Straw Dogs

In today’s New York Times, Paul Krugman explains the Bush mortgage bailout plan, announced last week by Treasury Secretary Henry Paulson.

The plan is, as a Times editorial put it yesterday, “too little, too late and too voluntary.” But from the administration’s point of view these failings aren’t bugs, they’re features.

In fact, there’s a growing consensus among financial observers that the Paulson plan isn’t mainly intended to achieve real results. The point is, instead, to create the appearance of action, thereby undercutting political support for actual attempts to help families in trouble.

In particular, the Paulson plan is probably an attempt to take the wind out of Barney Frank’s sails. Mr. Frank, the Democratic chairman of the House Financial Services Committee, has sponsored legislation that would give judges in bankruptcy cases the ability to rewrite mortgage loan terms. But “Bankers Hope Bush Subprime Plan Will Scuttle House Bill,” as a headline in CongressDaily put it.

As Elizabeth Warren, the Harvard bankruptcy expert, puts it, “The administration’s subprime mortgage plan is the bank lobby’s dream.” Given the Bush record, that should come as no surprise.

The plan has so many conditions that Barclays Capital estimated only about 12 percent of all subprime borrowers, or 240,000 homeowners, would qualify for relief. For example, people already delinquent on their payments, or anyone the mortgage lender decides ought to be able to pay the subprime mortgage, are excluded.

Krugman says there are three problems with the plan. First, banks and other financial institutions will take huge losses. Second, hundreds of thousands, probably millions, of American will lose their homes. And third, there is injustice, since many of the people stuck with subprime loans were victims of predatory sales practices.

Free-market culties tsk-tsk any mortgage relief program as short-sighted. Robert Murphy wrote at Townhall:

Lenders will learn the lesson that their contracts aren’t safe; contrary to popular belief, the government will not serve to enforce the law. (Or rather, the “law” can change on a dime, depending on the public’s mood.) Lenders won’t simply shrug their shoulders, say “aww shucks,” and continue with business as usual.

No, lenders will rationally respond to the new environment, by being much pickier in giving new loans. After all, it becomes much riskier to grant a mortgage to a young couple with little job experience, if the government will shield them from the consequences of default on the loan. Many people say that “the American dream” involves homeownership, yet this will be harder to achieve if the government introduces yet another uncertainty for lenders.

Another cultie named Peter Schiff thinks the problems lies with borrowers who simply aren’t taking big enough risks:

Lost in current discussion is the fact that few subprime borrowers have any skin in the game in the first place. Having put nothing down or having extracted equity in previous refinances, most subprime borrowers will lose nothing if their homes go into foreclosure. In some cases the teaser rates were so low that borrowers actually paid less than what they might otherwise have paid in rent. In fact, those who have already extracted equity have received huge windfalls from their homes and will leave their lenders holding the bag.

Talk about lucky duckies! However, according to Krugman,

Relief is restricted to borrowers whose mortgage debt is at least 97 percent of the house’s value — which means that in many, perhaps most, cases those who get debt relief will be borrowers who owe more than their house is worth. These people would be nearly as well off in financial terms if they simply walked away.

So, no equity “windfalls.” But let’s go back to Murphy, who explains the beauty of the capitalist system:

The reason borrowers agree to adjustable rates (which have the possibility of skyrocketing) and to pledging their home or other assets as collateral, is that this allows them to receive concessions from the bank—in particular, it allows them to borrow a great deal more money than would otherwise be possible. Very few people would persuade a bank to lend them money to buy a house, if the bank didn’t ultimately have the right to take ownership of the house in the event that the borrower couldn’t make the mortgage payments. Yes, borrowers would prefer that they get a $300,000 mortgage with no strings attached, but lenders wouldn’t be too happy with this arrangement. The beauty of a capitalist system is that property owners must compromise to reach mutually beneficial arrangements, since private transactions are voluntary.

He acknowledges that there are some “shysters and shady characters” in the home loan biz, but for the most part “the politicians want to grant a mulligan to hundreds of thousands who bought homes they couldn’t afford.”

But Krugman wrote,

The Wall Street Journal found that more than 55 percent of subprime loans made at the height of the housing bubble “went to people with credit scores high enough to often qualify for conventional loans with far better terms.”

And at Newsweek, Daniel McGinn wrote of a borrower who didn’t know a $300 property tax bill would be added to her monthly mortgage bill. I suspect this happens a lot, especially to first-time buyers. In my own home-buying experiences I learned you sometimes have to threaten the mortgage broker with bodily injury — or close to it, anyway — to get a straight answer to the question “what will be my total monthly payment?” In my book, a transaction is not “voluntary” if one of the two parties is withholding information from the other to maintain an advantage.

McGinn has more sympathy for the borrowers than Schiff and Murphy:

My own view is more sympathetic, for two reasons. The first, frankly, is self-interest. As a homeowner I’m concerned about the value of my own home. Studies show that anytime a house is foreclosed, the value of nearby properties tends to drop. Last month I spotted a “public auction” sign in front of a house two blocks from mine. I hope it’s not the first of many. My own mortgage is a conservative, fixed-rate loan, so I won’t directly benefit from the subprime bailout—but if it keeps some of my neighbors from losing their homes, I’ll benefit because it will help my house retain more of its value. (I will, of course, also be happy to avoid watching neighbors traumatized by foreclosure, but in this column I’m weighing the pros and cons economically, not emotionally.)

