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Mortgage Crisis Bailout Gains Momentum

With home prices spiraling down, the foreclosure crisis spreading and Wall Street paralyzed by a credit crunch, the once-unthinkable notion of a big

Jul 31, 2020
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With home prices spiraling down, the foreclosure crisis spreading and Wall Street paralyzed by a credit crunch,the once-unthinkable notion of a big government bailout of the subprime mortgage market is gaining momentum.
The housing mess has gotten so bad that even conservative economists and Wall Street – not the usual fans of government intervention – are beginning to speak out, saying that the Federal Housing Administration, the Treasury Dept. or someone, anyone, needs to begin buying up distressed subprime mortgages and refinancing them. In a big way — to the tune of as least $300 billion or so, and maybe even more. And soon. Because with all the pitfalls that could accompany Big Government entangling itself in the mortgage market, the crisis is so severe that the cost of doing nothing could be much, much higher.
Illustration by: Matt Mahurin
“I think we’re at a stage where we’re looking at the least bad option,” said Desmond Lachman, an economist at the American Enterprise Institute,a conservative, pro-business think tank. “We’re looking at a real mess. The problems with the banks can get really, really big. Any government program will have to be very large in scope to make a difference. I think this is where we’re going to have to end up.”
On Wall Street, which has spent the last decade pushing for more deregulation of the financial system, the belief is that the housing market will stabilize only when “the U.S. government opens its wallet,” said William O’Donnell, strategist for UBSSecurities in Stamford, Conn.
“They won’t call it a bailout, but that’s essentially what it will be,” O’Donnell said. “You can argue all day as to what it’s going to look like. But we believe it’s going to happen, one way or another. And the whole purpose will be to prevent further damage to the economy.” On Tuesday, UBS announcedits latest writeoff, $19 billion, due to subprime losses.
The Fed has already been “tearing pages out of a book that hasn’t been open since the Great Depression” to try to stem the crisis, O’Donnell said, and the possibility of the government buying subprime mortgages is a natural extension of that tactic.
The bailout idea got a huge boost on Tuesday, as the Senate worked quicklytoward action on a bipartisan housing relief bill. The measure may include more housing counseling money and tax credits for borrowers, but no wide-ranging plan for the government to intervene.
The Fed has already been “tearing pages out of a book that hasn’t been open since the Great Depression
Still, the rapid support raised hopes for a proposalby Sen. Chris J. Dodd (D-Conn.) and Rep.B. Barney Frank (D-Mass.) that calls for the Federal Housing Administration to provide $300 billion in guarantees to refinance risky subprime loans into more affordable terms. Lenders and investors would agree to substantial losses on the loans in return. Homeowners would have to prove their ability to repay the lower loan amounts and would be barred from profiting if their homes sold at higher prices.
The Dodd-Frank bill is not new, but it didn’t have widespread support until the Federal Reserve stepped inrecently with $30 billion in credit lines to help engineer the takeover of the ailing investment bank, Bear Stearns. The move promptedcriticismthat the government was bailing out Wall Street while ignoring the plight of homeowners. The worsening condition of the subprime mortgage market has propelled even skeptics to begin considering seriously whether government intervention might be the only way out.
On Tuesday, Deutsche Bank warned of looming defaults in securities tied to Alt-A loans, which are mortgages made to borrowers with decent credit — the first time a major bank has issued such a dire warning for this market, reported.Default rates in the Alt-A market had been far lower than defaults for subprime loans, but they have jumped dramatically in the last few months. In addition, more than 8 million homeowners either have zero equity or owe morethan their homes are worth, a total that could double this year as housing prices continue to fall in the wake of foreclosures and lagging sales, Lachman said.
That even among the anti-government philosophy of Wall Street the bailout idea is gathering steam “speaks a lot to the scope of this crisis,” O’Donnell added. Especially since Wall Street is well aware that getting help from the government could mean opening the door to new regulation in return.
Wall Street’s fear is that if the government doesn’t act, credit will continue to dry up – and so will growth. That would mean an even more severe recession than the one already expected, O’Donnell said.
