Congress Mulls Mortgage Guarantees; Critics See More Harm than Good Likely

Published July 1, 2008

Slow housing sales, falling property values, and rising mortgage defaults and foreclosures have prompted Congress to ready a bill to intervene in the housing market.

But the bill’s supporters face tough opposition from critics who believe it constitutes an unjustified bailout. The plan would grant taxpayer guarantees to refinance up to $300 billion in private mortgages across the nation.

The bill would allow the Federal Housing Administration (FHA) to insure troubled mortgages for lenders that voluntarily agree to cut by 15 percent the amount of principal borrowers owe. Borrowers would receive a smaller, refinanced loan but would have to pay FHA 3 percent of the new loan amount and up to 2 percent in closing costs.

FHA would guarantee the new loans, and the lender would have no further credit exposure. For refinanced loans that went bad, taxpayers would cover the losses.

Lenders Would Benefit

The proposal would benefit lenders, who would take relatively small write-downs in exchange for the opportunity to rid themselves of loans with a high chance of default. The Congressional Budget Office estimates the bill would affect 500,000 mortgages over the next five years.

The bill has cleared the House, and a slightly modified version has passed the Senate Banking Committee. Full Senate passage remains uncertain, and even if the bill makes it through the Senate, it faces a veto threat from President George W. Bush, who issued a statement saying the House version would aid real estate “speculators.”

“It is important that we reduce the number of foreclosures both as a matter of alleviating the pain for some individuals and stabilizing some neighborhoods,” countered Rep. Barney Frank (D-MA), the bill’s chief sponsor, in a press statement.

Frank, who chairs the House Financial Services Committee, told The New York Times he thinks Bush’s veto threat represents an unwillingness to help homeowners. Frank maintains the bill would bring a measure of economic calm to areas with high default rates.

Instability Predicted

Not everyone agrees with Frank’s positive assessment of the measures. Some lawmakers say the program would foster even greater instability in the housing market, rather than stabilize neighborhoods.

In a floor speech, Sen. Tom Coburn (R-OK) said the Senate version of the bill “only creates more opportunities for borrowers to receive government-backed loans, increasing the liability on American citizens but not preventing the possibility of delinquency or default.”

Others see the potential for moral hazard. Rep. Marsha Blackburn (R-TN) told The New York Times Frank’s approach would “reward recklessness and provide a safety net for irresponsibility.”

Bailout for Big Banks

Many others are concerned the bill essentially serves as a handout to big banks.

FreedomWorks, a free-market advocacy group in Washington, sponsored an online petition opposing the bill because it represents a government bailout of the mortgage industry. To date, more than 54,000 people have signed the petition, and many have left heated comments on the organization’s Web site.

Wayne Brough, chief economist for FreedomWorks, says the reaction is to be expected. He points to poll numbers showing a majority of Americans oppose such legislation. He says public frustration is justified.

“This gives banks the freedom to take their riskiest loans–many of which they never should have taken in the first place–and offload them onto America’s taxpayers,” Brough said. “It’s a publicly financed get-out-of-jail-free card for lenders who made bad bets on risky loans.”

Adam Brandon ([email protected]) is press secretary for FreedomWorks, a Washington, DC-based free-market advocacy group.