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October 2008 Archives

October 3, 2008

Why direct mortgage subsidy is a bad idea

In my continuing series (okay, well, two posts make a series I guess) about the economy, I want to address why the populist approach won't work.

A friend pointed me the other day to a Guardian article which was full of the usual ignorant mish-mash of "solutions to help Main Street, not Wall Street" and included this:

At the same time, several steps can be taken to reduce foreclosures. First, housing can be made more affordable for poor and middle-income Americans by converting the mortgage deduction into a cashable tax credit.

The Guardian article is the only place I've seen this idea explicitly, seriously suggested, but I have seen a similar sentiment ("The government should be helping out Main Street, not Wall Street!" "The real victims here are those who took out subprime mortgages? What's in it for them? Why aren't we helping them out directly?") in very many places. But actually, the idea of "giving money directly to Main Street, and letting Wall Street hang" is precisely counterproductive to this goal.

So, let's think about this for a minute. Pretend that, suddenly, the US passes legislation to allow mortgage interest to be a tax credit. What this means is that you can tell the US government that you spent $X on mortgage interest in 2008, and they will subtract $X from your tax bill. If this makes your tax bill negative, the government will send you a check for $X - (your tax bill). It is basically saying, "the US government will pay your mortgage interest."

This sounds great, doesn't it? If you're a US citizen with a mortgage, anyway. But let's think about it for a minute. The interest on a loan is the money that the bank who owns the loan is making, as recompense for your having taken their money to buy something for yourself. Generally, when you have first bought a house, the mortgage interest comprises the majority of your payment. (Play with a mortgage amortization calculator if you don't know what I mean.) So the Guardian writer is proposing, basically, that the government should pay the bit of people's mortgages that makes up the vast majority of the monthly payment right now. It also means that the government should pay, over the life of the loan, the part that is the payment to the lender for having made the loan. And so:

  1. This will make it a lot easier for people to pay the mortgage, at least in the first few years.
  2. This means that most of the mortgages that have been sliced & diced into CDOs will be good.
  3. This means that the banks who bought CDOs will receive the profit, that is the mortgage interest, courtesy of the US government.
  4. This means that the "toxic debt" won't be toxic anymore.
  5. This means that the CDOs will have precisely the inflated value that the banks assumed all along that they would have.
  6. This means that the US government will directly be paying interest money to the banks who hold the debt, that is, the investment banks who bought the CDOs.
  7. This means that the "bad, stupid" CDOs that the investment banks bought won't be so stupid after all—they'll be guaranteed by the full faith and credit of the United States government! There will be a party on Wall Street again after all!

It's a great way to get the money straight to Wall Street, with some incidental benefit to Main Street. But wait, I thought we were supposed to be bailing out Main Street and not Wall Street? Oops.

The best feature about the Paulson plan is that it pays a fair price (including the pessimism about Main Street being able to pay their mortgages) for these CDOs, and since it's a fair price, they will be able to sell these CDOs for at least the price paid, in future. The taxpayer will not, in the end, lose money if this plan is executed properly. (Yes I know, that's a big "if", but at least it's not a dead certainty that we'll lose money.) The plan has the side benefit, which Congress seems to have noticed, that the US government would hold a lot of slices of a lot of mortgages, and it would suddenly become possible (as it isn't at the moment) to put these mortgages back together and re-negotiate the terms with homeowners on the edge, and try to keep them in their houses. But the main benefit is that Paulson has come up with a way to put a bunch of taxpayer money on the line to keep the economy functioning, and get the money back in the end, so that the taxpayer won't be out of pocket in the end. This is the part that I love. How many government employees do we have who can still think of ways to retain the taxpayer's money in such an impressive way?

About October 2008

This page contains all entries posted to collected eccentricities in October 2008. They are listed from oldest to newest.

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