"Clean and quick," whistled Henry Paulson past the mortgage crematoria. The Treasury secretary's hope for expedited passage of his bailout plan may be realized, but clean and quick won't describe its implementation. You wanted a bailout; you got a revolution.This column has advocated injecting the money at the level of the collateral -- buying and demolishing the least-wanted, market-souring homes in the subprime hot zone of Florida and the Southwest. This solution really would be clean, quick, would minimize the subsidy to bad actors, could be turned off as soon as it had served its purpose, and would involve no sticky issue of whether to bail out foreign banks along with U.S. ones.
Instead, Treasury's plan is to enter the market at a higher level, buying the depressed mortgage securities supported by these houses. In brief and eye-opening remarks in the Senate yesterday, Ben Bernanke spun a scenario in which derivative mortgage debt would be boosted in market value closer to the value of the underlying cash flow, restoring the banking system to solvency. Then why not just let banks value them that way on their books now, so they aren't teetering on insolvency? Wait for it. We'll get there, but not now apparently.
Nor does the Paulson plan have the Occamite virtue of cutting to the heart of the problem, the housing market. So many mortgage cash flows have been sliced and diced and spread over different kinds of securities owned by holders all over the world -- a big stumbling block to the private sector trying to manage its way out of a hole. It's not clear the new agency offers a solution to this problem. It would probably have to buy the entire outstanding stock of questionable mortgage debt before it would have any hope at getting at the underlying collateral, i.e., houses. But then it would become the world's biggest, most troubled landlord and biggest forecloser on homes. Politics would intervene -- and any potential taxpayer gains would likely be frittered away to keep nonpayers in houses they can't afford.
"No bailouts" makes a nice slogan, but taxpayers are already on the hook for half the nation's mortgages through Fannie, Freddie and the FHA. And nobody wants to find out what total meltdown of confidence in the financial system feels like. But with Chris Dodd ready to nationalize the banks and Barney Frank to dictate executive pay -- and with Clement Attlee Obama waiting in the wings to pile on his own big-government plans in the name of compensating "the middle class" for its sacrifices on behalf of Wall Street -- a more minimalist approach than Treasury's suddenly has a lot to recommend it.
Here it is: Let the government be a buyer of last resort for mortgage derivatives for a set price (say, 25 cents on the dollar), hoping others will gain confidence to step in. Hope, too, that this whets the appetite again for investors to recapitalize hurting banks. If banks continue to falter even with the option to dump their mortgages on government for a deep discount, deal with those challenges as they occur, with forbearance where possible. Meanwhile, use taxpayer dollars to clean up the housing mess in the Southwest and Florida -- the surprisingly confined source of all our troubles.
Every time we mention demolishing houses, somebody slaps us over the head with Bastiat -- the French economist who'd say you don't increase wealth, you reduce it, by destroying some houses to make the value of others go up.
True -- but we're in a situation today where responsible homeowners will pay one way or another for the acts of irresponsible lenders and buyers. The cheapest bailout would be one that weeds out enough surplus housing to stop the free fall in a handful of overbuilt markets, whose foreclosure epidemic is dragging down the entire securitized mortgage market. We're talking about buying thousands of houses, not millions of mortgages. And yet the resulting higher mortgage debt prices automatically would help to recapitalize the banks, while (knock wood) leaving some Paulson powder dry for future contingencies.
The fine print of the Paulson plan includes sweeping authority to buy "other assets." Going after houses and knocking them down would fit this commodious garment -- and would let the agency wrap up its work quickly and go away in the natural course of things, whether everyone was satisfied with the result or not.
That's a virtue not to be sneezed at. All the monumental interventions of recent months will have unintended consequences. Once the panic dissipates and the political class returns to form, we'll have a hell of a time unwinding the cure.
By: Holman Jenkins
Wall Street Journal; September 24, 2008
