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Plan to Bailout US House Market

Posted Wednesday, May 21, 2008

Just when you thought the politicians had sunk as low as they possible could, they manage to do something to lower your assessment even further. Congress is on the job this with week with a plan to pay for a housing bailout by taking money from low-income renters.

Unfortunately, that is not a joke. This was the result of the compromise worked out by the leadership of the Senate Banking Committee last week.

Just to remind everyone of where things stand, Congress was wrestling with the situation of several million low and moderate-income families who are facing foreclosures on the mortgages on their homes. The main problem here is that they were pushed to buy over-priced homes in bubble-inflated markets. Making matters worse, many of these homeowners were also the victims of subprime mortgage scams. They got loans that started with relatively low teaser rates. These rates then reset, typically after two years, to much higher rates that made the mortgages unaffordable.

This is bad news not only for the homeowners facing the loss of their homes, but also for the banks that will take large losses foreclosing on homes that now sell for much less than the money owed on the mortgage. Congress's answer to this problem is a complex bailout scheme in which it would have the Federal Housing Authority guarantee new, lower interest-rate mortgages.

The new mortgages would pay off the first mortgages at 85% of the appraised value of the house. While the banks will still lose money under this plan, they will almost certainly end up much better off than if situation was just left to the market. In fact, since the banks decide which loans get into the program, it is virtually guaranteed that they come out ahead.

Homeowners can benefit also, in that many will be able to stay in their homes with more affordable mortgages. However, in many of the bubble-inflated markets such as San Diego, Los Angeles and Boston, the new mortgages are still likely to cost far more than renting comparable units, draining money away from other necessary expenses, such as healthcare and childcare.

Furthermore, since prices are still falling rapidly in these areas, it is unlikely that these homeowners will ever accumulate equity. For homeowners in these bubble-inflated areas, banks will be the main beneficiaries of this bailout.

It would be possible to prevent this problem by restricting the guarantee prices to some multiple of rents. Rents never got out of line with fundamentals even at the peak of the bubble. For example, if the guarantee price was set at a multiple of 15 times the appraised rent on a property it would offer greater assurance that the homeowner was not paying too much on their mortgage and might also accumulate some equity in their home.

Congress has shown little interest in ensuring that the new guarantee prices reflect fundamentals, making it likely that many of the people "helped" under the programme will end up facing foreclosure a second time. However, to make matters worse, they came up with the idea of financing the plan by taking away a stream of funding that had been dedicated to help low-income renters.

That's right; Congress wants to take away money from low-income renters to help bankers that made bad loans in the housing bubble. As we all know, when the banks are in trouble, it is not the time to talk about the free market.

The real painful part of this story is that it would be very easy to help the real victims in this story - the low and moderate income homeowners who were suckered into buying homes at bubble-inflated prices with bad mortgages. Congress could just temporarily change the rules on foreclosure to allow moderate income homeowners facing foreclosure the option to stay in their home paying the fair market rent.

This would provide these families with housing security. At least as important, it is likely to result in many of these families remaining in their houses as homeowners, since banks will have a strong incentive to negotiate new terms on mortgages in order to avoid becoming landlords. And the best part of this story is that families would benefit from this change the moment that Congress passed the law. There is no need for a new bureaucracy or any taxpayer dollars.

That is what Congress would do if it was serious about helping families facing foreclosure. Unfortunately, the banks seem to rank higher in its concerns - remember just three years ago when it made the bankruptcy laws more stringent (applied retroactively) to boost bank profits.

Apparently, the banks rank so high that Congress is even prepared to take money away from low-income renters to meet their needs. Stealing candy from children would be a step up for this crew.
By Dean Baker