Poll shows Americans almost evenly split on housing bailout

If you read the many housing blogs hosted by angry renters, you'd think that there was overwhelming resentment towards any bailout of people who bought more homes than they could reasonably afford. However, according to a recent poll conducted by CNN/Opinion Research, 49% of respondents actually support some type of special treatment for homeowners in danger of losing their homes vs. 48% against it. From a CNNMoney.com story:

Americans remain split on whether homeowners about to default on their mortgages should receive special treatment to help them keep their houses, according to a new CNN/Opinion Research Poll.

The poll finds 49% of Americans believe such homeowners should receive special treatment, while 48% feel homeowners should not get assistance. Three percent of those polled had no opinion...

Congress also appears split on the issue. On Wednesday, the House began debating Democrat-sponsored legislation that would let the government back loans for homeowners facing foreclosure and would reduce the principal owed on those mortgages. Many Republicans oppose the bill, and President Bush has threatened to veto it.

The proposed legislation would allow the Federal Housing Administration to insure up to $300 billion in new loans over four years.

In order to qualify, lenders would have to cut the debt to no more than 85% of the homes' appraised value. If the FHA-refinanced loans defaulted, the FHA would pay the lender the outstanding principal.

Side effects to financial medicine

Writing in the San Francisco Chronicle, Kathleen Pender argues that the experiments currently being conducted by the federal government to rescue the financial markets aren't immune to their own -- and often unforeseen -- perils. In other words, like drugs, there could be side effects:

It would be nice if the federal government would fess up about the potential side effects of the medicine it has been delivering in increasing doses to the financial markets.

That might be hard to do, considering that most of these experimental remedies are being invented on the spot and unleashed on the market without a bit of the rigorous testing required of new drugs.

But make no mistake: If the feds succeed in preventing a financial collapse, there will be a price to pay...

Economists say they are likely to include some combination of higher taxes, higher interest rates, higher inflation, slower economic growth and a weaker dollar.

Let's remember for a moment what got us into this predicament.

After the stock market crash in 2000 and the terrorist attacks in 2001, the Federal Reserve kept interest rates too low for too long. The federal funds rate stayed at 1 percent throughout 2003, long after the 2001 recession had ended.

Low rates fueled speculation in housing and the creation of new mortgages and mortgage-backed securities that were sloppily underwritten, poorly rated and widely misunderstood. Hedge funds and other investors used these securities to borrow money to buy other assets, creating a mountain of debt atop a small slice of fragile collateral.

Banking regulators, Congress or the Bush administration could have stepped in to restore some sanity to the markets but declined to do so in the name of homeownership and free enterprise...

"We are going to nationalize the mortgage market," says Ken Rosen, chairman of the Fisher Center for Real Estate at UC Berkeley, consultant and hedge fund manager. "It's the outcome of not regulating at the right time."

Economists say they are likely to include some combination of higher taxes, higher interest rates, higher inflation, slower economic growth and a weaker dollar.

As much as he dislikes it, Rosen says, it's the right thing to do in the short run. "If they did not stop the credit crisis, we would have something much worse - a meltdown like we had in the '30s," he says. But "it's not a good thing in the long run."

Rosen predicts that when all is said and done, there could be as much as $1 trillion worth of losses in the financial system. He predicts that investors will bear 60 percent of the losses and the government could shoulder the rest...

To pay for these losses, the government will have to raise taxes, sell more debt or both.

Near term, Rosen predicts that the Fed will have to keep cutting interest rates to prevent further weakness in housing and the economy. That will put further downward pressure on the dollar. A falling dollar will fuel inflation because imports, oil and other commodities will cost more.

Long term, the government will have to raise interest rates to entice foreigners to buy our debt.

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.

Like it or not, more government rescues are on the way

Despite the public outrage that will inevitably arise from a government (and thus taxpayer) bailout of Wall Street firms and borrowers caught up in the mortgage crisis (rumor has it homebuilders have been told not to expect much, if anything, from the White House), it looks like a series of smaller bailouts (such as Bear Stearns) will ultimately result in a much larger rescue. For renters waiting to pounce on heavily discounted homes, that may come as bad news, and they continue to rally against a bailout. But what they don't understand is the consequences of doing nothing is far more important than their desires to (a) allow the market to punish the greedy and the stupid; and (b) snap up a bargain once the dust has settled. From an article in the L.A. Times:

...some experts say Bear Stearns' woes warn of potentially larger calamities that will severely test the Fed, the economy and, ultimately, taxpayers as the government gets more deeply involved in fixing the markets' troubles.

"We will lose, in some form, several major financial institutions before this is over," said veteran economist Allen Sinai of Decision Economics Inc. in New York.

The heart of the problem is that the nation is living through an unwinding of a 25-year-long, consumer-led borrowing binge. Bear Stearns was a key player in financing that binge, most notably in high-risk mortgages...

