"It's The Foreclosures, Stupid!"

What's left in Uncle Sam's economic tool kit?

The commitment of $700 billion didn't impress markets here and around the world. Neither did fresh interest rate cuts. Stocks plunged yet again on Thursday.

The government still has some unused options — like buying up foreclosed properties and making direct loans to homeowners — that might ease the credit and housing crises and brighten the economic outlook.

But the options are dwindling and generally involve partly taking over private companies, an idea that's anathema to economic conservatives and others in America.

Even as policymakers counsel patience in waiting for the medicine already prescribed to fully kick in, they are searching hard for other approaches.

"So long as financial conditions warrant, we will continue to look for ways to reduce funding pressures in key markets," says Federal Reserve Chairman Ben Bernanke.

The Fed's primary tools are lowering interest rates and flooding the system with money. It's already done plenty of both.

The Fed presided over by Alan Greenspan kept interest rates at 1 percent for a full year earlier in the decade — and many economists suggest that was one of the root causes of the housing bubble, making it too easy for people to take out loans they couldn't afford.

And besides, in Japan holding rates near zero for years did little to help a deeply troubled economy.

The Fed could inject more money. But it has already flooded the financial system with hundreds of billions of dollars.

Apart from the Fed, Congress last week enacted a bailout package backed by up to $700 billion in taxpayer money, on top of a $300 billion housing package passed in the summer. Treasury Secretary Henry Paulson says it will be weeks before the government actually starts using the bailout money to buy up soured mortgage-based securities.

The Treasury is now considering using some of the money to take part ownership in certain U.S. banks. But that could put the government in the uncomfortable position of regulating banks in which it is also an investor.

Many economists say that actions taken so far do little to address what is at the heart of the spreading financial contagion: falling housing prices and rising foreclosures.

Former White House economist Glenn Hubbard proposes that the government refinance every U.S. mortgage held by Fannie Mae and Freddie Mac into 30-year loans fixed at 5.25 percent. He also suggests that putting in place a cleanup agency modeled on the Resolution Trust Corporation of the late 1980s and early 1990s could help.

The RTC was set up to deal with the savings and loan crisis. The government actually took over more than a thousand failed S&Ls, and all their assets. It wound up owning foreclosed homes and other property, eventually reselling them.

It took six years to clean up that mess. The total cost to taxpayers: about $125 billion.

Republican presidential candidate John McCain has proposed a $300 billion program for the government to help financially troubled homeowners stay in their homes by taking over their mortgages and renegotiating the terms — a step authorized by the $700 billion package signed last Friday by President Bush.

While that would be expensive, McCain said, "until we stabilize home values in America, we are never going to start turning around and creating jobs and fixing our economy." Critics of the McCain plan complained that many of the mortgages involved have been repackaged into complex investments that are now nearly impossible to value — and that the government would be hard-pressed to unravel and buy them individually.

Democrat Barack Obama has called for the administration to move quickly to "use the authority they already have to purchase troubled assets, including mortgages."

It's the empty houses, stupid.

In case anyone has forgotten the core of the current economic crisis, here's a reminder: empty homes, both present and future. Empty homes are behind all the supposedly worthless mortgage-backed securities that no one wants to buy on Wall Street. Fear of the coming avalanche of empty homes -- what the Center for Responsible Lending calls the “tsunami of foreclosures” -- has made Wall Street’s mortgage-related paper nearly worthless.

It seems that filling those empty homes by dealing with foreclosures and stoking demand to buy homes should be the first order of business. So why -- as we discuss the most dramatic government intervention in nearly a century -- is there only passing mention of all these vacancies?“This was kind of a game of chicken and I'm afraid it looks like the consumer advocates in Congress are the ones who blinked ,” said Adam J. Levitin, a bankruptcy expert at the Georgetown University Law Center.

Details of the not-quite-completed-bailout-plan are still emerging, but by all accounts it will not include the most obvious and direct tool to stem the empty house problem: adjustments to bankruptcy law that would allow judges to modify the mortgages of at-risk homeowners.

