Repartay

So it seems the Treasury plan to subsidize new mortgages at 4.5 percent is every bit as dumb as I first thought. Commenter “Bri”, who have I have it on good authority knows something about the mortgage business, said:

If it goes thru [sic] as solely available to purchase loans, it would in effect be a builder bailout. Including refinance mortgages would help some who are having trouble making their payments, and others who might get cashout to use (spend) toward some other purchase (stimulate the economy). I have faith in this getting screwed up.

Indeed, and according to the New York Times:

But the cheap mortgages would be available only for people buying houses, not the roughly 50 million families that already have mortgages and would want to refinance at a lower rate.

As a result, the plan offers no direct relief to the millions of people who face foreclosure because they took out exotic mortgages that they could not afford. Nor would the plan offer any benefit to people who have stayed current on their mortgages and would simply be interested in taking advantage of a lower rate. As envisioned by Treasury officials, homeowners who now pay 6 percent would be watching new neighbors arrive whose monthly payments were almost one-third lower.

Right, so the plan doesn’t include provisions for mortgage refinancing, which at once is unfair to those who can afford their mortgages and more importantly, does nothing directly to address imminent, and perhaps not even medium-term foreclosures. So in effect, it’s a short term boon for prospective home buyers and home builders, which might make sense if the housing market were actually under valued. In fact, there’s no reason to believe this. What’s more, in the long term, it’s hard to see how this would do anything but delay the inevitable. If the government doesn’t continue to subsidize loans at 4.5 percent, presumably rates will return to market levels, driving down housing demand and thus lowering housing values yet again.

Perhaps there’s some short term imperative that would make this plan the correct policy choice, but it’s worth returning to the cause of the crisis: the worthlessness of collaterized mortgage debt vis-a-vis widespread foreclosure. The most straightforward way to address the problem is thus stemming the tide of foreclosures by directly intervening in troubled mortgages, not artificial invigoration of the housing market which may or may not address the root of the crisis at some point in the future.

Again, I invite any experts to comment.

Now, maybe I’m just not smart enough to understand this, and I’m happy to be corrected, but why in god’s name is Hank Paulson proposing a plan that would finance new mortgages at 4.5 percent?

Treasury officials told the [National Association of] Realtors that the plan could be a more effective way to help homeowners than focusing efforts solely on borrowers who are struggling to meet their monthly payments, the sources said. Democratic lawmakers have been advocating a proposal to modify the mortgages of distressed homeowners.

I’m assuming the logic is that by artificially reinvigorating the housing market (sound familiar?), home values rise, and homeowners who can’t afford their mortgages will no longer be “underwater” (meaning their homes will no longer be worth less than their mortgages), these folks will now sell their homes, and in doing so, will stave off further foreclosures. This makes a certain degree of sense, but how long would something like this take? What guarantees their homes will be bought? Is there a more circuitous method to be taken? If the point is to help distressed homeowners, wouldn’t it be a lot faster to follow Sheila Bair’s lead and just restructure troubled mortgages?

Of course, if the point is to stimulate one of the industries most culpable for this mess with a possible side effect of helping distressed homeowners, then this sounds bitchin’. Pitching it as an aid to homeowners though is like suggesting that the best way to save a drowning person is by draining the pool.

I know there are a few people involved in this industry that read this blog, so feel free to leave your thoughts in comments.

So Matt Yglesias thinks it’s actually necessary for a bailout to include provisions for limiting executive salaries.

To roughly summarize, in order to bail out banks that would go under absent a bailout, we need to also provide access to bailout funds to banks that wouldn’t go under without a bailout. To only bail the very least responsible banks out would create a terrible perverse incentives [sic] problem. But on the other hand, to bail out banks that don’t need bailing out would be a horrible waste of money.

Hence the need for executive compensation provisions. If we limited executive pay for bailed out institutions — say by forcing executives to work on government pay scale — then firms’ managers would have a strong incentive to avoid taking taxpayer money unless it was genuinely necessary. Banks that would mere [sic] prefer to get bailed out because it would enhance their profits won’t do it if taking the bailout means a big cut in executive pay. But institutions that would actually collapse absent a bailout will take the deal because they have no choice.

This doesn’t seem to quite add up to me, and I think it’s because Matt is conflating the object of the bailout (bad debt) with the conduit of the funds (the banks who made bad investments). 

In the Paulson/Bernanke plan, the object of the bailout isn’t to save the banks, it’s to fix an insolvency/liquidity issue (depending on who you believe) by resuscitating bad debt, which, incidentally, will have the additional effect of improving the financial standing of the bad debt’s owners. While this may seem wildly unfair — the banks who made the most mistakes will receive the most aid — limiting participation in the bailout by capping executive salaries wouldn’t change the fact that banks who had behaved most poorly will benefit disproportionately. What’s more, by discouraging participation, firms who had behaved prudently and limited bad debt will actually be penalized for their good behavior by being barred from a proportionate payout.

In a system where the government receives equity in exchange for its bailout (the Dodd plan), it’s equally unclear why a limit on executive salaries would prove more equitable, simply because the underlying theory still relies on transmuting bad investments into good ones. The key difference between the two approaches is that the government’s equity stake would guarantee, or at least seek to protect, the taxpayer from losses on the deal. In this case then, encouraging participation no matter the level of investment in bad loans is especially important in ensuring equitable treatment of financial institutions. That is, if the debts are ultimately worth less than they were valued by the government, the more heavily leveraged firms stand to lose the most. If the debts are ultimately worth more than they were valued by the government, the more heavily leveraged firms are rewarded for their sagacity. In either scenario in the Dodd model, taxpayer money goes unwasted.

Finally, if a bailout were to be structured by a government guarantee of the bad mortgages, or even split between buying bad debt and restructuring mortgages (and how do you fairly decide who gets a restructured mortgage and who doesn’t?), the more heavily leveraged companies would still be rewarded. Thus, capping executive salaries has the benefit not only of being a good political bargaining chip, but also of being a bad idea in the first place. Democrats should be celebrating.

On another note, there is simply no way around the fact that someone gets screwed in this deal. Even if you can countenance the socialism of a plan that restructured every bad mortgage to terms favoring homeowners, then those owning homes they can afford are penalized for not having bought homes they can’t. The only “fair” plan would be to leave the markets to their devices, in which case we all get screwed. It seems that fairness just isn’t on the table.