The unfairness question around a bailout is resolving itself. With so many more homeowners owing more on their mortgages than their homes are worth, the sympathy factor is increasing, AEI’s Lachman said. Even the Bush administration, in an acknowledgement of the reach of the crisis, has reportedlybacked off its initial opposition to government involvement and is working to expand the FHA’s ability to buy distressed mortgages, though in a far more limited way than the Dodd-Frank bill.
Debates over a government bailout of the mortgage market among investors and economists first began to percolate last fall, when top investment guru Bill Gross of Pimco arguedin favor of it. “If we can bail out Chrysler, why can’t we support the American homeowner?” he wrote in an investment outlook. Last month, Princeton economist and former Federal Reserve vice chairman Alan Blinder floatedthe idea of creating a new Home Owners’ Loan Corp., based on the agency established during the Great Depression to buy up distressed mortgages. Consumer and housing advocates also have been pushing the idea.
“If not the government, then who else?” asked Bob Zdenek, interim executive director of the National Housing Institute.
Although not accompanied by the publicity generated by the Bear Stearns deal, the government has already been taking steps to prop up the housing market, and it is relying on New Deal-era programs in order to do so, notedSlate columnist Daniel Gross. The Federal Home Loan Bank,for example, which was created in 1932 to provide a stable source of mortgage money, lent Countrywide Financial Corp. more than $50 billion to keep it afloat, Gross said.
But until recently a bigger and more comprehensive bailout seemed out of the question. The Bush administration initially opposed the the use of any taxpayer funds or government guarantees, and Sen. John McCain (R-Ariz.) the Republican presidential candidate, saidrecently that government should not rescue lenders or borrowers who behaved irresponsibly. In addition, any government program that harkens back to the New Deal automatically raises opposition among those opposed to government meddling in the free markets. On Monday, Treasury Secretary Henry M. Paulson announced an overhaul of regulatory oversight of the financial markets without calling for a bailout.
Even supporters acknowledge that the government has a poor track record when it comes to some housing programs — pointing to scandals at the Dept. of Housing and Urban Development and the resignationlast week of Secretary Alphonso Jackson. They also agree that wading into the subprime market is fraught with potential problems for the government, considering the inflated home prices in the bubble markets of California, Florida, Las Vegas and elsewhere. There’s also the complexity of securitization, which complicates refinancings because loans are packaged as bonds and sold to investors instead of being held by a single bank or lender. Loan servicers might balk at any deals, or even sue over them. And there’s a persistent belief among some economists that the housing market should be left alone to suffer the pain of a correction, because that’s how bubbles burst.
Still, with all those potential problems, standing by and doing nothing is a far worse alternative, some said.
“This kind of thing should have been done nine months ago, instead of futzing around with ideas that don’t work,” said Sherle Schwenninger,director of the economic growth program at the New America Foundation. “We’ve already done some real damage.”
Unlike the private market, the government can buy the mortgages at big discounts and hold on to them or restructure them without earnings pressure from Wall Street or worries about write-offs and possible exposure to unknown losses, Schwenninger noted. “It gets a lot of junk out of the financial system,” he said.
He added that the experience of the Resolution Trust Corp. in the 1980s and the programs of the New Deal era prove that buying distressed mortgages can work. Anything short of doing so means the government is just bailing out investment banks like Bear Stearns as a “backstop.” That doesn’t address the real problem of so much negative equity among homeowners, he said.
Camilo Wood

Camilo Wood

Camilo Wood has over two decades of experience as a writer and journalist, specializing in finance and economics. With a degree in Economics and a background in financial research and analysis, Camilo brings a wealth of knowledge and expertise to his writing. Throughout his career, Camilo has contributed to numerous publications, covering a wide range of topics such as global economic trends, investment strategies, and market analysis. His articles are recognized for their insightful analysis and clear explanations, making complex financial concepts accessible to readers. Camilo's experience includes working in roles related to financial reporting, analysis, and commentary, allowing him to provide readers with accurate and trustworthy information. His dedication to journalistic integrity and commitment to delivering high-quality content make him a trusted voice in the fields of finance and journalism.
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