NEW YORK (Jan. 31) -- A proposal to bail out subprime mortgage borrowers who are at risk of foreclosure was floated at a Senate Banking Committee hearing Thursday.
Sen. Chris Dodd, the committee chair, said he is working to create a Home Ownership Preservation Corporation, which would purchase mortgage securities that are backed by at-risk, subprime loans from lenders and investors.
This corporation would give these lenders and investors a better price for the securities than they would get if the properties backing them were put through foreclosure.
Additionally the loans on these properties would be restructured so that borrowers could afford the new payments and remain in their homes.
Lesser of two evils
Although economists believe that the mortgage-backed securities would sell at a steep discount to their original values, they contend that the investors would still recoup more of their outlay this way, rather than going through the expensive foreclosure process.
Borrowers could see their monthly costs drop dramatically.
According to today's testimony, the fund might require $20 billion-$25 billion in seed money from taxpayers and, after that, it should self-fund.
Dodd said his proposal is supported by both ends of the ideological spectrum. He pointed out that two of the witnesses testifying on Thursday in support of this bailout -- Michael Barr, from the progressive Center for American Progress, and Alex Pollack, with the conservative American Enterprise Institute -- are usually on the opposite side of economic issues.
But there was dissent from members of the Banking Committee. Sen. Jim Bunning, R-Ky., said, "Government meddling could make matters worse."
Sen. Bob Corker, R-Tenn., was concerned about the "moral hazard" of rewarding borrowers' risky behavior.
A big step
Mark Zandi, chief economist for Moody's Economy.com, suggested a plan similar to Dodd's in early December, and agrees that it's a big and very complicated step. "But we have to prepare for the possibility that something like this will be necessary," he said.
And he contended that any bailout must be made with taxpayer money. "It has to have the triple-A credit of the United States backing it," he said.
The biggest problem facing housing currently is that the market is frozen, according to Zandi, because investors who buy mortgage-backed securities have abandoned that market. That's created a liquidity squeeze which has made it difficult for even well-qualified borrowers to obtain a loan.
Zandi thinks the fund should buy existing mortgage-backed securities in an auction-type process, which would immediately establish what those securities are really worth.
"As soon as there's a price [for the securities], there's a market," Zandi said. "Everyone can then start appropriately valuing what's on their books."
Jared Bernstein, an economist with the Economic Policy Institute, a progressive, Washington-based think-tank, agrees.
"Auctioning the debt to discover its true price might be ugly but it's the way to go," he said. "You can't hit bottom until transparency is back in the system and this will help bring it back."
Bernstein added that such a plan is not unprecedented. "There's a long history of the government providing precisely this kind of help for people facing foreclosure," he said.
There are currently several government-backed efforts under way to combat the housing crisis.
The stimulus package now before Congress would raise the caps on loans that Freddie Mac and Fannie Mae can purchase in the secondary markets to create more liquidity, while a hike in FHA caps would do the same. Meanwhile, the Federal Reserve has moved swiftly to cut interest rates, which will also put more money into credit markets.
"All these efforts may not be enough," said Zandi. "[But this bailout] will cost taxpayers a lot less money than leaving the market in a deep freeze."