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Mccain's Screwy Mortgage Plan

Like a lot of people, I was initially intrigued by the mortgage bailout plan McCain announced Tuesday night without much elaboration. But, the more I think and read about it, the more I'm persuaded it's a terrible idea.

This Obama ad gets at the gist of the problem:

I'd ad a couple more points:

1.) To simplify somewhat, there are two kinds of mortgages out there. Mortgages that stay intact, and mortgages that banks sell to Wall St. (often through middlemen), which get sliced up and repackaged and sold to investors as securities. Both are weighing down the economy as borrowers fail to keep up with their payments. But the Treasury, via the recently-passed bailout, can now buy up to $700 billion of the latter. In principle, then, Treasury should be able to renegotiate the terms of the mortgages it will own through those securities. So, even though McCain's plan applies to both types of mortgages, it's really only necessary for the former: bad mortgages some bank is still sitting on.

2.) If a bank has a bad mortgage on its books--that is, the borrower has fallen behind or stopped paying--but the borrower could conceivably make payments under some new, more forgiving arrangement, it's already in the bank's interest to pursue this. For example, suppose a bank gave someone a $200,000 mortgage on a house that's only worth $100,000 today, and that the borrower could keep up with a $100,000 mortgage but not $200,000. (Ignore interest rates for the sake of simplicity.) Well, surely salvaging that $100,000 mortgage is preferable to foreclosing on the house, putting it back on the market, and probably getting even less than it's worth--while paying the costs of maintaining it in the meantime.

The reason many banks don't do this (though many do) is that they don't want to admit the asset they've valued on their books at $200,000 is only worth $100,000 (and because, in practice, it can be hard to figure out who's legitimately unable to pay and who's just a deadbeat). So the banks might need a bit of a nudge here, but they shouldn't need much of one.

3.) If it's basically in a bank's self-interest to eat the difference between what a borrower can pay and what they owe (because the cost of foreclosing is even bigger), why on earth should the taxpayers eat the difference, as McCain is proposing? That's not a nudge, it's a massive Christmas present.

4.) As this eminently reasonable National Review Online editorial points out, there's already legislation in place--the Frank-Dodd bill that passed this summer and went into effect last week--that provides the necessary nudge, by having the government insure the mortgages that get renegotiated. (The bill also lets lenders who sold their mortgages to Wall Street negotiate workouts on behalf of investors who bought pieces of the original mortgage.) 

So pretty much* the only thing McCain is proposing that we're either not doing now or couldn't do if we wanted to is compensating banks for making stupid loans in the first place. That doesn't sound like a great deal to me.

*I say "pretty much" because we could expand the scope of the Frank-Dodd legislation if we wanted to. In its present form, it only applies to up to 400,000 distressed homeowners.

--Noam Scheiber