Bush's Mortgage Bailout

A few weeks ago I wrote a column about a Florida condo owner named Hyacinth O'Meally. When she bought her home in 2005 she took out an adjustable-rate subprime mortgage. She paid exorbitant closing costs and was surprised to find out her monthly mortgage payment didn't include her property taxes of more than $300 per month. That confusion, compounded by a drop in income, made her monthly payment more than she can handle. Now, even after the bank has modified her loan, she's behind on her mortgage and may lose her home.

After that column ran, I received lots of e-mail from readers in similar straits. Some of them expressed hope that the Bush administration's proposed plan to ease the subprime crisis might offer them a solution. But these troubled borrowers are likely to be disappointed.

Here's why. Under the terms of the deal, lenders are offering to freeze the interest rates and monthly payments for five years for subprime borrowers who fit a limited set of conditions. Borrowers must be current on the loan, the loan's interest rate may not yet have reset, and the lender must determine that the borrower lacks the capacity to afford the higher payment if the interest rate adjusted upward. According to a study cited by today's New York Times, Barclay's Capital estimates that just 12 percent of subprime borrowers will benefit from the interest-rate freeze. Even before the program was officially announced it drew criticism from consumer advocates and Democratic presidential candidates.

After exchanging e-mail with a number of troubled borrowers, I can understand the criticism. When you talk with these people, what's striking is how the decision they made about their mortgage—a choice that was, in retrospect, ill-advised—is rarely the only strain on their finances. Many have also suffered a hit to their income, often due to illness, disability or job loss. While none of these borrowers have sent me their credit reports, I suspect their mortgages aren't the only payments that are causing them distress; many of them, I'd bet, are also plagued by high credit card debt or outsize car payments. Today's Wall Street Journal reports that auto loan delinquencies have jumped lately, providing new evidence that Americans' growing debt woes extend beyond home loans.

By definition, someone who has taken out a subprime mortgage has either shown a history of having trouble managing his credit or did a less than stellar job of shopping for a mortgage. (On Tuesday the Wall Street Journal reported that many subprime borrowers could have obtained a regular mortgage but were steered into a higher-cost loan.) So it's not surprising if many of these borrowers have also made other poor financial decisions. The government's bailout plan is trying to deal with the mortgage mess in isolation. Helping people with more complicated financial problems is trickier, not unlike the challenge facing doctors treating patients who suffer from two or more diseases simultaneously.

It's no surprise that there are plenty of folks who oppose a bailout of any kind. They argue that letting borrowers off the hook penalizes lenders and sets a bad precedent. If nothing else, the mortgage crisis of 2007 has helped millions of us better understand the definition of moral hazard.

My own view is more sympathetic, for two reasons. The first, frankly, is self-interest. As a homeowner I'm concerned about the value of my own home. Studies show that anytime a house is foreclosed, the value of nearby properties tends to drop. Last month I spotted a "public auction" sign in front of a house two blocks from mine. I hope it's not the first of many. My own mortgage is a conservative, fixed-rate loan, so I won't directly benefit from the subprime bailout—but if it keeps some of my neighbors from losing their homes, I'll benefit because it will help my house retain more of its value. (I will, of course, also be happy to avoid watching neighbors traumatized by foreclosure, but in this column I'm weighing the pros and cons economically, not emotionally.)

The other reason for my sympathy is that I'm aware of how hideously complicated mortgages have become over the last two decades. I have absurdly well-educated friends who don't really understand how mortgages work. Even though I write about this stuff for a living, at times I've agonized over whether to pay points or whether my mortgage broker's fees are legit.

In the coming weeks many of us will tune into "It's a Wonderful Life," that heartwarming tale of George Bailey and his family's efforts to bring homeownership to their town's working class. In a way, our 21st-century world of teaser rates, option ARMs, balloon payments and "0% Down!!" advertisements—all factors that led to the current crisis—are simply extensions of the pre–World War II financial innovations, like the Baileys' savings and loan, that helped the less affluent buy homes in the first place.

But financial innovation comes at a cost. Just as the move from defined-benefit pension plans to 401(k)s has shifted the onus onto individuals to save for their own retirements, the explosion of mortgage products has required borrowers to be a lot more savvy about the fine print of their home loans. Even some smart people overestimate the average borrower's sophistication in these matters—as evidenced by Alan Greenspan's 2004 speech in which he argued that more Americans would benefit from taking out adjustable-rate mortgages. It's a thesis that makes theoretical sense, but seems to assume the average homebuyer understands interest-rate risk as well as someone trading LIBOR (London Interbank Offered Rate) futures at Goldman Sachs.

So while the Bush administration deserves praise for persuading lenders to ease the strain for troubled borrowers, today's news is likely to be just the first step in easing the hangover from our real estate orgy. Today's deal won't help Hyacinth O'Meally nor many of the other troubled borrowers who have been e-mailing me in recent weeks. Unless Americans want a lot more "public auction" signs sprouting from lawns near them, we're likely to see some more accommodations down the road.