Should we have bailed out the homeowners instead of the banks?

A legitimate question that I think deserves some elucidation – please discuss

What does a bailout of homeowners mean? That the government would make mortgage payments on behalf of individuals who could not afford them?

I am assuming so, yes. I was just looking up a view of Ron Paul who says we should have let the big banks fail and bail out the homeowners instead.

I am not sure what it means either. If you helped people make mortgage payments that were artificially high, wouldn’t that help the banks as well? It would also keep housing prices high rather than let them settle to the new market level.

My position is that neither one of them should have been bailed out. They are both guilty parties in a bad business transaction and need to suffer the consequences for it as swiftly as possible so that the correction won’t be overly drawn out.

I just chalk that kind of talk up to political pandering. Plus I find it extremely strange that an alleged libertarian would advocate intervening in the market in that way.

A better program would be to just increase means tested benefits, like unemployment insurance, medicaid/care, everything but paying their mortgages and as much as possible in a form that’s shielded from a foreclosure proceeding. That way the homeowner can make a rational decision about whether to default on the loan, and the market can clear itself of dud mortgages and overvalued properties.

But anyway it’s not a either/or question. You could do all of the above, but a collapse of the banks would still be a major disruption to the economy much like the collapse of the Detroit car makers would have been, and on balance some kind of nationalization/rescue would probably have been better than nothing. Ron Paul can argue that it shouldn’t have ended up like that in the first place but until Ron Paul travels back in time to fix mistakes that were already made he has nothing more useful to offer. Most people on the left would have argued that the bank bailouts should have been accompanied by some kind of massive purging of bank management, i.e. closer to what happened to the carmakers and closer to straight up nationalization than a simple bailout, but it’s not really clear what this would have accomplished in the aggregate other than make people feel better about the whole thing in their gut.

I think the OP means that if the largest problem behind the financial crisis was the US housing bubble than rather than giving money to the banks the US should have paid off the mortgages the banks held. This would have ended the securitisation and credit default swap problems as everyone along the chain would be assured of getting paid- similar to what did happen + with the added bonus of freeing millions of people from their mortgages.

You’d have to balance of the added demand the economy got from people without debts, the money the USD lost through bailing out AIG (Now that’s a mess to sort out) and the possibility that removing those assets would create more of a need for banks to lend to other businesses.

I don’t think its at all clear what would have been cheaper for US citizens in the long run.

What about a guy who is 12 years into a 15 year mortgage making payments with no problem. Plus a vacation house on the lake he owns free and clear? Does he get “bailed” out?

I’m not arguing, I’m just wondering what the details of a “bailout plan to homeowners” would be.

Under the plans I recall hearing about he would potentially be in line for a bailout. The two criteria I remember hearing were being underwater or being delinquent.

I tend to think the most useful plan would have targeted delinquencies as those are the ones were all parties should have the best incentives to make a deal.

Also, there were a few bailouts passed which basically amounted to incentives to banks to rework loans - these proved insufficient motivation. A larger-scale plan of using FDIC to acquire mortgages directly and then rework them (as was done with IndyMac) was proposed by Sheila Bair but was never implemented AFAIK.

We should have done both. Banks foreclosing doesn’t suddenly make the bad mortgage good, after all. A much better policy, which would indeed require federal coercion, would be:

  • Force banks to renegotiate loans where the rates escalated after the discount period ran out into market rate loans, with no prepayment penalties. The money from this would redeem the subprime notes. Holders of those would get a haircut, but what do you expect when you think you are buying high return notes with almost no risk.

  • Underwater loans should be rewritten to reflect market prices with the banks getting some reasonably high upside percentage of later value increases. This would keep people in their houses, and given the reduction in housing inventory from this the banks would probably have more value on their books than after a foreclosure.

  • Those who cannot afford their mortgages even under these conditions, from being way over their heads or from having lost jobs still lose their houses. No way around it. The value they get from the sale is higher than what we’ve seen, and there are fewer of them.

  • Finally, if banks need to be recapitalized after this, help with it just as we did.

Well, shit, give me 2-3 months to get delinquent and I’ll take that free house you’re giving away.

ETA: that was in response to Jas09.

Who said anything about giving anything away?

If you want to take the hit to your credit rating to get a government encouraged and subsidized re-fi (or, perhaps, re-work) then go for it (in this hypothetical world, of course). In the end I still think it’s probably decent policy, as far as stimulus goes, because housing costs are such a large part of the monthly budget for most people. And drops in home values wrt mortgage principle make people “feel” much poorer, which drags down demand.

Voyager is on the right track, IMO.

Well, snark aside, I think most proposals were for long term delinquencies, as in people who haven’t paid (and can produce evidence for being unable to pay) for an extended period of time.

There’s definitely a moral hazard argument to the concept, in general. On the other hand, that same argument is also there for bank bailouts.

As distasteful as it may have been, I understand the logic of helping banks remain solvent. If banks start going under, it has serious effects throughout the economy, both for people experiencing financial trouble and for those who are on good footing. And frankly, I think it’s easier to choose which banks to help, as opposed to which individuals to help.

Once you open the door to choosing which individuals to help, it’s a freakin’ free for all. As someone who can afford his house and has no financial problems, I’d be pretty pissed off if I found out my no-count neighbor got tens of thousands of dollars in mortgage payments in order to prop up the whole mortgage industry while I got nothing. As it stands, I have no idea how much of a bailout my bank got, only that me and the public benefited from not having the disaster of unknown numbers of large banks go under.

The crisis was immediate. We could give a small number of banks a ton of money really quickly. Giving millions of homeowners money would have taken too long, and risked bank failures anyway. Unless we just dumped cash on everyone, regardless of whether they needed it or not.

Not that I was a big fan of bailing out the banks instead of the little guy, but I think that’s where the problem would lie.

There could never be such a choice in reality.

TARP, which most people think of as the bank bailout, was a $700 billion LOAN to the banks in the form of preferred stock purchases. The nine big banks TARP was intended for bought back the stock as quickly as they could. TARP may eventually turn a profit for taxpayers.

$700 billion given to delinquent homeowners would not have gone very far and would only have delayed the foreclosure crisis. There are 53 million mortgages in the US with outstanding debt of $11 trillion today. Setting up a bureau to deal with eligibility by itself would have taken a year. Even if the will existed the logistics would have been horrendous.

And how would you feel if you were a renter and a homeowner got $25,000 worth of payments? And you knew you would have to pay it?

This is a very good question. One on which the record (and even the discussion on this Board) is gloomy.

Greece. Did it happily take a 50% haircut on its bonds, or what?
Wall St. Banks. While several big firms were (almost) zeroed out, several other big banks were essentially propped up with taxpayer money.
Donald Trump. Isn’t forfeiting failed real estate collateral one of his paths to riches?
Credit cards. Look at the interest rates on some of these to realize defaulting on loans is a way of life in banking, more the rule than the exception.

Yet, despite haircuts accepted even by Sovereign Greece, many Dopers Booed “Sanctity of contract. Against market principles.” when in a thread a few months ago another Doper and I argued in favor, at least in principle, of principle reductions for American homeowners. :smack: (A more nuanced scheme I espouse postpones final reckoning, placing many underwater mortgages onto a temporary rental basis.)

Interesting. Now I’m curious what the actual Paul position is.

Schemes would have to be carefully designed to approach fairness. One simple idea to address this issue is:
… Underwater homeowner has one-time option to knock, say, 5-20% off the principle. If you take this path, you forfeit right to the rental/delayed reckoning plan.

As so often, Voyager has the correct answer.

It wasn’t necessary to dump cash on the homeowners. Much good would have been done (and perhaps still should be done) by simply stating terms where foreclosing banks must instead offer an arbitrated rental plan. (The details of such an arbitration, with repurchase clauses, are beyond the scope of this post.)

I discussed this in my blog. The main consideration isn’t who to bail out, but when. When the housing market crashed it wasn’t so much the start to a chain of bad events as the start of a snowball rolling down a hill, getting bigger on the way. The mortgages were bundled in with other investments by the banks, pulling those down as well, and adding to the total amount that had to be bailed out. This made the market go down, hurting a lot of other investments that the banks depended on, adding to the total amount that had to be bailed out and of course wrecking the market.

The main reason to have bailed out the homeowners would be because that’s the earliest step in the process. And really, all you have to do as far as a bailout goes is to ensure the same default rate as the banks had expected to get. You don’t have to pay for people’s houses, you just need to pay a percentage of the value going against the interest, not even the principal, since it was the moving interest rate that screwed people up. If you pegged them all at the non-moving interest rate that they had started with and “bailed out” any additional interest, then you’re talking a total amount of about $39 billion, based on the numbers I was able to calculate.* That might not be a loan - and thereby get paid back - but it keeps the country from entering a recession.

The important thing, though, would be that the market be assured of such a plan being agreed upon by mid-2007. Any later and things would have started to go downhill regardless.

I would almost wish to subscribe to your newsletter, but what about the homeowner that had the final judgment of foreclosure entered against him the day before this law was proposed/went into effect? The homeowner foreclosed on the year before?

What would stop new risky loans with consumers secure in the belief that the feds would come through again and not let them lose their homes?

Yes. Bailing out homeowners would have indirectly bailed out the mortgage banks anyway. Only they would have had to work for their money.