The other reason for my sympathy is that I’m aware of how hideously complicated mortgages have become over the last two decades. I have absurdly well-educated friends who don’t really understand how mortgages work. Even though I write about this stuff for a living, at times I’ve agonized over whether to pay points or whether my mortgage broker’s fees are legit.

But the Bushie plan offers little for most subprime borrowers, but at the same time does little to reduce investor losses. So what’s the point? I think Krugman called it exactly — it was created to undercut any attempt by Congress to actually help people holding subprime mortgages in danger of foreclosure. Free market culties like Schiff and Murphy may not like it, but in this case government is being used to prop up “free markets.”

In ancient times the Chinese made dogs and other animals of straw to be offered in sacrifice. Before the ritual a straw dog would be wrapped in embroidered cloth and handled with great care, but once the offering was made the straw dog was trampled and burned. “Straw dog” became a metaphor for something utterly expendable. “Free market,” unregulated capitalism makes straw dogs of us all.

6 thoughts on “Straw Dogs

  1. Seems to me that elected politicians, their appointed lackeys, and influence peddlers who make up all three branches of the federal government in DC comprise one very large, extremely powerful corporation. Like any proper corporation it operates according to the supreme law of capitalism, that is to first and foremost accrue capital, whether political or financial – hopefully both.

    However, unlike most corporations, the Corporation of Washington DC not only ignores the wishes of its shareholders (us), it refuses to pay us our rightful dividends when we need them. (Even the Wall Street Journal would frown on that behavior)

  2. Equity is not extractable apart from giving up the full title. Anything short of that is just an illusion created to make you borrow money that you think is yours.

  3. Good post, Barb. I admit I was hoping for more help for the poor schlep who got suckered in a crooked deal. A few things to add- the degree of fraud is hardly reported. In come cases (I do not know how often) appraiers were paid to deliver inflated appraisals. So the loan issued was more than the property was worth.There is/was no way the owner could sell, but the expectation/hope was that eventually the value would catch up with the price..

    Meanwhile the loan(s) got bundled and sold and bundled under the expectation that the profits from these loans would be tremendous (if the homeowner could keep up with the payments). Instead the market cooled WAY off, the buyers could not keep up with the growing payments and they could not sell for the inflated price in the ice-cold market. Does it sound like regulation is needed here?

    As I heard it on NPR, the FBI is investigating over 500 cases of real estate fraud, a 500% increase over a year ago. (Check my numbers, that’s what I remember.)

    The flip side Barb touched on briefly. Mortgage brokers were offering their services for NO charge. They were taking kickbacks from the loan companies to issue the adjustable-rate mortgages and even steering buyeres who WOULD HAVE QUALIFIED for conventional loans into the risky, more expensive loans, and they never disclosed WHO was paying them – or how much. Does it sound like regulation is needed here?

    Last point, the housing boom was going soft and the builders and real estate speculators were not ready to step off the gravy train. The lookers in the market – at the end of the boom – were lower income people with weak credit. (Insert picture of me.) To keep building, a conspiracy between builders, appraisers, lenders and mortgage brokers was formed with the HOPE that the bubble would not burst – and the knowledge that if it did, they all had their money stashed. The buyer would be forclosed and the bank would resell. What they did not anticipate was the scope of the forclosures, and the impact on the entire economy. We are just seeing the first wave. If there is no more help than I am seeing described here, the number of forclosures in the next 13 months may be catastrophic for the economy.

  4. Consider that Paulson as CEO of Goldman Sachs received 18.7 million good bye bonus for 6 months of work as he left for his job as Secretary of Treasury.

    Consider also that Goldman Sachs announced they shorted sub-prime mortgages, and are siad to have done so since 2004 during Paulsons regime, and they stand to do well.

    Shades of Cheney/Halliburton.

    The bubble needed bursting, glad someone made out well.

  5. Pingback: The Mahablog » An Attorney’s Take on Paulsen’s Plan

  6. Two things.

    First, idiot rightie from above: “No, lenders will rationally respond to the new environment, by being much pickier in giving new loans.”

    He says that like it’s a BAD thing… The whole reason we’re in this mess is that banks have been horribly remiss in assessing risk. They gave out loans to people who should never have qualified in the first place, or gave out loans that were inherantly riskier because of the loan structure, and now they’re acting all surprised that it’s about to bite them in their collective ass.

    Second, I think righties who make an argument of the form “people who took mortgages they couldn’t afford are stupid and don’t deserve to get bailed out” are missing the point.

    I tend to agree, a lot of people made a lot of stupid decisions, and on an individual level probably government shouldn’t be in the business of shielding them from consequences. However, government SHOULD be in the business of shielding the economy as a whole from the worst excesses of unbridled capitalism, and if nothing is done, the economy as a whole is going to be destroyed.

    We should be bailing out homeowners NOT because they do or do not “deserve it”, but rather because if we don’t, everybody is going to suffer at the hands of the resulting horrible economy.


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