Anger Over Bush Mortgage Plan Is Misplaced

The threat to the economy trumps the "moral hazard" issue.


I am still getting E-mail from many of my readers (especially the more libertarian-inclined) moaning about the Bush-Paulson subprime mortgage plan. In short, they view it as unnecessary government meddling in the economy that will serve only to insulate dumb/greedy borrowers and dumb/greedy lenders from their financial follies. And to some degree, they are certainly correct. (Some even accuse the White House of "buying votes" for the GOP's 2008 hopefuls.) But to trot out the old Clinton campaign mantra, "It's the economy, stupid." The impact of the credit crunch goes beyond individual borrowers and lenders. Consider this on-point analysis from economist Jim Glassman of JPMorgan Chase:

1) Financial markets remain traumatized by the scale of losses on mortgages and the difficulty in assessing where those losses reside amid high-profile assertions about looming recession threats. That's what 2-year Treasury note yields at 3% and 10-year yields around 4% signify.

2) Mortgage lenders and creditors have strong incentives to avoid unnecessary foreclosures. ... But the workout process is time consuming and could be overwhelmed in coming months. So, the Treasury Secretary's participation has helped to set a broad industry template that will work with borrowers in the fairest and most sensitive way.

3) The interest rate moratorium is a loss of income to the lender and investor in a mortgage pool, because the initial "teaser" rate on subprime mortgages was subsidized to a below-market rate. But investors and creditors must weigh the alternative losses associated with property foreclosure and recovery value of underlying collateral.

4) [The Bush-Paulson plan offers] some assurance to market participants that events are not overwhelming the central bank. That belief—that the central bank was falling behind and could not stave off recessionary tendencies—was undermining confidence in financial markets ...

5) The 5-year moratorium offers some hope that certain subprime borrowers can "grow into" a more conventional mortgage. For example, if a household's income rises 5%, 25% over the course of a 5-year period, the mortgage payment that household could afford would rise by that percentage as well. ... So, under normal circumstances, a borrower should be able to handle—"grow into"—a 2 to 3 percentage point rise in his mortgage rate from the initial teaser rate over the next five years.

6) The danger lies in the loss of investor confidence in some securitized vehicles. New investor reluctance to hold certain securities—for example, $400 billion of outstanding asset backed commercial paper has vanished since August—will require that a greater share of credit be obtained through more traditional channels. The rise of securitized finance isn't threatened ... but the advance of securitized finance, which in this decade has seen a $10 trillion expansion in asset backed vehicles broadly defined, is sure to slow, implying that credit will be expensive and less available.