Backers of a plan to allow the government to borrow up to $700 billion to buy troubled assets from banks and financial institutions insist that it’s been miscast as a taxpayer-funded bailout of Wall Street, even as opponents rolled out a competing proposal to unfreeze credit markets.
Supporters of the bipartisan plan voted down by the House Monday, including real estate industry trade groups, say the cost to taxpayers is likely to be significantly less than $700 billion and that the government may even make money on the deal.
The consequences of not acting will have very real consequences on Main Street, as a worsening of the credit crunch could cut off access to credit for small businesses and families, raising unemployment and pushing already depressed housing markets into a deeper funk.
But opponents remain adamant that any action the government takes to unfreeze credit markets not put taxpayers at risk. Several lawmakers said they would introduce an alternative plan today that is said to involve greater involvement by the FDIC, which would purchase "net worth certificates" to shore up the capital of troubled banks, buying them time to weather the downturn.
The alternative plan is also said to include relaxed "mark to market" accounting rules and raising limits on FDIC deposit insurance to stimulate lending.
The Bush administration and House and Senate leaders of both parties who back the $700 billion "rescue bill" say they’ve considered such alternatives, and that more drastic action is needed.
Not just housing
When it comes to explaining the importance of the plan to voters, "I do think the starting point is the economy in general," said David Crowe, the head of regulatory and housing policy for the National Association of Home Builders. "The end is obviously to get the credit markets flowing again, which serves more than just housing."
The economy also has a big impact on housing markets, Crowe said.
"If people don’t have a job, they won’t buy a house, or they will lose the house they have."
Crowe said he thinks the rescue package would have a big effect on the jumbo loan market. Because the secondary market for jumbo loans is "completely frozen," most such loans are being made by lenders who can fund them themselves and hold them in their investment portfolios. But lenders can only hold so many jumbo loans on their books before they run out of capacity to make new ones.
The jumbo loans banks already have on their books can limit their capacity to do more lending, even if those loans are performing well, because regulators require banks to maintain a certain level of capital in relation to the loans they make.
"If banks can unload other assets that have some cloud on them, that should benefit (the jumbo) market as well," Crowe said.
Home builders are also "very concerned" about the ability to obtain production loans, which have become "very difficult and expensive to get," Crowe said.
"Institutions that normally loan to home builders no longer have enough liquidity to do that," Crowe said. "That will be a concern, if once this recovery does occur builders are not able to bring product back on line."
Because it takes time to obtain land and build houses to meet demand, "That credit needs to be available before the recovery begins," Crowe said.
If builders can’t meet demand for homes once a recovery begins, some markets could see another boom-bust cycle.
"It’s entirely possible we’ll get a ratcheting up and down, some sort of stop-start behavior, if we can’t get this gliding to take off the way it usually happens," Crowe said. Traditionally, housing downturns are driven by an economic downturn or recession, and housing markets "take off pretty fast" once there’s an economic recovery. But the current economic slowdown has its roots in the housing downturn and losses in mortgage lending.
If the rescue package is not approved, the threat to the financial system "is so big, and so out of the ordinary, there’s no past experience to give you some sense" of what might happen, Crowe said. "I do believe (Federal Reserve Chairman Ben) Bernanke is honestly concerned this could lead to a complete breakdown in credit markets. It’s close to that now, and spreading beyond the U.S. I’d look for much prolonged economic troubles if something isn’t worked out soon."
Push by NAR
The National Association of Realtors is urging members to contact their lawmakers in support of the rescue.
NAR maintains that without it, it will become hard for consumers and businesses with good credit to obtain mortgages, small-business loans and short-term loans. That will drive up consumer and business bankruptcies, as options for refinancing are shut down.
Consumers and businesses could see the borrowing limits on their credit cards scaled back, and their interest rates jacked up. That would reduce spending, further depressing the economy. A significant increase in unemployment could follow, and all levels of government could face deficits in the face of falling tax revenue, NAR claims.
If the plan is rejected, NAR economist Lawrence Yun conceded that "it is possible the economy will be able to muddle through this."
But there are warning signs — including high short-term interest rates, which indicate banks are reluctant to loan each other money — that "the system is clogged," Yun said. "The word ‘capital’ in ‘capitalism’ is not working right now. I’m worried that one accident that occurs in a surprise way could dry up credit."
If the plan is ultimately rejected, there might be very little short-term change in the availability of mortgages.
"However, any unpleasant surprise in the financial market and overall credit including mortgages could quickly dry up," Yun said. "I’m really concerned not only about the (impact on) housing markets from one surprise accident, but the overall economy. Most jobs are created by small businesses, and small-business loans will be very difficult to obtain, which may lead to job cuts and a weakening economy, which indirectly harms housing markets."
The rescue plan is intended to provide insurance against that happening, Yun said, by allowing banks with difficult-to-value mortgage-related securities to loan money out instead of holding onto extra cash to meet capital requirements.
Not a bailout?
"I think there (has been) very bad communication on behalf of the White House, and Henry Paulson," to explain the plan to the public, Yun said. "They are doing hard work, but some of the language is not connecting with ordinary Americans. I don’t consider this a bailout, but an investment in the U.S. financial system and an investment in the U.S. economy."
