The U.S. Treasury Secretary today promised to work with Congress to launch a massive federal rescue of the U.S. housing markets in order to protect the global financial system from complete collapse. If the Bush administration had taken more aggressive steps many months ago—as the Center for American Progress detailed again and again as the housing crisis gathered pace—perhaps such a radical plan might not be required now. But given where we are today, there is no choice but to act. Done right, this could be a turning point for both capital markets and, most importantly, the finances of American families.
Done right is what Congress has to ensure happens. After all, the Bush administration is culpable for this financial crisis. First it enabled the housing crisis by ignoring widespread irresponsible mortgage lending and irrational financial market practices Then, as the escalating market crisis became apparent, the administration insisted only on “voluntary steps” to address the underlying cause of the crisis—the crashing performance of mortgages and the resulting drop in home values.
The Center early this year unveiled a plan to quickly restructure mortgage loans and unlock frozen financial markets well before the cascading collapse of some of the country’s more powerful financial institutions. We have to say the core idea remains the best starting point for Congress. Addressing home and mortgage values is still the key. Under our original plan, called Saving America’s Family Equity, the government would create a process for the transfer of at-risk mortgages to new owners who would rapidly modify them at new loan levels tied to the current value of the property and affordable to the homeowners. The new loans would benefit from a government guarantee.
The Federal Reserve would run auctions at which current holders of mortgages would offer to sell and new investors would offer to buy the loans at a discount determined by the market, knowing the government backing was available for restructured loans. The original mortgage holders would take a hit, trading a reduction in asset value and yield in exchange for liquidity and certainty. Proposed changes to the tax code governing trusts holding mortgage-backed securities would give mortgage lenders, service companies, and investors strong incentives and sound legal grounding to remove existing barriers to widespread loan restructuring.
The vast majority of American homeowners know their house is worth more than 22 cents on the dollar—the price that Wall Street (until this week’s crisis) was willing to pay for pools of mortgage-backed securities. It is no solution if taxpayers take those losses and new purchasers get a windfall when values return. Congress has to make sure Paulson’s proposal to purchase these mortgage-backed securities from financial institutions and investors worldwide results in the taxpayers getting the benefit of future restored value, in exchange for putting up our Treasury at risk to absorb current market risk.
A bulk restructuring program like the SAFE plan will cleanly separate the bad mortgages from the vast array of ones that are sustainable (some at lower principal amounts) in a way that protects the taxpayers, helps more homeowners stay in their homes, and protects communities from a further rash of foreclosures and the consequences to neighborhood stability. .
This is the direction congressional leaders should take as they work with Treasury Secretary Paulson over the coming weekend to craft enabling legislation. One way to accomplish the repricing is to put the auction mechanism in the hands of a separate institution modeled after the Depression-era Home Ownership Loan Corporation updated for modern mortgage markets. The now taxpayer-owned mortgage giants Fannie Mae and Freddie Mac also can play a role by purchasing more mortgage-backed securities, both to provide fresh capital to struggling financial institutions and to begin the process of loan restructuring that will need to happen to unlock the true value of the U.S. housing market.
Thanks to the leadership of Federal Deposit Insurance Corporation Chair Sheila Bair, Congress has a model to work with. The FDIC is doing just this at failed California-based IndyMac Bank. By engaging in systematic loan restructuring, rather than foreclosing on the failed bank’s mortgages, the FDIC will likely end up preserving more value and reducing taxpayer exposure. Whatever agency Congress assigns to this broader task should do the same, restructuring troubled loans in the portfolio of mortgages they purchase in a systematic manner, rather than through piecemeal modifications. The result of refinancing more loans than private holders have been able or willing to do will be fewer defaults and foreclosures.
The financial markets are but one of the economic problems we face. The last eight years brought stagnant wages and weak job creation—with the situation getting even worse over the course of this year. Restoring our economy requires a plan to address the financial crisis and the underlying weakness in our economy. We need to make job-creating, growth-producing investments in our infrastructure and transform to a low-carbon economy. The legislative package that moves rapidly through Congress to implement Paulson’s new plan should also include expanded unemployment benefits and heating assistance for low-income families, increased food stamps, and assistance for states in providing health coverage to families in need during these difficult times. The folly of Wall Street and the negligence of the Bush administration has produced today’s pain on main street. It would not be right if the rescue only rescues firms and not families.
Taking these steps will ensure that the end of the Bush era results in steps to help jump-start the U.S. economy and the necessary creation of a new plan to rescue it from the failures of conservative stewardship—just as the 1980s ended with the creation of a new federal agency, the Resolution Trust Corporation, to cope with the savings-and-loan crisis spawned by equally bad conservative supervision of our financial institutions. It’s as necessary now as it was then.