Monday, March 2, 2009


Obama has announced his Homeowner Affordability and Stability Plan (HASP). It’s oddly difficult to get a sense of what the whole plan is about although supposedly all will be revealed on March 4. You can read the official information here and Bloomberg has a Q&A. But let’s start with a USA Today editorial which identifies three main elements in HASP:

1) Current rules make it difficult for homeowners to refinance when the amount of their mortgage is more than 80% of the current value of their home. HASP “will make it easier for certain homeowners to refinance to lower rates if their mortgages are 80%-105% of the value of their homes.”

2) For “certain homeowners facing foreclosure [t]he government and lenders will share the cost of bringing mortgage payments down to 31% of monthly income.”

3) Obama “would alter bankruptcy law to allow judges to modify troubled mortgages just the way they do virtually all other debts.” This portion of the plan requires legislation; that is, this is the only part of Obama’s plan that he cannot impose by fiat.

Let’s dispose of the third portion of the plan first. This won’t cost the taxpayers anything directly but it does seem to me that it will make mortgages more difficult to get since it puts lenders at a distinct disadvantage. This will make it harder for people to buy homes in the future and harder for the housing market to recover much less rebound.

Furthermore, most mortgages are:

de facto or de jure ‘no recourse’. This means that the debtor cannot be held personally liable for the mortgage even if, after a foreclosure, the bank receives only a fraction of the total mortgage outstanding from the sale of the house.

With a ‘no recourse’ mortgage, the debtor effectively receives a virtual put option to ‘sell’ to the mortgage-issuer the house at the amount of the loan still outstanding.

Obama’s proposed change to the bankruptcy laws will set up an asymmetry in which a lender can be forced by a judge to eat part of the homeowner’s loss while the homeowner will still be able to simply abandon the house whenever he chooses. To redress that imbalance, we could change the other side of the equation so that any mortgage that can be changed by a bankruptcy judge is always a recourse loan. However, this would probably just encourage generous judges to be even more generous.

This leads me to the third problem with this proposal: a homeowner’s result depends entirely on how kind a judge he gets. I realize this is the case with other aspects of bankruptcy but I suspect it won’t take long for stories to start appearing in which two virtually identical cases have vastly different outcomes because one case is heard before a sympathetic judge and the other before a tougher one.

In other words, I think the modified bankruptcy element of Obama’s plan is a bad idea. Now let’s consider the elements that cost taxpayers money directly. The first two elements have a price tag of $75 billion. As far as I can tell, this includes financial incentives for lenders to refinance (probably $1000 per loan up-front then monthly or annual payments for some period); government payments of interest as needed to bring monthly payments down from a refinanced rate of 38% to the desired rate of 31%; and flat payments to homeowners who refinance and remain current for some period of time. (There is also a provision - not mentioned by USA Today - to pump money into Fannie Mae and Freddie Mac. I’m not going to discuss that but according to National Review this has a price tag of either $200 billion or $400 billion. Like I said, it’s hard to figure out exactly what’s in Obama’s proposal.)

So how will the first two elements of Obama’s plan work? Let’s consider two couples who are recent homeowners. Look first at John and Mary. They were both working a year ago making identical salaries when they bought a house. They had saved up their pennies for a few years beforehand and made a 20% down payment. The monthly house payments accounted for 25% of their combined take-home pay. Miraculously, they live in an area where the value of their house has not declined and after making payments for a year the amount of their mortgage is now 79% of the house’s market price. John loses his job. The house payments now account for 50% of the couple’s take-home pay. Nonetheless, they have cut other expenses to the bone and are still current on their payments. They do not qualify for Obama’s help. Because their mortgage is less than 80% of their income they can probably refinance without government help but there’s no guarantee of that since their income is now greatly reduced.

Right next door live Sam and Jane. Through an eerie coincidence they, too, were both working a year ago making identical salaries when they bought a house. Since they hadn’t saved their pennies, they only made a 5% down payment on their house but since they made more than John and Mary their monthly house payments also accounted for 25% of their combined take-home pay. Like John and Mary’s house, Sam and Jane’s house has held its value and after making house payments for a year the amount of their mortgage is now 94% of the house’s market price. Sam loses his job. The house payments now account for 50% of Sam and Jane’s take-home pay. Like John and Mary, Sam and Jane have cut expenses to the bone and are still current on their payments. Unlike John and Mary, however, Sam and Jane do qualify for Obama’s help because the amount of their mortgage is more than 80% of the current value of their home. The government will encourage their lender to refinance their mortgage perhaps at a lower rate than John and Mary could obtain without government sweeteners.

