Moral Hazards for me but not thee
by digby
So the administration is sufficiently worried about getting re-elected in this economy that they are apparently casting a serious eye toward the housing market and using re-financing as a new stimulus. The road to getting there is revealed in this long WaPo article about the debates within the White House over the past three years about what to do with the massive numbers of foreclosures. It’s well worth reading in its entirety, but I think this gets to the nub of what happened (or rather didn’t happen):
The advisers also worried about the problem of “moral hazard,” when forgiving debts could encourage borrowers not to pay back loans.
Rather than targeting debt, the administration focused its efforts on making monthly mortgage payments more affordable — for example, paying banks to lower the interest rates on loans. At the end of the day, homeowners would still have as much debt
Even with this less-dramatic approach, Obama’s economic advisers worried about spending too much taxpayer money to help borrowers who still might not pay back their loans. So they excluded large categories of borrowers, including those who could not provide extensive documentation of a steady income.
A debate unfolded at the White House about whether to try to reduce the debts of underwater borrowers, which could increase their confidence and free them to spend more, or to sell their homes and seek jobs elsewhere.
Obama sought to strike a difficult balance, as he often did.
“A lot of his concerns and questions were about trying to figure out how we could do more on housing,” said Michael Barr, a former assistant Treasury secretary, “while also being mindful of the costs and risks, and making sure our approach was fair to taxpayers and homeowners who were not going to directly be getting helped.”
As virtually everyone in the nation who read that article this morning undoubtedly exclaimed: there’s certainly no moral hazard to worry about in “too big to fail,” but you wouldn’t want to let the plebes get the idea that they don’t have to pay through the nose for being on the receiving end of a fraudulent loan. Makes the country weak.
And yes, we have President Goldilocks once again trying to find a “balance” between doing nothing and something. As usual, it added up to almost nothing.
I realize that Rick Santelli is a fearsome human being with super-natural powers, but I’m afraid that I just don’t believe that the administration was afraid of the Tea Party or that Tim Geithner was worried about the nation’s moral fabric. They were afraid of the bankers.
So, earlier, I said “what’s not to like.” Here’s what’s not to like. The “reps and warranties” part of this. When you refinance a loan, you’re essentially creating a new mortgage, unlike a loan modification, where you modify the old mortgage. Under the plan, the FHFA will eliminate their ability to force repurchases on these old loans, and they would lower their ability to force repurchases on the new loans created. There will be a “modest fee” associated with relieving these reps and warranties, according to Donovan, which won’t be set until November 15. They will be lower than the current risk-based fees that Fannie and Freddie charge.What does this mean? A “reps and warranties” case is a case where the loan was originated improperly. When Fannie and Freddie get sold a bad loan like this, they have the right to force it back on the originator. New lenders are reluctant to refinance such loans, because they become liable for the put-back.What this means is that FHFA will essentially settle on all the loans that get refinanced for a “modest fee,” which we can safely assume will be next to nothing. And we know that a substantial amount of loans, perhaps a majority, were illegally originated during the bubble years. You’re letting the lenders who originated the loans off the hook for that, in exchange for allowing more refis.Banks will flock to this, because it essentially substitutes bad paper for good. Gene Sperling specifically cited this reps and warranties issue as the major barrier for refis. “We feel that removing the reps and warranties barrier has the potential to unleash competition for housing finance for loans backed by the GSEs,” Sperling said. “Those who are not the original mortgage holder will sit on the sidelines as long as the potential exists for a mortgage that was not originated perfectly to be put back on them.” What he means is that the legal liability for taking on these loans will be removed.There’s more to this. FHFA is currently in the middle of suing 17 banks over, among other things, reps and warranties. This initiative damages that lawsuit, as I said back in September, because it takes away some of the source material for it. The lawsuit would involve fewer loans, then, and it may tip the balance and hurt FHFA’s ability to proceed with the suit at all.I’m trying to get a few more answers on this, but the danger is obvious. Banks broke the law and this program helps them get away with it. The fact that Donovan mentioned in passing that this kind of program could be extended to bank-owned loans through the state AG settlement just shows you where this is all headed.
Indeed it does.
If there is one thing we have learned in all of this it’s that the biggest moral hazard in the world is forcing the financial sector to ever pay a price for screwing average people. Why, if that were to happen, we wouldn’t have the benefit of their superior talent and leadership. So, when something regrettable like a global financial meltdown occurs, the most important thing is to package every program with a “get out of jail free” card for the people who caused it. It would irresponsible not to.
However lest the nation get the idea that our leaders are endorsing a moral free-for-all, we must also embrace a harsh austerity program so that the polloi don’t get it into their heads that these rules extend beyond the very-important-people-who-keep-our-country-strong. You wouldn’t want to send the wrong messages.
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