Stick to poker, Michael Lewis
Michael Lewis (Liar’s Poker), has decided to write a quickie book on the global financial crisis from the sound of two Op-Ed pieces published last weekend in the New York Times. You can read them here and here. I say it’s a quickie book because I can’t imagine he’s taken a co-author (David Einhorn) for any other reason. This Einhorn guy has the goods and Lewis has the glib, I’m sure.
It is clear from these essays that Lewis plans to make Treasury Secretary Hank Paulson into the Devil, which may be the right thing to do, since Paulson’s policies to this point have been mainly about cronyism and barely about solving a global financial crisis.
Lewis is a very good writer. This is going to be an important work that will have at least a superficial effect on Obama policy. It isn’t clear whether Lewis can actually shape the ensuing debate, but he’s pretty darned good at what he does.
The reason I bring this up is because he’s proposing a homeowner bailout of sorts. It’s always dangerous when writers come to think of themselves as pundits. I should know.
Here’s his proposal, excerpted by me:
“If we are going to spend trillions of dollars of taxpayer money, it makes more sense to focus less on the failed institutions at the top of the financial system and more on the individuals at the bottom. Instead of buying dodgy assets and guaranteeing deals that should never have been made in the first place, we should use our money to A) repair the social safety net, now badly rent in ways that cause perfectly rational people to be terrified; and B) transform the bailout of the banks into a rescue of homeowners..
…. Congress might grant qualifying homeowners the ability to get new government loans based on the current appraised values without requiring their bank’s consent. When a corporation gets into trouble, its lenders often accept a partial payment in return for some share in any future recovery. Similarly, homeowners should be permitted to satisfy current first mortgages with a combination of the proceeds of the new government loan and a share in any future recovery from the future sale or refinancing of their homes. Lenders who issued second mortgages should be forced to release their claims on property. The important point is that homeowners, not lenders, be granted the right to obtain new government loans. To work, the program needs to be universal and should not require homeowners to file for bankruptcy.”
This idea may get a lot of play in coming weeks. It’s a clever idea but it probably won’t be allowed to work. Here’s why
Some of these tactics Lewis proposes are already in use with the Farmers Home Administration. Farmers Home will subsidize an equity position and loan amount that allows the would-be homeowner to buy a property in designated area in order to attract growth, (This is rarely done anymore, by the way.)
When the homeowner attempts to Sell or Refinance property under this program they must pay Recapture, (pay back to the FHA the amount of the loan subsidy). The big problem with the Lewis proposal is that release of claim by the holders of second mortgages: the banks won’t do it
This proposed second mortgage release of lien will cause problems due to the amount of write downs the banks will be facing. This will leave them unsecured on junior liens they currently service making that paper default at a much higher rate and therefore the value of the asset will drop considerably.
Let me explain this a little differently. By decoupling the second mortgage from its collateral (the house) the lender can no longer foreclose (take the house for non-payment) and therefore loses influence with the debtor (the homeowner). Less influence automatically translates into higher default rates on those second mortgages. Why pay the second if not paying doesn’t hurt you much? But the result of non-payment is that the value of the house automatically goes down, owner equity decreases, and our financial death spiral steepens.
While laudable as a good try, Lewis’s proposal not only won’t work, it will make things worse.
I’ll be writing a lot about these issues in the next few days. It is becoming very clear to me that the U.S. government is in a bad spot when it comes to effectively helping homeowners keep their homes. The government doesn’t know what it is doing for one thing. And for another, the lenders simply can’t be trusted to do the right thing
Toward the end of its life Pan American World Airways began to sell-off parts of its global route system to keep the rest of the company afloat. United Airlines bought Pan Am’s Asian routes along with staff, crews, and as I recall about 25 aging 747s. Before they handed over the big Boeings to United, Pan Am installed on those planes all their oldest engines, keeping the newer ones for their remaining fleet. At $1 million per engine it was a $100 million rip-off of United, which eventually had to trash every engine it got from Pan Am. If something like Lewis’s proposal makes it through we should expect similar behavior from the big banks, offering up first for government refinancing their worst loans, the ones most likely never to be repaid.
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