Such assistance could still materialize in Congress, but the Senate voted to reject the idea in April, spurred on by aggressive bank lobbying. By agreeing to this bailout deal without fixing bankruptcy law, Main Street’s advocates have surrendered nearly all their leverage.

I understand the theory that giving banks more money to lend can ultimately help restart demand for housing by making it easier for consumers to get loans and, as demand increases, boosting housing prices. But isn’t that how we got here in the first place?

The proposal to help at-risk homeowners was simple: allow bankruptcy judges to rework loans (essentially, lower the mortgage principal and payments) to keep them in their homes and out of foreclosure. Sadly, supporters of the plan surrendered and instead focused on CEO pay -- a populist issue that's a distraction from the real problem of empty homes.

Critic sees bailout as 'unfair and ineffective'

"The only way to stop the free-fall of housing prices is to stop foreclosures," Kathleen Day, spokeswoman for the Center For Responsible Lending, warned. "If you don't do something for consumers, this is going to be unfair and ineffective."

The proposal to amend Chapter 13 bankruptcy law (the kind where debtors repay their loans, but buy time and get some discounts) is hardly revolutionary. Under Chapter 13, filers can rework all kinds of loans: car loans, vacation home loans, investment/rental property loans. But primary residence loans are exempt. Struggling homeowners face two choices in current bankruptcy law -- pay every penny or walk away. The limitation stems from a 1970s law that was intended to encourage banks to lend more money to would-be homeowners.

The simplest way to prevent the coming avalanche of additional empty homes -- and thereby make those asset-backed-securities have some real value -- is to prevent people from getting kicked out. It's stunning that $700 billion is about to change hands with no direct plan for keeping them in their homes.

Allowing modification of home loans in bankruptcy would encourage banks to negotiate new terms, as it would allow the banks to avoid court costs and delays. Once bankruptcy courts set a few price points on modified loans, voluntary participation would likely follow.

The financial industry, which has long resisted modifying Chapter 13 bankruptcy, says that such a change would deal the mortgage-backed securities industry a body blow. Allowing judges to reduce the principal owed on a mortgage -- lenders call this a "cramdown" -- would lower the overall value of mortgage instruments, as a built-in bankruptcy discount would have to be applied, which would, in turn, harm consumers by restricting the flow of credit, banks say.

But Georgetown’s Levitin published a study last month that indicates that other loan markets are not adversely impacted by bankruptcy modification. There’s no difference in mortgage rates between primary residence loans and vacation residence homes, for example – and there would be if there were a “bankruptcy premium,” he said.

Levitin argues that proposed Chapter 13 bankruptcy changes would in fact be “market neutral.” Bankruptcy judges are well trained in determining consumers' ability to repay a loan, meaning many banks would get 50, 60, or 70 cents on the dollar, up to twice as much as they would realize after going through the costly foreclosure process, he said.

And neighbors would certainly agree that such a home loan modification would be preferable to another empty home.

"The contagion began on Main Street, and it has to be fixed there," said Day, from the Center for Responsible Lending. "You are not going to get at the root of this and really restore the economy until you stop all the foreclosures.”

    It's the foreclosures, Stupid! While the US Treasury Secretary, The Fed, The Bush Administration, Congress, Barack Obama and John McCain are concerned about buying out "toxic mortgages" bundled up in complex investment securities as the solution to the housing crisis, the idea of simply allowing homeowners in the foreclosure process to apply for bankruptcy and have the bankruptcy judge renegotiate their mortgage to a payment that will allow them to stay in their homes is rejected, an idea that would cost taxpayers nothing, stop the foreclosure epidemic and stabilize housing prices. Why doesn't Barack Obama, who always talks about solving problems "from the bottom up" support and advocate this idea? Why did John McCain, who supposedly hates "earmarks" support the final pork laden 700 billion dollar "rescue" plan that  "Smirking Chimp" President Bush signed into law? As I see it neither Congress, Barack Obama or John McCain have stood up for "Main Street" in dealing with the housing crisis. Remember that when you go to the polls next month and vote for someone who will! (Think Third Party!)

tags: wall street bailout  business  capitalism  bush  obama  mccain  takebackamerica  politics  2008  president  the congress  the fed  

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