
The House has approved a plan that will let the Federal Housing Administration take on as much as $300 billion in new mortgages so that people facing foreclosure can refinance. The measure could help as many as 500,000 struggling homeowners by cutting their payments by as much as half. Bush has threatened to veto the bill, which passed in spite of that threat by a majority vote of 266-134, including 39 votes from Republican representatives who come from states with the most severe housing problems.
In a separate bill, the House also approved a plan to send $15 billion to states to buy and fix up foreclosed property.
In spite of the 39 crossover Republican votes, many of the remaining House Republicans are vehemently opposed to the measures. Included in this second bill are two features Bush wants: one feature would overhaul FHA so that the federal mortgage giants Fannie Mae and Freddie Mac would be much more tightly regulated, and the other would provide first time home-buyer tax credits of up to $7500 that would be paid paid over 15 years. The tax credits (as well as the FHA overhaul) are designed to encourage home ownership in a failing market where credit has become impossibly tight and few homes are being sold.
Several major hurdles face this plan even if the it passes the Senate and Congress then overrides the threatened Bush veto. One is that the individual refinance packages depend on the original lender agreeing to take a loss on the principal owed on the mortgages. While the loss would be a smaller one that the loss the original lender takes in a foreclosure sale, the loss on a refinance would not be backed by reinsurance and would have to be absorbed in total by the original lender. So far, in other independent attempts to assist homeowners facing foreclosure, lending institutions have been notoriously loathe to cooperate, preferring to take the larger loss. As the housing crisis worsens and banks and mortgage companies continue to post huge losses, this may change.
A much bigger problem is the current condition of Fannie Mae and Freddie Mac. The two companies suffered combined losses of more than $9 billion last year on bad mortgages, and are expected to post even larger year-end losses for 2008. The two federal mortgage giants currently have $83 billion in required capital to back their loans, but the mortgages, other debt, and financial obligations of the two currently surpass $5 trillion. With major financial institutions dumping billions in subprime loans as fast as they can, the number of these loans held by Fannie Mae and Freddie Mac is mushrooming even without the new bill.
Insurance companies backing bank mortgages have been going through the same struggles with capital ever since November of 2007. Earlier this year, before the Bear Stearns failure, Wall Street was holding its breath hour by hour to see if any of them would fail or even look like they might fail. If that were to happen, the banking system in the US would have frozen up like inner city plumbing in January, and the country would have had a financial crisis on its hands that made the Great Depression look like the Not Really All That Bad Depression.
What we are witnessing here is essentially a game of musical chairs in which lenders, individual homeowners, and federal and state governments scramble to not be the one left holding the debt as fewer and fewer options for escape remain. A benefit of the house refinance plan is that it would spread the bad debt around a bit while keeping people in their homes: the bank would get stuck with some but not all of it, the government would take over the risky borrowers and write them new more conventional affordable loans, and the borrowers would get to keep their homes, preventing (in theory) any more freefall in housing prices by stabilizing neighborhoods.
On the downside–and it is a really steep slippery downside–in a worst case scenario Fannie Mae and Freddie Mac could go the way of Bear Stearns if the program isn’t managed well and if they don’t raise more capital to back all these risky loans. What does ‘tight regulation mean’? Fannie Mae was the target of a major accounting scandal and the smoke from that has not even cleared yet. Former Fannie Mae Chief Executive Franklin D. Raines and two others have been fined $31.4 million for their roles in cooking the books to (appear to) reach earnings targets between 1998 and 2004 and then pocketing millions of dollars in bonuses for (not really) doing so.
Republicans and some moderate Democrats will make a lot of noise about the slippery slope and moral hazard of rescuing people from their own bad decisions and how this is wrong and how those of us who have made good decisions shouldn’t have to bail them out. The problem is that the situation has gone so far past this issue that it now threatens to sink us all no matter what we do or don’t do.
For one thing, banks, lending institutions, and brokers were often criminally irresponsible in promoting and writing these bad loans during the peak of the housing bubble. Yes, people should make good decisions and not take out horrible loans they can’t pay back. The flip side however is that lenders shouldn’t make horrible loans to people who can’t pay them back. Lenders have a fiduciary responsibility to all their customers to make sound underwriting decisions, and that responsibility has of late flown out the window as pressure on CEOs to make ever-greater profit off of the same tired products grows exponentially year by year.
That is a nice way of saying that during the housing bubble we witnessed an era of unbridled greed which even had realtors shaking their heads at the sheer audacity of it. Laws were broken, money changed hands under tables, people were lied to, widows were bilked: It was ugly. When the bubble burst, all the players started scrambling to find a good safe rock to crawl under, and that is still going on today. What’s more, these irresponsible lending practices mutated into irresponsible highly-leveraged investment practices, many with incomprehensible initials–for example, SIVs—which are actually a form of CDO, which is… oh nevermind. The point is, Wall Street went on a Jedi-mind-trick binge in which they chopped up and repackaged bad debt and then speculated on it in a way that 1) made it impossible to trace who actually owned it, and 2) created money out of thin air.
I’m no economist, but even I know what happens when you create money out of thin air.
Meanwhile, back at the ranch, Bush and Congress were busy sniping at each other and accomplishing little, something they are still pretty good at. So there is plenty of blame to go around. The question now is not whether the American tax payer will get stuck with this mess–of course we will. The question is, how much of it will we get stuck with, and when, and how. A workable plan that sticks us with some of it and at the same time keeps people in their homes so prices can stabilize and equity can actually start to increase seems to me a good start. Will Congress be able to sell it to the financial industry in a way that keeps Fannie Mae and Freddie Mac afloat? Stay tuned.








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