Now let’s imagine that instead of cutting expenses to the bone and staying current, Sam and Jane stopped making their mortgage payments when Sam lost his job. They are now in danger of foreclosure. That means they qualify for even more government help. Not only will the government encourage their lender to refinance, it will take on part of the interest payments to get their mortgage payments down to only 31% of their income.

The probable result is that John and Mary, who arguably made the more financially responsible decisions - a larger down payment and staying current on their mortgage - will be forced to sell their home. Yes, they will get back their down payment but if they can even manage to buy another house it will have to be a cheaper one partly because their income has been reduced and partly because they may have to pay a higher interest rate than Sam and Jane. Sam and Jane on the other hand will see some of their indebtedness paid by the government, will be able to stay in their more expensive home, and will never have to repay the taxpayers - including John and Mary - for their help.

But isn’t this sort of what I was proposing with my Bottom-Up Bailout (BUB)? No. First - and most important - under BUB, homeowners who got any type of monetary help from the government had to repay that help when they sold their home. Homes, actually, because the debt remained until it was paid off regardless of how many homes the owners went through. Someone seems to have pulled the chain on this light bulb at least for a couple of people at The Corner. Stan Liebowitz says:

Yet the government asks nothing in return from those being helped, even though it wouldn’t lend money to business without asking for something in return. Yet it would be easy to design a plan that had any helped homeowner pay back the help they are receiving out of any future capital gains on future house sales.

His co-blogger, Victor Davis Hanson, offers what he calls “a modest proposal”:

If you want the government to come in to rescue your mortgage, either by subsidized lower interest or reduced debt or both, then any future profits (not entirely impossible) you make at the time of any future sale must be divided 50/50 with the government.

Well, duh. Or to be more polite: Frankly, this seems to me to have been such an obvious provision for Obama to include - as Hanson says, “It seems a way to placate criticism that 92% are bailing out the less responsible 8%” - that I am tempted to assume there is some specific reason for not including a pay-back provision. Perhaps the portrayal of the mortgage holders as “victims” would be undercut by such a provision. Or perhaps the assumption is that those being bailed out will be the same people who would not be able to own homes at all unless the government had pushed for them to do so. In that case, a pay-back provision might have been considered undesirable because their problems are the government’s fault in the first place or because the government continues to believe they need help without responsibility. Or perhaps this omission really is simple incompetence or political tone-deafness.

As for other differences between Obama’s plan and BUB, I can pretty much just copy and paste the reasons BUB was better than FDIC Chairwoman Sheila Bair’s earlier mortgage plan:

1) BUB cleans up all primary residence mortgages where the amount of the mortgage is more than 80% of the house’s current value with no top end limitation). HASP only cleans up mortgages where the amount of the mortgage is between 80% and 105% of the house’s current value so if your home has lost a lot of value you're toast. Unlike HASP, BUB also cleans up all primary residence mortgages where the homeowner’s payments are more than 25% of income. Under HASP, if you have a mortgage that's seriously underwater or your payments are eating you alive, you're only going to receive help if you stop making payments and flirt with foreclosure.

2) BUB reduces mortgages to no more than 25% of income not 31% as Obama proposes. BUB thus frees up more disposable income which will translate into more spending. (In the long run. In the short run I hope people are smart enough to dig themselves out of debt first.)

3) BUB promulgates fixed-rate mortgages. Because Obama’s plan allows interest rates to rise after some number of years, he is essentially calling for adjustable rate mortgages. (Isn’t that part of how we got into this mess?)

4) BUB reduces principal; this helps soften the landing for the housing bubble implosion. Obama does not reduce principal; this keeps housing prices jacked up too high. (Obama’s plan does avoid Bair’s error of encouraging 40-year mortgages.)

In other words, as I said about Bair’s plan:

If you want a plan to help individuals because you feel bad for those who are losing their homes, this is fine. If you want a plan that will help stabilize the economy then this is - I’m sorry - just plain stupid.

Let’s face it. If only 8% of the people who have mortgages have any need for help, if a “mere” $75 billion can clean up the housing meltdown, then how much of a crisis do we really have? Either we’ve been sold a bill of goods about the underlying cause of the economic crisis or Obama is putting a band-aid on a mortal wound or Obama is proposing just the first round in what will be a continuing series of homeowner bailouts. I suspect the last is closest to the truth. As Phil Kerpen points out, deja vu in the housing bailout arena has been the order of the day.

Another factor that favors BUB is that it spreads the pain to the lenders. BUB requires them to take a 25% hit on the principal pay-down; Obama pays them off for refinancing. If we don’t want to encourage bad behavior, it’s far wiser for lenders who were greedy or stupid to take their lumps as a reminder to behave better in the future.

