Hostage Taking Bankers and Subprime Borrowers
There is little public support for using taxpayer dollars for protecting the richest people in the country from bad investment decisions. For this reason, when the government goes to help out those rich investors who cannot fend for themselves, it must come up with some alternative explanation.
The most recent example of this exercise is Treasury Secretary Henry Paulson's efforts to help some of his banker friends remove hundreds of billions of bad debt from their books without incurring large losses. Paulson's effort appears to be failing, but it is noteworthy that he is trying nonetheless. The ostensible reasons for the federal involvement are to maintain stability in financial markets and help sustain the mortgage market.
While stable financial markets are better than unstable markets, the public is best served by markets in which investors face the consequences of their bad judgment. We all benefit when the people who invest hundreds of billions of the nation's capital are capable of clear thought. That means that the banks that made bad bets in the mortgage market should be forced to eat their losses. If that puts some of them out of business or causes some top executives to be fired, the loss of inefficient institutions and incompetent bankers will be a gain to the economy.
The most effective way to help homeowners in trouble is to help the homeowners directly. Proposals to help homeowners by bailing out lenders, whether through Paulson's scheming or through the intervention of Fannie Mae and Freddie Mac, are trickle down economics on steroids. These plans may save some big banks, but they will put less money in the pocket of troubled homeowners than a Bush tax cut.
The quickest and most direct way to help the millions of homeowners who have mortgages that they can no longer afford is to change the rules of foreclosure. This measure requires no new bureaucracies and no taxpayer dollars.
Congress can alter the rules on foreclosure, so that homeowners facing foreclosure will have the option to rent their home indefinitely at the fair market rent. This rent would be determined by an independent appraiser, appointed by the judge handling the foreclosure. The appraiser would determine the fair market rent in the same way that appraisers determine the market value of a home before a bank issues a mortgage.
This measure would ensure that current homeowners could at least keep a roof over their head. If they like the home, the neighborhood, the schools for their children, they would have the option to stay in their home as long as they wanted.
More importantly, this change in the foreclosure rules would give lenders a strong incentive to renegotiate the terms of mortgages. Most lenders will not want to become landlords. They would have the option to sell the home, but the tenant would go with it, substantially reducing the resale value. Since the foreclosure option will be significantly less attractive, lenders will be far more likely to try to negotiate terms that allow current homeowners to remain in their houses as homeowners.
This own to rent provision can be limited by both the date of issuance of the mortgage, and the value of the home, so as not to seriously disrupt the workings of the mortgage market. In recognition of the fact that the housing market was subject to a bout of irrational exuberance, that hopefully will not be repeated, the own to rent option can be restricted to mortgages issued before July 1, 2007, or some other date in the past.
To ensure that only less affluent homebuyers benefit, it can be restricted to homes that sold for less than the median price in an area. While it would be best if Congress took action so that homeowners across the country could benefit from an own to rent provision, each state has the option to pass an own to rent rule in the absence of national legislation.
The collapse of the housing bubble will almost certainly throw the economy into a recession and will cause many homeowners to lose much of their life savings. However, it is possible for Congress (or state legislatures) to protect the most vulnerable segment of homeowners if it approves an own to rent provision on foreclosures. The plans for bailing out lenders, whether with bank consortiums or through Fannie Mae and Freddie Mac, should be abandoned. The bankers should not be allowed to get another big bailout under the guise of helping moderate-income homeowners.