The Housing Chronicles Blog: An RTC-type bailout: The Home Ownership Preservation Corporation

Friday, February 1, 2008

An RTC-type bailout: The Home Ownership Preservation Corporation

While many people could argue that bailing out those who signed up for unaffordable loans is blatantly unfair to those potential buyers patiently waiting in the wings for home prices to fall so they can buy a home, the sheer size of the mortgage crisis may require the Federal government to step in through some type of Resolution Trust Corporation-type bailout. Although Senator Chris Dodd's $20 billion plan is just a fraction of what could be required, it is the first concrete example of a government-sponsored (i.e., taxpayer-sponsored) bailout. From a story:

A proposal to bail out subprime mortgage borrowers who are at risk of foreclosure was floated at a Senate Banking Committee hearing Thursday.

Senator Chris Dodd, the committee chair, said he is working to create a Home Ownership Preservation Corporation, which would purchase mortgage securities that are backed by at-risk, subprime loans from lenders and investors.

This corporation would give these lenders and investors a better price for the securities than they would get if the properties backing them were put through foreclosure.

Additionally the loans on these properties would be restructured so that borrowers could afford the new payments and remain in their homes...

According to today's testimony, the fund might require $20 billion to $25 billion in seed money from taxpayers and, after that, it should self-fund.

Dodd said his proposal is supported by both ends of the ideological spectrum. He pointed out that two of the witnesses testifying on Thursday in support of this bailout - Michael Barr, from the progressive Center for American Progress, and Alex Pollack, with the conservative American Enterprise Institute - are usually on opposite sides of economic issues.

But there was dissent from members of the Banking Committee. Senator Bunning, R-Ky., said "Government meddling could make matters worse."

Senator Bob Corker, R-Tenn., was concerned about the "moral hazard" of rewarding borrowers' risky behavior.

But in his testimony, Barr insisted, "This is not a bailout for investors and speculators. Investors would take a hit in exchange for liquidity and certainty."

Barr added that they'll get back much less than what they paid for the securities, and pointed out that only owners who occupy their homes will be eligible for loan modification.

"Ninety percent of the time, [government] intervention is not a good idea," said the more conservative Alex Pollock, who would generally prefer market corrections to address a problem. "But we're in the 10 percent of the time when it is needed."

Economists such as Mark Zandi think that the true value of these mortgages (and the related securities) cannot be determined until something unfreezes the market:

The biggest problem facing housing, according to Zandi, is that the market is frozen, because investors who buy mortgage-backed securities have abandoned that market. That's created a liquidity squeeze which has made it difficult for even well-qualified borrowers to obtain a loan.

Zandi thinks the fund should buy existing mortage-backed securities in an auction-type process, which would immediately establish what those securities are really worth.

"As soon as there's a price [for the securities], there's a market," Zandi said. "Everyone can then start appropriately valuing what's on their books."

Still, there are concerns that such a plan would only prompt borrowers in trouble to stop paying their mortgages simply to be eligible for the program:

The American Enterprise Institute's Pollock compared the Dodd proposal with the Homeowners Loan Corporation, which operated during the Great Depression in the 1930s.

Pollock also conceded that the program is not without flaws. It could reward some people who bought more home than they could afford, while leaving more responsible borrowers unaided.

Might some of these people be tempted to stop making mortgage payments for a couple of months in order to get a government-sponsored cheaper loan?

"You're going to have some people going into default to get into the government program. That's part of the cost you have to reckon with," he said.

And yet the costs of such a program could still be far less than the continued losses from a market that has simply stopped operating:

"All these efforts may not be enough," said Zandi. "[But this bailout] will cost taxpayers a lot less money than leaving the market in a deep freeze."

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