Moving closer towards a government bailout of the housing market

Opponents of a housing/mortgage bailout -- which currently includes the Bush Administration -- talk of a 'moral hazard' that will reward scofflaws (lenders) and opportunists (speculators) who should realize the consequences of their actions.

But I would argue that the reason that the federal government will eventually have to step in with a rescue plan is because it was its own failings during the boom itself -- such as weak oversight and an arrogant refusal to listen to bloggers and economists warning against a financial catastrophe -- that allowed things to get so out of control. And, for better or worse, we have to accept the actions of a government that we elect, because crying now about bailouts is simply way too late. The chorus against a future government bailout would have made a lot more sense back in 2003 when the boom was just starting. So who failed the public -- the media, government, greedy lenders or uninformed borrowers? All of the above. That's why the problem is simply too big to ignore.

From an L.A. Times story:

From Wall Street to Capitol Hill, calls are growing for the government to get into the mortgage business as the only way out of the housing crisis roiling the economy and the financial markets.

Proposals to shore up tottering home loans with taxpayer money are gaining traction in Congress and moving to the forefront of presidential politics...

But while the Fed can help lenders and the investment industry, it has little authority to help individual borrowers or to force their lenders to modify repayment terms so that strapped borrowers can stay in their homes. That is putting pressure on Congress to step into the breach...

Thus far the Bush administration has resisted anything that resembles a taxpayer- financed homeowner bailout. Instead, it has placed its faith into several programs that encourage lenders and distressed homeowners to work things out voluntarily.

And Treasury Secretary Henry M. Paulson Jr., former chief executive of investment bank Goldman, Sachs & Co., has said he believes the housing bubble should be allowed to work itself out naturally.

Critics say that's tantamount to bailing out the big players while throwing the little guys to the wolves, and that a more evenhanded approach will make any government action more broadly palatable...

Still, a homeowner "bailout" could be a political minefield. Any relief program will have to be carefully fashioned to focus only on deserving homeowners whose financial ills are no fault of their own. Otherwise, the program could face a backlash from voters who believe they played by the rules only to have their tax money paid out to the imprudent or the crooked...

Others contend that what looks on the surface like a rescue of homeowners would really be a bailout of lenders who unscrupulously enticed borrowers into loans destined for trouble...

Some economists say the housing crisis is reaching such magnitude that it threatens to push the economy at large into a severe recession, a situation that would make the "moral hazard" debate seem irrelevant....

One way to balance government assistance to participants in the credit crisis -- whether it's branded a bailout or a rescue -- is to link it to tighter regulation of lenders and borrowers.

These can include strict capital requirements for investment banks that have accepted Fed money, underwriting standards for mortgages and consumer loans to prevent imprudent lending and borrowing, and mandated disclosures of the risks of various loans and bundled securities....

Among a number of rescue plans before Congress, perhaps the one with the most political clout behind it is a proposal sponsored by Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, and Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee.

The Dodd-Frank plan would grant the Federal Housing Administration expanded powers to back the refinancing of troubled mortgages -- essentially taking the loans off the original lenders' hands -- by providing $300 billion in guarantees for new loans. Frank has scheduled a hearing on the bill for April 9.

The program would be directed at homes with values that have fallen below the balances due on their mortgages. These are the homes most likely to wind up in foreclosure.

Under the plan, the lender would be paid to surrender the mortgage -- but would get no more than 85% of the home's appraised value. The amount would be less than the value of the original mortgage, but presumably higher than what would be received if the bank were forced to reclaim and resell the property.

The borrower would get a new loan on terms that he or she could manage. The deal would be offered only on homes that are occupied by borrowers as their primary residence, which is designed to exclude speculators and vacation homes. If the home is sold within five years, moreover, the government would get a percentage of any profit to discourage "flipping." Frank's committee estimates that the program could refinance as many as 2 million homes.

Everybody benefits, Frank argued in an op-ed article for the Washington Post this month, when "a prudent write-down and appropriate refinancing" take the place of a foreclosure.

Another proposal, sponsored by Sen. Richard J. Durbin (D-Ill.), would change bankruptcy law to allow mortgage terms on primary residences to be altered by bankruptcy judges in individual cases. Currently, these are the only debts that remain outside a judge's jurisdiction.

Supporters of this plan contend that it would serve only homeowners unquestionably in distress because they would have to subject themselves to Chapter 13 bankruptcy to take advantage of its terms.