Credit Crisis Expert Says Proposed Plan to Bail Out Delinquent Homeowners May Face Too Many Problems to Succeed

By William Patalon III
Executive Editor
Money Morning/The Money Map Report

A tentative Bush Administration plan aimed at keeping as many as three million homeowners who are behind on their mortgages from losing their houses will be difficult to administer, and could end up costing the country hundreds of billions of dollars more than the plan’s architects expect, a Money Morning contributing editor and credit-crunch expert said yesterday.

R. Shah Gilani, a retired hedge-fund manager and
Money Morning contributing editor who is emerging as an expert on the worldwide financial meltdown, noted that the plan was apparently still that – a plan. Even so, he said that “any bailout plan that directly addresses foreclosures is political posturing that will ultimately be overwhelmed by inevitable economic realities.”

The New York Times carried the first reports of the Bush Administration’s new housing rescue new proposal yesterday (Thursday). According to the newspaper report, this program would be the most sweeping and direct government initiative aimed at home-loan borrowers since the financial crisis started last year.

As proposed, the federal government would incur half the loss on a home loan if the mortgage company that controls the loan agrees to lower the borrower’s monthly payment for at least five years. On any given loan, the mortgage company would reduce the payment borne by the homeowner by writing off part of the loan balance, reducing the loan’s interest rate or changing other loan terms, sources told
The Times.

The newspaper said it could not name the three senior officials who provided details of the plan because it was still being worked out.

In this case, the devil truly will be in the details: Trying to take a massive rescue plan – and matching the benefits up with individual homeowners – may be just too much to ask, Money Morning’s Gilani says.

“Who will be eligible, how will that be determined, what will happen when prices continue to fall and mortgage holders eventually walk away” are just some of the tough questions a workable plan would have to answer, Gilani said. Plus, “is the government going to shackle them to their mortgages the same way they’re shackling taxpayers to all these other ill-begotten bailout schemes?”

The plan – which would be part of the $700 billion banking-system rescue plan the government approved early this month – would cost $40 billion to $50 billion, with the money being used to cover future losses on loans that are deemed eligible for federal support.

That price tag is likely to be very much on the low side, Gilani says.

“The $40-$50 billion price tag could only have been plucked from thin air,” he said. “The real gravity of the problem will weigh in closer to $500 billion – at least.”

Officials with both the U.S. Treasury Department and the Federal Deposit Insurance Corp. (FDIC) are collaborating on the proposal, and insiders believe that an announcement may be made sometime soon. FDIC Chairwoman Sheila C. Bair – a leading proponent of such a plan – publicly discussed the possibility a week ago.

Bush Administration officials clearly want to stabilize the U.S. housing market. But that’s easier said than done. Even at a time when roughly one in every 10 mortgages was either delinquent or in foreclosure – as was the case this summer – companies have been highly reluctant to aggressively reduce payments for two key reasons:

  • They’re afraid the borrowers might default again.
  • And they fear that the buyers of mortgage-backed securities might sue.

By offering to incur half the losses, federal officials hope that the U.S. housing market – and the accompanying market for mortgage loans – might finally settle out, which could also ease the financial crisis even as it provides a bit of a boost to the U.S. economy [For a related story on the U.S. economy – including a look at third-quarter gross domestic product (GDP) – check out this report elsewhere in the current issue of Money Morning.]

There’s one key challenge, however: If the economic slump ultimately ends up being deeper and longer-lasting than anyone right now predicts, the housing program could end up being much more expensive than planned – dumping still more unexpected debt onto the U.S. balance sheet. And the plan – or, at least, the details that have leaked out so far – doesn’t seem to address the one key problem with the U.S. housing market: Housing prices keep going down.

“Tragically, there’s no guarantee the plan won’t collapse on homeowners and taxpayers as it does nothing to stem the continuing slide in home prices, which is the real problem,”
Gilani says.

Treasury Department spokeswoman Jennifer Zuccarelli told
The Times that it would be premature to discuss a plan that policymakers were still working on.

“As we said last week, the administration is going through the White House policy process to look at ways to reduce foreclosures, and that process is ongoing,” she told the newspaper. “We have not decided on a particular approach.”

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning at Money Map Press.

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