Because the value of the debt the Treasury Department buys from banks and financial institutions would increase in value when housing markets recover, "that means there is a potential return for taxpayers," Yun said. "If that were communicated (to them), the general public would be more willing to support" the plan.
Dick Lepre, a loan agent for San Francisco-based Residential Pacific Mortgage who also writes about economic issues, mortgages and real estate, called worries that the rescue package would be a "bailout" of Wall Street "absurd."
For one thing, Lepre maintains Wall Street — if defined as the investment banks that were involved in pooling home loans and other debt into complicated investments that were marketed to investors — doesn’t exist anymore.
The big investment banks have either folded or been acquired by more strictly regulated retail banks, and "the model that came into existence when assets got diverted from the (regulated) banking system into investment banking is finished," Lepre said.
"Making the argument that we are bailing these guys out is absurd," Lepre said. "They are toast. This is a bailout of the economy. The problem, in essence, is that the Federal Reserve has gotten so overextended they don’t have the money to do this, and thus it’s become necessary to approve more borrowing by the Treasury."
The money that’s injected into lending through purchases of troubled assets such as mortgage-backed securities will generate perhaps 10 times as many loans, Lepre said, because it will help banks meet their regulatory capital requirements.
"Were talking about the injection of a gigantic amount of money, and the amount of lending (created) will be massively greater," Lepre said. "That doesn’t mean everything will be over. Banks will have other reasons not to lend people money, but at least this massive impediment will have been resolved" by taking bad loans off the banks’ books.
Over time, Lepre and other experts like PIMCO’s Bill Gross expect the troubled assets the government buys through a competitive auction process will appreciate at a much greater rate than the 2.5 percent annual interest it might pay to borrow money by issuing Treasurys.
"The debate is framed incorrectly," Lepre wrote in an opinion piece published by Inman News. "Treasury (the taxpayers) is going to make a handsome profit and the folks who hold this mortgage debt are going to take a loss."
An alternative plan put forward by opponents includes loosening accounting rules that require banks to "mark to market" the value of troubled assets like mortgage-backed securities. Some say such rules undervalue those assets, limiting lending or even driving some companies out of business. The alternative plan would also raise limits on FDIC deposit insurance to boost lending by encouraging savings.
Lepre said he thinks Congress should leave accounting practices like the mark-to-market rule to the Federal Reserve and other regulators.
"When politics becomes intertwined with economics, disaster tends to ensue," he said.
While Republicans who voted against the rescue plan said it would be a disaster for taxpayers, some Democrats who voted against it complained that it did not do enough for troubled homeowners.
A proposal to allow bankruptcy judges to "cram down" or change the terms of the mortgage on a troubled borrower’s principal residence did not survive the bipartisan negotiation sessions, and was omitted from the bill voted down Monday.
The bill, however, would have required Treasury to modify troubled loans where possible to help families avoid foreclosure, and expanded eligibility criteria for the FHA’s Hope for Homeowners loan guarantee program.
Lepre said that requiring the Treasury Department to go to great lengths to modify the terms of mortgages it buys — or dictating such a policy to loan servicers collecting payments on assets it buys — would run counter to the goal of selling the assets at a profit to protect taxpayers.
The best way to help troubled borrowers is through the Hope for Homeowners program, Lepre said, which may not realize the $300 billion in refinancings authorized by Congress because of limited participation by lenders and borrowers.
To participate in the program, lenders must be willing to write down the principal of existing loans, and borrowers must be able to demonstrate they will be able to make payments on a more affordable FHA-backed loan.
Fallout from vote
For now, uncertainty about the newly proposed rescue plan’s fate has sent short-term interest rates up, reflecting bank’s fears of lending to each other. The London Interbank Offer Rate, or LIBOR — used by many lenders to set rates on adjustable-rate mortgage (ARM) loans — has risen sharply.
When LIBOR fell in the wake of the Federal Reserve cuts to the federal funds overnight rate, "that lessened some of the burden on resetting mortgages," Yun said. "Now that LIBOR is high, it will be more of a burden for those facing (rate resets)."
The uncertainty has also generated turmoil in the stock market and created more worry that the economy is headed for a recession — issues that affect housing markets.
"In periods of intense uncertainty, people are going to sort of hold tight," said Leslie Appleton-Young, chief economist for the California Association of Realtors. "Everywhere I go I’m talking to people, and you’ve got first-time home buyers getting into homes they never thought they’d get into, and investors are buying, but clearly the events of the last couple days are going to impact activity."
Some people will be discouraged from buying a home by recent losses in their 401(k) retirement plans or other investments.
"It’s a great trade-up market, and there are some people who have some equity who could do some wonderful things trading up, but are choosing not to because of uncertainty in the financial sector," Appleton-Young said.
Realtors are not only coping with slower sales and tighter mortgage credit, but they are small-business owners themselves, Yun said.
"It is already difficult to get a (small-business) loan," Yun said. "One small accident, and ‘boom,’ all the small-business owners will be hit."
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