Interest Rate Roundup

Friday, November 30, 2007

The bailout process gathers steam

You've probably seen a lot of coverage today about what Treasury Secretary Henry Paulson is pushing -- systematic extension of teaser rates for borrowers facing rate and payment resets on their ARMs. This Wall Street Journal story has more details. The following is the key section dealing with the question of "why" this bailout program is happening now and "who" would potentially qualify:

"Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups: those who can continue to make their payments even if rates rise, those who can't afford their mortgages even if rates stay steady, and those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates. Only the third group would be eligible for help.

"The creditors are likely to look at whether the borrowers have equity in their homes, despite falling house prices, and whether their incomes are holding steady.

"Mr. Paulson, who is philosophically opposed to federal meddling in markets, at first rejected a sweeping approach to loan modifications when the idea was floated by Federal Deposit Insurance Corp. Chairwoman Sheila Bair. But he shifted his position recently. He told The Wall Street Journal last week that it would be impossible to "process the number of workouts and modifications that are going to be necessary doing it just sort of one-off."

"As a drumbeat of bad news about housing has continued -- including news of fewer home sales, falling prices and higher foreclosures -- the Bush administration has come under pressure to be seen as actively addressing the problem."

Now, let's talk about it in more detail. I have long believed that a government-organized bailout of mortgage borrowers and lenders was all but inevitable. Indeed, whether you think it's right or not, the political reality is such that Congress, the President, and just about everyone else who depends on getting votes can't afford to sit around and do nothing while the housing market -- and the home equity of millions of voters -- continues to go up in smoke.

So is it "right?" Well, here's one particularly solid analysis from Minyanville of how we are essentially going the way of Japan -- taking the "crony capitalism" approach to lending risk, something that will come back to haunt us in the end. Here's another take from the Motley Fool on why a bailout is borderline ridiculous. On the flip side, here's a speech from Michael H. Krimminger, Special Advisor for Policy at the FDIC, addressing some of the suggested government efforts to keep people in their homes.

Personally, I understand the urge to "do something." But any solution has to be carefully tailored to direct relief to those who actually deserve it -- not speculators and not people who just made a dumb decision to buy more house than they could afford. And there's no way to get around the arguments that a bailout 1) will encourage future bubbles and 2) punish/stick it to those who acted prudently and didn't take on too much mortgage debt to buy overvalued homes.

The Fed can pooh-pooh the moral hazard argument all it wants, as Vice Chair Donald Kohn did earlier this week. But when you essentially ignore a massive future problem as it builds up (which is precisely what hands-off, monetary policymakers and regulatory officials did when all these stupid mortgages were being made in the first place) ... then turn around and try to protect borrowers and lenders from the consequences of their foolishness after the problems come home to roost ... you are sending out a powerful message. That message: Go ahead and speculate. We'll be there to bail you out when the going gets tough.


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