John McCain's Bottom-Up Housing Bailout

Republican presidential nominee Sen. John McCain of Arizona unveiled a $300 billion housing initiative—the American Homeownership Resurgence Plan—during Tuesday night's presidential debate. The plan calls for the government to buy mortgages from homeowners and mortgage servicers and swap them for more affordable, fixed-rate home loans guaranteed by the Federal Housing Administration.

In a conference call with reporters Wednesday, McCain senior policy adviser Douglas Holtz-Eakin said the recently enacted $700 billion bailout primarily addresses the "top level" of the current financial crisis: the souring mortgage-related securities now clogging credit markets. The McCain plan, however, would take the opposite approach. "We are going to start at the bottom level and try to work our way up: try to stabilize the housing markets, stabilize the mortgage finance, [and] stabilize the values of [mortgage-backed securities] as a result," Holtz-Eakin said. "Hopefully, it will offset some need for that $700 billion, and we will get an effective package that has a lower price tag and helps homeowners."

Here's how it works:

Step One: Struggling homeowner contacts mortgage broker
To initiate the process, struggling borrowers tell their mortgage broker that they would like to refinance their loan through this initiative. The program would be open to a wide swath of distressed borrowers: You do not have to be in foreclosure or even underwater on your mortgage to participate. Participation is limited to primary residences and homeowners who can prove that they were creditworthy borrowers when they got their original loan.

Step Two: Government buys the distressed mortgage
If the troubled borrower qualifies, the government will buy the mortgage.

Step Three: Government provides a new, federally guaranteed mortgage
After acquiring the distressed mortgage, the government will swap it for a more-affordable, fixed-rate home loan backed by the FHA. Holtz-Eakin said the rates for the new mortgages would be "in the low fives at this point." That's significantly less than current 30-year fixed rates. Funding would come from existing initiatives such as the recently enacted $700 billion bailout. By stabilizing the housing market, Holtz-Eakin said, the plan might be able to ease the stress in the credit markets enough to reduce the final tab of the $700 billion bailout.

How many people will it help?
Holtz-Eakin said McCain's plan "could help literally millions of people."

Will it work?
Susan Wachter, a professor of real estate at the University of Pennsylvania's Wharton School, says that while the plan could certainly help struggling borrowers, it may end up costing more than estimated. "Three hundred billion does not sound like it's nearly enough," she says. That's partly because there are so few limitations on who can participate in the program. "The way it reads here, tomorrow we should all be lining up [to participate]," Wachter adds.

Meanwhile, Christopher Thornberg of Beacon Economics doesn't think the plan will be able to halt the painful decline in home prices. "The problem is not people losing those homes; the problem is people trying to buy those homes can't afford them," he says. Despite precipitous declines already, home prices have to fall further before they become affordable to most Americans, Thornberg says. McCain's plan is predicated on the notion that "if we could just stop home prices from falling, everything will be fine," Thornberg says. "And my comment to that would be: 'Yes, and if we could just stop gravity, we could all fly.' "