Neither Fair Nor Effective
Paulson Plan Ignores Homeowners
SOURCE: AP/Richard Drew
Unless U.S. Treasury Secretary Henry Paulson’s first stab at a $700 billion rescue of the global financial system is revised to incorporate restructuring troubled mortgages, it will be neither fair nor effective. Paulson’s draft legislation attempts to rescue the balance sheets of Wall Street but does almost nothing for homeowners on Main Street. That’s a fundamental flaw. The U.S. housing market won’t recover without restructuring of underlying mortgages that are troubled. Global credit markets will not respond to this exceedingly expensive plan unless we get our fundamentals right. Moreover, taxpayers will be saddled with increasingly worthless paper as many of the underlying mortgages fail.
The Paulson plan demonstrates a disturbing disconnect between the “mortgage-related assets” that taxpayers’ $700 billion is being used to purchase and the necessary restructuring of the troubled mortgages themselves. Many hard-working Americans are having trouble paying on their mortgages, which in turn is driving down the value of their neighbors’ homes across the country. Tens of millions of families have seen their home values plunge through no fault of their own. Nearly 1 in 10 American households—roughly 5 million—have a mortgage that is either in default or facing foreclosure. These are the families still struggling to pay their mortgage even after the earliest subprime borrowers have already lost their homes.
Without provisions expressly aimed at helping these borrowers restructure their mortgages with the assistance of the federal government or through judicial modification, this grand plan to buy "toxic" assets from the financial institutions that engineered this market meltdown will not help the U.S. housing market recover. The Bush administration, however, is clearly only interested in trying to provide immediate relief to financial institutions.
Under Paulson’s draft plan the Treasury secretary will have the cash and the power to buy troubled assets, and help financial companies cleanse their balance sheets. But it is not at all clear at what price, or through what mechanism, these purchases will be made. These are critical details if the plan is to work even by its own terms. Congress is raising legitimate concerns about not creating windfall opportunities for investment banks, securitizers, lenders, and investors to sell their distressed debt to Treasury at above-market prices. To address those concerns, Treasury should set a maximum price to be paid, then conduct a transparent auction to determine a real market value for the assets, wherever feasible.
But even if the Treasury Department can buy up mortgage-backed pools of bad debts, all that will do is provide (admittedly much needed) capital to the giants of the financial service industry. This may help to stem the panic in global markets, but it won’t help homeowners. The securities purchased by the Treasury will only be a small fraction of those whose interests must be analyzed by the servicer before modifying the loan. And in many cases, a second mortgage may stand in the way of modification. Owning the securities will not give the government the power to modify mortgages to reflect their current market value after they are purchased.
What happens if Congress grants the Treasury unprecedented authority to buy up bad debts without requiring restructuring of the underlying mortgages where possible? Millions more families will face foreclosure, further hammering home prices nationally and further eviscerating more household wealth. The crisis will not end.
As the Center for American Progress has argued for nearly a year, without addressing stability at the neighborhood level, our national (and now international) economic troubles will only worsen. That’s why Congress needs to make some sensible additions to the Paulson plan.
First, Treasury must be granted authority to buy whole loans or pools of loans out of existing mortgage-backed securities trusts. Leaving loans in the trusts, and buying up tranches of the securities, will not give Treasury the leeway it needs to modify troubled mortgages.
Second, we need to change the trust agreements that are blocking real mortgage restructuring through sales to Treasury or new lenders who are willing and able to restructure the troubled mortgage loans. To accomplish this, the special tax benefit these pools enjoy as so-called Real Estate Mortgage Investment Conduits, or REMICS, must be forfeited unless the trust agreements are modified to permit participation in the Treasury program, as proposed by CAP Senior Fellow and former Treasury official Michael Barr.
Third, experience in the real world also shows that the legislation must also provide for a "cramdown" on second-lien mortgage holders, who have blocked many modifications hoping that they could extract payment on their often worthless liens by driving a hard bargain. With a cramdown, second-lien holders will get paid at a fraction of the discount the first mortgage holder receives, reflecting the higher risk they took to begin with.
Fourth, not all at-risk mortgages will be in pools of loans whose securities or underlying assets are transferred to Treasury. Judges should be granted limited discretion to modify loans in bankruptcy to new levels related to the value of the property and borrowers’ capacity to repay at commercially reasonable rates, thus encouraging servicers to make modifications voluntarily, those at the Center for Responsible Lending have long argued. Furthermore, nothing in the legislation should impair the rights that consumers have under state law.
By modifying the Treasury plan, Treasury will have the power to restructure eligible mortgages for owner-occupants under consistent, fair standards designed to provide most borrowers the chance to stay in their homes. With appropriate oversight mechanisms, Congress and the public can monitor use of these authorities to ensure that America’s taxpayers, homeowners, and communities—not simply our investment firms—benefit from this extraordinary intervention and that the benefits are lasting.
The bad polices of the past eight years have brought us to an unprecedented highly volatile housing market, with no certainty that even $700 billion buying bad debt will stabilize anxious markets. The administration’s proposal means we could well end up with Wall Street’s investment houses bailed out while more American families are driven to foreclosure and bankruptcy.
David Abromowitz is a Senior Fellow at the Center for American Progress. Andrew Jakabovics is Associate Director of the Center’s Economic Mobility Program. For more on the Center’s housing analysis and policy recommendations please see our Housing page.
To speak with our experts on this topic, please contact:
Print: Liz Bartolomeo (poverty, health care)
202.481.8151 or firstname.lastname@example.org
Print: Tom Caiazza (foreign policy, energy and environment, LGBT issues, gun-violence prevention)
202.481.7141 or email@example.com
Print: Allison Preiss (economy, education)
202.478.6331 or firstname.lastname@example.org
Print: Tanya Arditi (immigration, Progress 2050, race issues, demographics, criminal justice, Legal Progress)
202.741.6258 or email@example.com
Print: Chelsea Kiene (women's issues, TalkPoverty.org, faith)
202.478.5328 or firstname.lastname@example.org
Print: Elise Shulman (oceans)
202.796.9705 or email@example.com
Print: Benton Strong (Center for American Progress Action Fund)
202.481.8142 or firstname.lastname@example.org
Spanish-language and ethnic media: Jennifer Molina
202.796.9706 or email@example.com
TV: Rachel Rosen
202.483.2675 or firstname.lastname@example.org
Radio: Chelsea Kiene
202.478.5328 or email@example.com