What's needed is a government body like the Home Owners Loan Corporation of the New Deal era, when America last faced mass mortgage foreclosures. The HOLC issued tax-exempt bonds, and used the proceeds to refinance distressed mortgages at low rates.
According to Alfred DelliBovi, president of the Federal Home Loan Bank of New York, writing in "The American Banker," by 1935 the HOLC had refinanced 20 percent of all qualifying US mortgages. It saved close to 1 million Americans from foreclosure.
It is typical liberal philosophy that any problem can be resolved with new bureaucracy. In this case, the problem is much more complicated than that, but that will be addressed in a minute. First, Kuttner of course puts all the blame in one corner...
Millions of borrowers face foreclosures because, knowingly or otherwise, they took out bait-and-switch subprime mortgages, often with no down payments. With housing values depressed, many loans now exceed the value of the house.
That is frankly a distortion of what happened but it is also irrelevant at this point. What Kuttner doesn't say and what needs to be said, is that these same borrowers used the new found equity of the housing boom to take out cash and many times multiple times. I believe these folks got themselves in over their heads initially, but whether that is true or not, many of them are way in over their heads because they borrowed, multiple times many times, against the equity in their homes. Whatever their original situation, at this point most of these folks are so deep in debt they couldn't be saved even if you reduced their rate to zero. Furthermore, by systematically renegotiating rates of distressed borrowers, you create a moral hazard. These folks made poor financial decisions. That may not be P.C. but it is the truth. If they are rewarded with lower rates, then we encourage these same folks to make the same mistakes again. While bailing them out with a new government bureaucracy may sound like the compassionate thing to do, I don't believe for one second that it is the right thing to do.
What Kuttner doesn't explain is that his proposal is quite risky. If he is wrong and his new government program doesn't work, then what he will have done is needlessly create more bureaucracy, more paperwork, and more government. Kuttner's perspective is the same faulty politically correct perspective that most media have. It isn't the borrower's fault and if we only give them some assistance, then everything will be fine. First, they must share some of the responsibility since their signature is on the documents. Second, whether or not they are sympathetic isn't the issue. The issue is whether or not they can be saved. Kuttner seems to believe that merely renegotiating mortgages en masse will save them en masse. If the problem were that simple it would have already been done. The problem is that these folks have mortgages that are too great for their budget. In other words, it isn't the interest rate that is the issue but rather the size of the loan.
The way to save these borrowers isn't to reduce their rate but to reduce their loan amount. What actually needs to happen is for twenty or twenty five percent of the mortgage amount to go away. A 250k mortgage must be reduced to 200k. Now, I doubt politicians would ever suggest that because it is patently ridiculous, and yet no one seems to have a problem suggesting that rates be renegotiated in masse.
Now, Kuttner goes on to indict the very system that made sub prime popular.
In the old days, before mortgage loans were packaged into bonds, a distressed borrower and a lender could negotiate a lower rate. If the bank just foreclosed, the borrower would lose the house and the bank would be stuck with a property worth less than the mortgage.
By lowering the interest rate, the bank would take a smaller loss, and the borrower would keep the house.
Today, however, the bank seldom holds the loan - because the geniuses who thought up subprime packaged the loans into bonds. Renegotiating terms of these bonds is like unscrambling an egg.
This is the system that Lew Ranieri created by taking sub prime loans, packaging them together and turning them into bonds. Kuttner is right. It is much more difficult to renegotiate these sorts of loans. What he doesn't say is that this system has opened up home ownership to millions of folks that otherwise wouldn't be able to enjoy it. By turning mortgages into bonds, this frees up money for banks that they can then use to lend to new folks. The system has flaws however I am all for any system that creates an opportunity for more people to own.
The system is not the issue frankly. What we do going forward is? We can be the land of government interference and bureaucracy everytime something goes wrong like Kuttner suggests. On the other hand, we can be the land of personal responsibility and respect for private contracts like I suggest.
We are in the middle of a housing crisis. This crisis will affect millions and millions will be hurt. I don't believe that it is the government's job to save an industry. I don't believe it is the government's job to bail people out when they make poor financial decisions. Beyond that, I firmly believe that not only will such action lead us closer to socialism, but frankly it is counter productive.