Even the current administration seems to be giving up on the idea that we should just wait out the subprime crisis and let the perfect market correct itself. Now the battle is shaping up over whether to act through a private, negotiated deal or to change the laws and bind the lenders.
David Sirota weighed in with support for one piece of proposed relief: amending the bankruptcy laws to permit renegotiation of home mortgages. In the special way that only Sirota can do, he lays into the Democrats who are siding with the mortgage companies to fight helping families with high-priced loans that exceed the value of their property.
Secretary of Treasury Paulson announced work on a private-deal approach that would stop the subprime mortgage meltdown by leaving borrowers in their current teaser rates longer. Homeowners in trouble will be divided into three categories: those who can continue payments after an increase, those who can continue payments only on the teaser rate, and those who can’t even pay the current teaser rate. The plan is that first group pays, the middle group gets help, and the last group gets moved out.
The economic idea behind both the bankruptcy amendment and the private deal is that dumping all the troubled properties on the market at the same time will chase home prices down further. The private deal would hold some people in their teaser-rate mortgages longer, and the bankruptcy plan will move some people into long-term fixed rate mortgage that would pay 100% of the value of the property. The two approaches use different measures, but both say that people who really can’t afford the homes need to get out.
There are a zillion issues in both plans, but four questions about the not-yet-released deal have me worried:
1. Will the plan stop the slide in the real estate market? The implication of the early reports is that the freezes are temporary. If that means the mortgages will be frozen until these people can be shifted into fixed, 30-year mortgages they can afford then it should have a stabilizing effect on the market (like the bankruptcy proposal). But if the plan is to jump up rates in six months or a year, then the real estate market is unlikely to stabilize. Buyers will wait, knowing that more distressed buyers will be selling soon.
2. What is the infrastructure? The bankruptcy courts regularly value real estate and test borrowers ability to pay. Will there be a new infrastructure to make the sorting decisions that the voluntary plan proposes? Or will the lenders make the decisions?
3. What is “voluntary”? If the Treasury plan is designed around voluntary give ups, then it may be an illusion that delivers little. If it is mandatory, then Congress will need to get involved. Unlike the bankruptcy proposal, which must pass Congress but that meets clear Constitutional guidelines, the private deal has no clear legal basis. Forcing wholesale revision of mortgage terms will result in a flurry of lawsuits, enriching the lawyers and tangling up the homeowners.
4. Bankruptcy screens debtors differently (see, for example, the means test) and would likely provide relief to a smaller group of people. Of course, once debtors had the power to rewrite their mortgages in bankruptcy, their negotiating leverage outside bankruptcy would change as well.
Most importantly: By trying to make the mortgage workout a one-time deal, does it stall the kind of legal change that would clean up the mortgage industry and that would help families whether they are the only one in trouble or one of two million?
