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080223-nyt-andrews--‘Moral Hazard’forHousingBailout-SortingVictimsFromVolunteers

080223-nyt-andrews--‘Moral Hazard’forHousingBailout-SortingVictimsFromVolunteers

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Published by: ax-is on Feb 26, 2008
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February 23, 2008News AnalysisA ‘Moral Hazard’ for a Housing Bailout: Sorting the Victims From Those WhoVolunteeredBy EDMUND L. ANDREWSWASHINGTON — Over the last two decades, few industries have lobbied moreferociously or effectively than banks to get the government out of its businessand to obtain freer rein for “financial innovation.”But as losses from bad mortgages and mortgage-backed securities climb past $200billion, talk among banking executives for an epic government rescue plan issuddenly coming into fashion.A confidential proposal that Bank of America circulated to members of Congressthis month provides a stunning glimpse of how quickly the industry has reversedits laissez-faire disdain for second-guessing by the government — now that it isin trouble.The proposal warns that up to $739 billion in mortgages are at “moderate to highrisk” of defaulting over the next five years and that millions of families couldlose their homes.To prevent that, Bank of America suggested creating a Federal HomeownerPreservation Corporation that would buy up billions of dollars in troubledmortgages at a deep discount, forgive debt above the current market value of thehomes and use federal loan guarantees to refinance the borrowers at lower rates.“We believe that any intervention by the federal government will be acceptableonly if it is not perceived as a bailout of the bond market,” the financialinstitution noted.In practice, taxpayers would almost certainly view such a move as a bailout. Iflawmakers and the Bush administration agreed to this step, it could be on a scalesimilar to the government’s $200 billion bailout of the savings and loan industryin the 1990s. The arguments against a bailout are powerful. It would mostlybenefit banks and Wall Street firms that earned huge fees by packaging trillionsof dollars in risky mortgages, often without documenting the incomes of borrowersand often turning a blind eye to clear fraud by borrowers or mortgage brokers.A rescue would also create a “moral hazard,” many experts contend, by encouragingbanks and home buyers to take outsize risks in the future, in the expectation ofanother government bailout if things go wrong again.If the government pays too much for the mortgages or the market declines even morethan it has already, Washington — read, taxpayers — could be stuck with hundredsof billions of dollars in defaulted loans.But a growing number of policy makers and community advocacy activists argue thata government rescue may nonetheless be the most sensible way to avoid a broaderdisruption of the entire economy.The House Financial Services Committee is working on various options, including agovernment buyout. The Bush administration may be softening its hostility to arescue as well. Top officials at the Treasury Department are hoping to meet withindustry executives next week to discuss options, according to two executives.“There are a lot of ideas out there,” said Scott Stanzel, a spokesman forPresident Bush, when asked at a White House press briefing on Friday about a
possible buyout program. “There are many different ways in which we can addressthis problem and we continue to look at ways in which we can do that.”Supporters contend that a government rescue could be the fastest and cleanest wayto force banks and investors to book their losses from bad mortgages — a painfulbut essential first step toward stabilizing the housing market.The government would buy the mortgages at their true current value, perhapsthrough an auction, at what would probably be a big discount from the originalloan amount. The mortgage lenders, or the investors who bought mortgage-backedsecurities, would be free of the bad loans but would still have to book theirlosses.If the government took control of the bad mortgages, supporters of a rescuecontend, it could restructure the loans on terms that borrowers could meet, keepmost of them from losing their homes and avoid an even more catastrophic plunge inhousing prices.“Every citizen has a dog in this hunt,” said John Taylor, president of theNational Community Reinvestment Coalition, a community advocacy group that hasdeveloped its own mortgage buyout plan. “The cost of spending our way out of arecession is something that everybody would have to bear for a very long time.”Mr. Taylor estimated the government might end up buying $80 billion to $100billion in mortgages. But he said the government could recoup its money if it wasable to buy the mortgages at a proper discount, repackage them and sell them onthe open market.Surprisingly, the normally free-market Bush administration has expressed interest.Treasury officials confirmed that several senior officials invited Mr. Taylor topresent his ideas to them on Feb. 15. Mr. Taylor said he had also received callsfrom officials at the Office of Thrift Supervision and the Office of theComptroller of the Currency, which is part of the Treasury Department.But even supporters acknowledge that a government rescue poses risks to taxpayers,who could be left holding a very expensive bag.Ellen Seidman, a former director of the Office of Thrift Supervision and now asenior fellow at the moderate-to-liberal New America Foundation, said thegovernment’s first challenge is to buy mortgages at their true current value. Ifthe government overpaid or became caught by an even further decline in the marketvalue of its mortgages, taxpayers would indeed be bailing out both the industryand imprudent home buyers.“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are variousauction mechanisms, both inside and outside government.”A second challenge would be to start a program quickly enough to prevent thehousing and credit markets from spiraling further downward. Industry executivesand policy analysts said it would take too long to create an entirely new agency,as Bank of America suggested. But they expressed hope that the government couldbegin a program from inside an existing agency.But even if the government did buy up millions of mortgages and force mortgageholders to take losses, the biggest problem could still lie ahead: deciding whichstruggling homeowners should receive breaks on their mortgages.Administration officials have long insisted that they do not want to rescue

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