Frank's Bill Passes Committee

By a vote of 46-21, Barney Frank's sweeping mortgage reform bill passed the Banking Committee in the House.

The U.S. House of Representatives Financial Services Committee on Thursday approved a sweeping bill to enable the government to finance $300 billion in distressed mortgages with the aim of helping 2 million homeowners.

The legislation, approved by a 46-21 vote, would provide an infusion of capital and new mandate for the Federal Housing Administration to guarantee home loans when a property has sunk in value since the mortgage was written.

Lenders would have to erase a portion of the original loan in order to secure a government guarantee on future payments.

The plan would "put liquidity back in the market and not interfere with the market, I think, but help restore (it)," committee Chairman Barney Frank told reporters after the vote.

Now, the last paragraph is most troubling to me, but before analyzing that, let's look at the rest of the bill. First, this bill redefines moral hazard. The bill would have the federal government guarantee distressed loans, but only if the bank wrote down some of the principle. In other words, if you are late on your mortgage and in danger of going into foreclosure, the government will not only guarantee you a new loan, but at a reduced principle. In other words, if you did owe 250k, you will now only owe 200k. That's of course, if you are in danger of going into foreclosure. Keep in mind, this bill gives absolutely no consideration to those that have been responsible enough to pay on time. What this portion of the bill does is reward irresponsible behavior.

Just as troubling is the 300 billion dollar figure. Most of the numbers thrown around used to be up to 30 billion (the amount the Fed guaranteed to procure the Bear Stearns deal). This bill would guarantee about 300 billion dollars worth of loans. On the one hand, at least the bill recognizes the magnitude of the problem. On the other hand, that is an awful lot of money for the government to guarantee. I am of the opinion that most of these folks will eventually go bad on their next loan, or at least a large percentage of them.

In mortgages, folks near foreclosure wind up getting what are known as "hard money loans". The rates are well above 10% and the loan to values are 65% and less (the value of the loan divided by the value of the property). The government would set in place loan terms far better than that. Those loan terms aren't merely set by greedy banks to bleed money from borrowers. They are set to guarantee a profitable loan program. If a distressed borrower were to get a nice thirty year fixed rate in the 6 percent range, the bank would fail because the loan would never make any money. Yet, that is exactly what the federal government is planning on doing and furthermore, they will spend 300 billion dollars to do it.

Then, there is the issue of FHA. FHA loans lie somewhere between the best so called conventional loans and sub prime loans. Frank wants FHA to take on many of these distressed borrowers. Frank is totally oblivious to the reality that FHA works as a product because it takes on borrowers with far superior credit profiles to the ones he wants them to take on. FHA was never meant as a loan for the worst of borrowers. That is the sort of folks he wants FHA to reach out to.

Finally, there is Frank's assertion that this won't "interfere with the market". Of course, this statement shows an utter lack of understanding of how markets work, and certainly the dynamics of this one. What Frank wants to do is prop up distressed borrowers who can't make the payments they are supposed to make with loans they would never qualify for in the market. That is interfering with the market. It is one thing to make policy based solely on politics, but quite another to pretend as though it is rooted in sound economic fundamentals. Frank is plain dangerous.