Hank to Homeowners: Drop Dead

Treasury Secretary “Hank” Paulson yesterday made it absolutely clear that he had no intention of using the authority granted to him by Congress under the $700 billion Troubled Asset Relief Program, or TARP, to purchase troubled mortgage-related assets or to provide relief to struggling homeowners facing foreclosures. The message was clear to homeowners facing foreclosure and their neighbors watching the value of their homes plummet—drop dead.

Having already spent $250 billion to recapitalize banks with no strings attached and an additional $40 billion to restructure and sweeten the now $150 billion bailout of U.S. insurance giant American International Group Inc., there remains only $60 billion available to Treasury to spend before having to go back to Congress to request the second $350 billion tranche appropriated by Congress for TARP. But Paulson told Congress none of that money will be used to purchase mortgage-related assets—despite that being the premise under which the staggering sums of money were granted.

Paulson was quite open in his about-face: “In crafting the financial rescue package, we and the Congress agreed that Treasury would use its leverage as a major purchaser of troubled mortgages to work with servicers and achieve more aggressive mortgage modification standards. Now that we are not planning to purchase illiquid mortgage assets, we must find another way to meet that commitment.”

Translation: Having foreclosed making an investment in mortgages for the purpose of restructuring them, we now need to scramble to find an alternative.

The Center for American Progress has long advocated for the transfer of troubled mortgages out of the hands of the current holders of these assets because they are either unable or unwilling to modify the loans so that families can pay their mortgages, shifting these mortgages into the hands of an entity able and willing to make the necessary modifications to provide benefits to homeowners and investors alike. With simple modifications to the so-called Real Estate Mortgage Investment Conduit, or REMIC rules, barriers to participation by mortgage servicers in mortgage restructurings would be eliminated, and Treasury could purchase the mortgages.

The discount at which mortgage-backed securities are currently valued in the secondary market by institutional investors provides ample room for modifications to be made while still offering Treasury—and by extension the taxpayers—a reasonable return on these investments. But given that Treasury is not using the money to deal with the housing crisis, what are they going to use the money for?

“With the Federal Reserve we are exploring the development of a potential liquidity facility for highly-rated AAA asset-backed securities,” Paulson said in his remarks. “We are looking at ways to possibly use the TARP to encourage private investors to come back to this troubled market, by providing them access to federal financing while protecting the taxpayers’ investment. By doing so, we can lower costs and increase credit availability for consumers.”

It remains to be seen how the liquidity facility will work for these AAA-rated securities. Even if we assume that the AAA-rating has any real meaning—remember how well the credit-rating agencies performed their “due diligence” in the run up to this crisis—what makes credit card-backed securities or securitized auto loans or college loans any easier to evaluate and price than mortgage-backed securities?

Let’s cut to the heart of the anything-but-mortgages approach. Paulson wants to help the auto lenders, education lenders, and credit card issuers, all of whom are suffering from the same sort of liquidity crisis that froze interbank lending earlier this year. Leaving aside the auto lenders (despite nearly doubling interest rates for new car loans between July and September, dollar volume fell less than 8 percent) and the education lenders (the Department of Education has already stepped in to lend directly to students and announced last week it will purchase securitized student loans going back to 2003), there are three main problems with the credit card securities plan.

First, the top credit card issuers are JPMorgan Chase & Co., Bank of America, Citigroup inc., and American Express. The top three issuers have all been given capital infusions through TARP already, and American Express recently (and hastily) converted to bank holding status, making it eligible for capital infusion under the existing infusion program. These and other major credit card issuers are already enrolled in the financial rescue package, and yet have done little with the Treasury funds but bolster their balance sheets.

Second, as a matter of public policy, it is certainly questionable to promote increased lending for credit cards. Outstanding revolving consumer debt is approaching a trillion dollars. Encouraging further household indebtedness is hardly responsible.

Third, making more money available to credit card issuers isn’t going to convince them to lend more, as we’ve seen to date with the bank recapitalization effort. In the second quarter, lenders charged off 5.5 percent of their outstanding credit card loans, which represents a 77.4 percent increase over the first quarter of 2006.

In fact, it stands to reason that credit card issuers will be even less willing to lend than mortgage lenders, as credit card debt is unsecured. At least the mortgage lenders’ debt is tied to the houses.

Which brings us back to where we started—the housing crisis. The solution is simple: Focus on the mortgages. Gain access to home mortgages and restructure them. Now.

Andrew Jakabovics is Associate Director of the Center’s Economic Mobility Program. To read our analysis and recommendations for solving the U.S. mortgage crisis and global credit crisis go to the Housing page of our website.