This morning I made a lengthy defense of McCain's new housing proposal. Brad DeLong has a post making the opposite argument, and since he's an actual economist, I've got to modify things a little, in part because McCain spokesperson Doug Holtz-Eakin made slightly different points than McCain made the night before on the conference call I was on this morning and to Politico. It's also not clear how the plan would be executed, but I'm assuming since it is supposed to use existing authorities, then it does so.
DeLong's objection is simple: When the FHA insures a new, stable loan for a homeowner facing foreclosure, it will be at ninety percent of current home prices, which are much lower than the price of the original mortgage the lender provided. McCain's plan is, in part, offering to make up the difference between the two loans out of the $300 billion authorized by the summer's Dodd-Frank bill to insure new mortgages for people facing foreclosure. (On the other hand, any mortgages the Treasury buys directly or through purchasing mortgage-backed securities could be refinanced more easily, but taxpayers would likely eat the loss in value during the purchase of those securities, which is another discussion altogether). This way of making up the differences diminishes the moral hazard of the lending companies and, in DeLong's view, funnels way too much money to the lenders, thus diminishing the availability of funds to homeowners in need.
This is problematic. But as the FHA fact sheet on HOPE for Homeowners points out, many mortgage owners are facing more prohibitive losses from foreclosures, and have an incentive to write down the principal -- I don't think anyone can say, as DeLong does, that McCain's plan will involve paying double the current home value to banks. As Holtz-Eakin said this morning, it would involve paying the difference between something like 90 percent of the current price and the original price (if the mortgage was bought around the peak of the housing bubble, the current price is 20 percent less, on the high side).
So, in a very rough analogy, if a house cost $100 when it was bought, and it costs $80 today, the FHA would insure refinancing at $72, and the maximum difference to be made up would be $28 -- and that's assuming that the government doesn't pay less, which is not unbelievable since foreclosure isn't profitable and neither is sitting on these assets. (It's possible my math/understanding of this is wrong, and I look forward to correction from my elders).
Now, do we trust a hypothetical McCain administration to execute this plan fairly? No. Is it as cheap as demanding that lenders take a loss (which is presumably doable under the rescue bill)? No. But it's worth considering whether the outlay to these lenders is important simply as a method for keeping people in their homes and paying their mortgages, thus addressing the underlying cause of the financial crisis. Part of the problem is that the $300 billion everyone refers to is authorized as insurance for private mortgages, not money to lend. (If McCain is talking about using that money just to buy up mortgages, then he's wrong when he says the authority already exists).
I take Brad's side of the Paulson/Elemendorf conflict that he describes in his post. But both of those proposals deal with the financial derivatives of mortgages, not the mortgages and their potential foreclosures. Elmendorf doesn't seem to address the problem of foreclosure directly. The modified Paulson plan that passed, if Treasury chooses to implement it in a certain way, does address that problem because it offers a direct outlet for the government to refinance mortgages. The McCain plan would empower existing programs in the modified Paulson plan that passed and the summer's housing bill to deal with foreclosure directly. As I mentioned in my first post, the voluntary nature of the original HOPE for Homeowners plan had some economists worrying that no lenders would even use that $300 billion insurance fund. We don't have data yet to determine this either way, since the program began on Oct. 1.
So here's my question for Brad: Should a progressive policymaker prioritize preventing foreclosures? If so, how is that best done using the existing authority provided by the rescue bill and this summer's housing bill?
--Tim Fernholz
