fix to varying degrees, so none of them will lend to the others because they aren’t sure if they’re lending to institutions that are really bankrupt, in which case they might lose most of the money they loaned. Credit markets freeze up.

Steps (7) and (8) aren’t relevant to this discussion, but I tossed them in because with them, we’ve got a quick guide to the overall crisis, at least as I understand it. (I’m not an economist or finance geek, and would welcome correction and clarification from those that are.)

But getting back to it, we’ve got a bunch of mortgages out there that aren’t just worth way less than face value; they’re worth way less than 1/3 of face value.

And everybody owns a share.

It may not be just a giveaway to the banks, but it’s principally a giveaway to the banks. Say those mortgages are worth 25% of face value on the open market, just to be optimistic. McCain’s proposing that we spend $300 billion in this way. $225 billion of that $300 billion would be a giveaway to the banks.

Sure - of the remaining $75 billion, some of that will ultimately be a homeowner subsidy, and the rest will be an investment in refinanced mortgages. Plus the government would get an equity stake that might ultimately yield a decent return on that $75 billion.

But we’d still be bestowing a gift of $225 billion on the banks.

18

Update: McCain makes it clear now he’s recommending mortgages be bought at face value to help the lenders.

Why anybody would think “this one” knows what the hell he’s talking about on the economy is beyond me.

19

I think he’s out of his tiny little mind. He’s just plain desperate.

I have no power on this issue - can’t even vote as I’m a Canadian - but I was against the bailout in the first place and to add this idiocy to it is . . . idiotic. It might have been part of the bill but I bet no one actually sat down and figured out how to do it or had any idea what the effect on the crisis would be.

I can only imagine what it would be like to sit in my house, where I am making my mortgage payments, a house now worth $150 K but with $200 K mortgage - and my neighbour, who couldn’t afford to buy the bloody house in the first place, gets bailed out? Why shouldn’t I get mortgage relief?

Sure, we should all think long term. Housing prices may stabilize and begin to rise. But in the meantime, he got a present and I got hosed.

20

Banks make a profit by lending money to people. For their business to be succssful, they must figure out who will be able to pay them back, and who won’t. It is in their best interest to do that well.

Recently, they have done that very badly. They failed at one of the core missions of their business.

McCain proposes that we buy these mortgages out at full face value. So, the banks will not share in the losses caused by their incompetence, and they will not merely break even. They will make the same profit as if every backed mortgage were paid back in full.[sup]*[/sup]

That part of the plan is a giveaway to the banks.

Money in a lump sum is worth more than the same amount paid over time. If McCain is proposing that we pay face value all at once, the banks would see even greater than if the bubble had just kept growing.