The GOP candidate wants to spend $300 billion to buy out "underwater" homeowners at the original value of their mortgages, a plan sharply criticized by a top Obama adviser
Anyone sitting down to watch the second Presidential debate on Tuesday night, Oct. 13, had to wonder what answers the two candidates would have for the nation's unfolding financial calamity. Earlier that day the Dow Jones industrial average had crashed another 508 points (BusinessWeek.com, 10/7/08), and stocks were on track for their worst year since 1937.
There was really only one new proposal offered in the debate, though, and it came in Senator John McCain's answer to the first question. Asked how he would deal with the housing and economic crisis, McCain said he would order the Treasury Secretary to "buy up the bad home-loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes."
The notion of having the government buy up mortgages directly and play a more active role in reworking troubled homeowner loans has been discussed since the early days of the financial meltdown and has generally been backed by Democrats. Senator Barack Obama has backed similar efforts in Congress and recently argued such moves should play a key role in the Treasury's $700 billion rescue efforts as well. But for McCain, the idea is new—and it's a big shift. He clearly meant to use it to position himself as different from both President George W. Bush and Obama on dealing with the average American's woes. It's also a huge ideological shift for a man who is running as a fiscal conservative and who was far slower than his Democratic rival earlier in the year to argue that the federal government should step up to aid homeowners facing foreclosure.
Breaking Down the Proposal
Given the way the sentence was phrased, it wasn't immediately clear what McCain meant—or what the financial implications of his idea might be. Was he saying the government should buy up every bad mortgage at its original value and then refinance the homeowner into a lower-priced, affordable mortgage? That would stick the government with the difference between the original loan values and current, much lower values. Or did McCain mean that the Treasury should negotiate first with the lenders or investors holding the mortgages to reduce the values of the original mortgages to realistic current values before buying them out and refinancing the loans? In that case, banks and investors currently holding the loans (or the mortgage-backed securities they've been packaged into) would have to agree to take that immediate loss in hopes of avoiding the greater loss that could come from foreclosure.
In a conference call Wednesday morning with reporters and in a follow-up call, McCain's top economic adviser, Douglas Holtz-Eakin, made clear that the Arizona Senator is proposing the first option. Under his plan, the government would buy the mortgages from banks and investors at the original value of the loan, no matter how overinflated that now appears to be. "We're [proposing] buying back the original mortgage at the original value and then giving [the homeowner] the new mortgages" at current values and more affordable interest rates, Holtz-Eakin told BusinessWeek. "Obviously the taxpayer is on the hook for the difference."
That could be a huge sum: Enormous numbers of homes are now "underwater"—no longer worth the value of their mortgage —and are no longer worth anywhere near the value of their current mortgages. Indeed, The Wall Street Journal reported that 1 in 6 homes is now underwater. Moreover, buying out mortgages at their current values would essentially mean bailing out the lenders who made those loans, or the investors who now hold them, at what have proven to be highly inflated values. (These are values that were often inflated with the complicity of the lenders and appraisers who made the loans.) They would essentially be made whole on those loans.
Taxpayers to Take the Hit
A statement that's up on the McCain-Palin Web site says the plan would cost $300 billion. Holtz-Eakin says an earlier proposal by McCain would have required lenders and investors to take a loss by selling the mortgages for more reasonable current prices. That's the idea behind legislation that was passed this summer that went into effect on Oct. 1, known as the Frank-Dodd measure, after its sponsors in each house, Representative Barney Frank (D-Mass.) and Senator Chris Dodd (D-Conn.). But given the severity of the problem—and the limited response such a proposal is likely to get from mortgage holders, since it's voluntary on the part of those banks or loan servicers—Holtz-Eakin says the government must step up and take the hit in order to put an end to the foreclosure crisis.
"Our original proposal had that feature in it—it required the voluntary participation" on the part of the lender, he says. "But that gets you smaller scale of activity, it slows everything down, and…I think the balance has shifted [to the need] for a broader more aggressive approach."
Austan Goolsbee, one of Obama's top economic advisers, called the proposal "truly stunning." While Obama was one of the early backers of the Dodd-Frank bill and has long backed the principle of having the government do more to facilitate loan workouts for struggling homeowners, Goolsbee was highly critical of the notion that the government should pay full value for the troubled loans. "This proposal, if enacted, would be a massive government subsidy from taxpayers to the most irresponsible banks, including the ones who committed fraud," Goolsbee says. He points out that if a lender engaged in appraisal fraud or other questionable behavior to bump up the original value of the mortgage, that lender would get bought out for a larger amount than one that had not done so. "This proposal would give the taxpayer all the risk, with no gain," adds Goolsbee.
The statement on the McCain Web site fills in some other details: It says the plan would buy mortgages directly from homeowners and mortgage servicers and replace them with "manageable, fixed-rate mortgages." That help would be available to mortgage holders who live in the home as a primary residence, who can prove they didn't fake their qualifications for the loan, and who provided a down payment. The statement also indicates McCain believes the purchases can be made quickly as a result of the authority given the Treasury Secretary in various pieces of legislation.
Clearly, addressing the underlying foreclosure crisis will be critical to resolving the broader financial crisis in the coming months. And simply buying bad mortgage-backed securities and loans from the banks and others who hold them won't be enough if average Joes keep losing their homes. But still more explanation will be needed if McCain's proposal is going to be taken seriously and not simply as fodder for a debate.