"We have far too much leverage in the system, and we're now in the process of de-leveraging," said Tom Atteberry, a money manager at investment firm First Pacific Advisors in Los Angeles. "We think there's a lot more to go."

That mentality is widespread, and it is feeding on itself: Investors don't want to pay current market prices for mortgage-backed bonds and other debt because they worry that more borrowers will have trouble making payments. That further shuts down lending, making credit tighter and squeezing more borrowers...

At times like this the focus for Wall Street firms primarily is on surviving. No bank or brokerage will lend to a peer, even in routine daily transactions, if there is any doubt at all that the borrower can repay. Failure then can become assured once rumors start about a firm...

Wall Street's propensity to abandon its own has sunk all sorts of financial institutions over the last century. In 1984 the government had to rescue Continental Illinois, then the seventh-largest bank, once creditors pulled the plug. Brokerage Drexel Burnham Lambert Inc. failed in 1990 after its funding lines were cut...

But the current crisis is far larger in scope than those. Because so many banks, brokerages and investors were involved in financing the recent real estate boom -- the biggest housing bubble ever, by many accounts -- the growing problem of mortgage defaults infects nearly every corner of the financial system...

That is why a bailout is becoming more of a certainty --when the U.S. economy is at stake, politicians have no choice but to risk the ire of angry renters who don't support such a move by risking their tax dollars.

Across Wall Street, there is a widespread belief that the Fed's use of its own capital to shore up Bear Stearns is just the first step toward an eventual government bailout of the housing market.

"The history of major financial crises is that the government is going to come in at some point," said Richard Sylla, a professor of financial history at New York University.

A bailout for lenders and borrowers still helps everyone

One of the more increasingly specious arguments against a government-led bailout of lenders and homeowners facing foreclosure is the issue of fairness. No, it's not fair to bail out those who are adults and made their own mistakes, but given that the entire economy seems to be at stake, we may have little choice. From columnist Steve Pearlstein at the Washington Post:

Forget all that nonsense about the Bernanke Fed being too timid or behind the curve. In the face of what is turning into the most serious financial market crisis since the Great Depression, the Fed has been more aggressive and more creative in using its limitless balance sheet -- in effect, its ability to print money -- than at any time in history.

We can argue till the cows come home about whether this is a bailout for Wall Street. It is -- but only to the extent that it is also a bailout for all of us, meant to prevent a financial and economic meltdown that drags everyone down with it. In broad strokes, we're going through a massive "de-leveraging" of the economy, wringing out trillions of dollars of debt that had artificially driven up the price of real estate and financial assets, and, more generally, allowed Americans to live beyond their means. The Fed's goal has not been to impede that process, simply to make sure that it proceeds in an orderly fashion. But even that has required central bank intervention that is unprecedented in scale and scope. And despite yesterday's huge rally in the stock market, Fed officials warn that this de-leveraging is nowhere near finished...

...the real problem began in late February, as several of Wall Street's biggest investment banks prepared to close their books for the quarter and realized they were looking not only at big declines in profit from issuance of new stocks and bonds and fees from mergers and acquisitions, but also another round of write-offs in the value of their holdings. In response, the banks began to hunker down, instructing their trading desks to raise margin requirements for hedge funds and other customers, requiring them, in effect, to post more collateral on their heavy borrowings.

Thus began a chain reaction in which hedge funds began selling what they could -- largely mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae -- to raise the cash to meet their new margin calls. That wave of forced selling drove down the price of those bonds, which prompted more margin calls and more forced selling. By the end of last week, the interest rate spread on those securities -- the difference between their yield and that of risk-free U.S. Treasury bonds -- had jumped four, five, even 10 times the normal rate....

The Fed hopes that by injecting $400 billion of liquidity, it can help restore the more normal functioning of credit markets and encourage banks to lend again rather than hoard their cash. For it is only when bank lending and credit markets have returned to more normal operations, say Fed officials, that the beneficial impact of their interest rate cuts can be transmitted to the economy. And they leave little doubt that, despite a heavy dose of monetary medicine already in the pipeline, they intend to add another dose at their meeting next week.

It's anyone's guess how long this credit crunch will last, but the chances are that we'll have several more market meltdowns and Fed rescues before it's over, probably in the fall. Until then, the dollar will continue to get hammered and stocks will continue their fitful decline. And if the last two financially induced recessions are any guide, it will be well into 2009 before the economy hits bottom, followed a couple of years of slow growth and "jobless" recovery.

A $1 trillion government bailout by Halloween?

According to a recent post on the Seeking Alpha blog (one of my favorites as well as one of the most respected on the web), the Financial Times is reporting in a video interview with George Magnus, UBS senior economic advisor that we can expect a bailout by October (just in time for the election!), something we've been predicting at Housing Chronicles since the beginning of the year. How big a bill will this be? Try $500 billion - or maybe even $1 trillion: