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W's Disastrous Mortgage 'Fix'

December 07, 2007

By Nicole Gelinas

PRINTER FRIENDLY

PART of the Bush administration's "mortgage-bail out" plan would make it easier for cities and states to conduct their own mini-bailouts alongside the feds. Should Congress go along, the proposal would imperil the fiscal, economic and credit outlooks of municipalities across America.

The centerpiece of Bush's plan is to encourage lenders, investors and their agents to freeze interest rates for up to five years on tens of thousands, and perhaps hundreds of thousands, of mortgages issued during the last three years at below-market "teaser" interest rates.

Yet this plan, bad as it is, has little chance of helping most of the people who face the possibility of foreclosure - after all, 1.5 million Americans will see their mortgage rates "reset" to higher rates next year.

So Treasury Secretary Hank Paulson will propose to Congress to let cities and states issue tax-exempt debt to bail out even more borrowers.

Cities and states would borrow billions and lend the money to "homeowners" (in fact, these borrowers don't actually "own" their homes; they only own the mortgage). The "homeowners," in turn, would use the money to pay off the mortgages they can't afford - and take out new, more affordable mortgages with their city or state government. (Not all tax-exempt debt is guaranteed by the city or state that issues it, but this debt would have to be - no private investor will touch this risk right now for an interest rate that would be "affordable" to these borrowers.)

The whole idea is disastrous - and not simply because it is massive government interference in the private markets. The problems are almost too painful to describe:

* It's a mass-scale payment from city and state taxpayers to banks and big investors - institutions that should have known they risked a huge loss from lending on such an unsustainable basis.

Consider: Many people are in trouble right now because they expected housing prices to keep rising and rising; thus, they expected to either sell their house for a quick profit or refinance their loan easily. But they can't do either in this market - hence, the "mortgage crisis."

When the bank forecloses, though, and finds it can only sell the home for a fraction of its last purchase price, it's the investors in the mortgages who take the loss. But if state and city money lets homeowners pay back that mortgage, it saves those investors from that loss - while you, the taxpayer, wind up paying for someone else's investment mistake. (Sure, maybe local governments would negotiate with banks and mortgage investors to share the pain - but the government is often a bad negotiator.)

* By encouraging people to stay in homes they can't afford, the plan keeps the housing market artificially high. When a bank forecloses on a home, conversely, someone else can buy it at a much cheaper price.

Politicians in New York and elsewhere have been complaining about a lack of affordable housing for years now; you'd think they'd be happy to have the opposite problem. Yet the bailout plans use government money to keep the market from finding its true price. This, when first-time homebuyers benefit immensely from falling home prices.

* The Bush plan encourages foolish local-level borrowing. City and state have limited funds; they should raise bonds only for crucial capital projects, like building and fixing roads, bridges, tunnels, schools and subway systems. Any money the government raises to bail out a homeowner who made a bad decision is money taken directly from fixing a pothole-scarred road or an aging bridge.

* Encouraging city and state governments to guarantee new mortgages for precarious borrowers puts the credit ratings of those governments at grave risk.

Consider: The banks will likely cherry-pick the "best" of the worst borrowers under Paulson's rate-freeze plan - leaving the worst risks for cities and states. But many (perhaps most) of the borrowers so "rescued" would still wind up defaulting on their new government loans. (One study showed that 40 percent of borrowers whose private lenders rework their mortgages eventually default anyway.) So municipal governments, having put their own credit rating on the line on behalf of risky borrowers, will be left holding the bag.

They'll also be left holding residential property - since, by rights, they'll have to take back all that defaulted property once the borrowers prove once and for all they can't pay. Other cities, towns and states may lack the experience to alert them to this risk - but New York just finished selling off all the property it ended up owning during tax defaults of the '70s and early '80s.

Yet, city and state taxpayers would start paying for this risky plan even before the defaults begin. Consider: Investments in the riskiest mortgages have tanked in recent months, because investors don't want to go near these overvalued homes and risky borrowers anymore. What will happen when city and state governments (under the Bush plan) take on the very same bad risks? Investors in those goverments' bonds will insist on charging a premium to cover the greater risk - meaning higher interest rates for cities and states.

Investors are already more nervous about some municipal bonds than they were a few months ago - because the private companies that insure some municipal some bonds (so that investors don't have to worry about default) also insured some of the riskiest mortgages. If a big private insurer goes under, the municipal bonds it insured will face some turmoil and municipalities could face higher costs.

These risks, put together, spell higher payments on all municipal debt for any city or state that uses its own credit to back risky new mortgage obligations - just when these municipalities, as property taxes fall, can least afford it.

Cities and states should beware of the Bush administration's sudden generosity. It comes with a prohibitive price tag in the end, just like all those risky mortgages did.

Original Source: http://www.nypost.com/seven/12072007/postopinion/opedcolumnists/ws_disastrous_mortgage_fix_767611.htm

 

 
 
 

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