Last but not least, there is another huge problem with Obama’s plan that was also a problem with Bair’s plan - although I did not address it in my earlier post. Unlike my BUB proposal, Obama is not advocating regulation to insure we do not get into this mess again. Obama is not proposing legislation to require 20% down payments or perhaps even higher down payments when home prices are skyrocketing. Not only does he not want to eliminate adjustable rate mortgages or teaser rates, his own plan is an ARM plan. He is not proposing banning credit default swaps nor is he proposing any new Glass-Steagall type legislation. He is not proposing any penalties for or regulation of the rating agencies which seem to have been wandering around aimlessly slapping “AAA” sticker on all the garbage tranches. In other words, he wants our money to clean up the mess but is not doing anything to prevent the same thing from happening down the road.

And don’t tell me we have to stop the bleeding first then worry about everything else. Obama is the man who says, “We cannot successfully address any of our problems without addressing all of them.” He claims to be able simultaneously:

to create three million jobs, to redesign the health care system, to save the auto industry, to revive the housing industry, to reinvent the energy sector, to revitalize the banks, to reform the schools — and to do it all while cutting the deficit in half

Surely someone able to juggle all those tasks should have been able to couple his mortgage bailout with the regulatory and procedural changes necessary to insure we don’t need another one. Obama asking for my money to patch the housing crisis without fixing the underlying problems is like a roofer who charges you for putting a bucket under the leak in your kitchen ceiling: it doesn’t fix anything permanently and you know he’ll hit you with another bill when he comes back in a little while to empty the bucket.

Finally, a few words about fairness. My BUB proposal is unfair in the sense that it favors homeowners over renters and in the sense that, yes, some homeowners who were not innocently caught up but were actively rapacious would benefit. (At least I, unlike Obama, am willing to be up front about that.) In BUB’s favor, though, I would argue that it is at least as aimed at stabilizing the economy as were the $700 billion TARP bill; the money for the auto companies; the stimulus bill; and a seemingly endless list of other bailouts. We were told - and are still being told - that giving our money to companies that were greedy or stupid or both isn’t really fair but everyone will benefit in the end when the economy stabilizes. And besides the government will get all this money back someday. I believe I can make the same arguments for my BUB proposal and far more realistically. The pay-back feature; the greater inclusiveness; the more drastic reduction of payments; the insistence on fixed rate mortgages; the attempt to soften the landing for house prices without keeping them jacked up to prolong the bubble: all these elements address the economic problem as a whole rather than just targeting a handful of homeowners. Obama can not claim the same for HASP.

Oddly enough, however, that conclusion does not lessen the anger I feel toward Rick Santelli and those who have organized Tea Parties in response to him. I’m not saying Santelli and the Partiers shouldn’t be mad; they should be furious and I am, too - at least when I’m not feeling ill. It’s just that what touched off their outcry was a proposal by the government to help people with their mortgages. Not TARP; not the bailouts of various financial institutions; not the bailout of GM and Chrysler; not the stimulus package. According to Santelli, Obama’s mortgage plan “is promoting bad behavior.” And this makes it different from the earlier handouts how?

If Santelli was arguing that HASP was badly constructed and a better mortgage bailout plan was needed, I would be less angry with him. Instead he’s arguing that people who can’t pay their mortgages are “losers” who have no chance to “prosper down the road”. Does Santelli believe that the huge financial holding companies that tied themselves to those bad mortgages and keep coming back time after time for yet another handout are going to magically prosper somewhere down his road? How about the auto companies that haven’t made profitable cars in years? And what definition of “prosper” could possibly apply to all the pork barrel projects crammed into the stimulus package? Is Santelli saying it’s okay to give hundred of billions (not millions, billions) of taxpayers’ money to these “losers” but giving any money at all to homeowners makes Jefferson and Franklin “roll over in their graves”? Does he really expect me to buy the argument that AIG can be greedy and stupid and heavily implicated in poisoning the entire economy and still get government money (and get government money and get government money) but John and Mary who tried to do the right thing and got caught in the tsunami don’t deserve help?

I understand the mortgage plan may have been the straw that broke the camel’s back and I understand that it feels a lot more personal to have the government give money to your neighbor than to your credit card company. I also understand, though, that it all looks pretty ugly from where I’m sitting. A handout is a handout whether it goes to big corporations or the guy down the street and, frankly, if you weren’t out marching in the streets when AIG or Citi or GM got their money I’m disinclined to applaud you for rushing out your door the instant someone suggests giving homeowners some of that money, too.


All Bottom-Up Bailout posts are filed under the category “BUB”.

No comments: