Congress agrees to spend $700 billion to buy bad mortgages and bail out the banks
The House of Representatives passed a financial rescue bill on Oct. 3 that will let the government buy up to $700 billion in bad mortgages and other debt from banks and mutual funds.
It means -- at least in theory -- that homeowners facing foreclosure could get to negotiate a new mortgage repayment plan with the government instead of a private lender.
Some experts think the government may be more willing to reduce interest rates, forgive some debt or refinance loans than banks and big money investors have been, making this a good deal for homeowners, too.
But a closer look indicates that not many borrowers are likely to benefit from the Emergency Stabilization Act of 2008.
The Senate passed the bill on Oct. 1 and President George W. Bush signed it into law on Oct. 3, right after the House approved the bailout, 263-171, reversing its shocking rejection of the original plan on Sept. 29.
The clear winners are the investors holding millions of mortgages that are going into default. They can now sell those money-losing loans to the government and be done with them.
Make no mistake: We all should benefit from the plan. Taking all of that bad debt out of the credit markets should make it easier for banks to lend to each other and other businesses, reducing the chance of a deep and prolonged recession.
The legislation also extends a tax break that allows you to deduct state and local sales taxes on your federal return and offers a year's respite from the Alternative Minimum Tax, which can cost middle-class taxpayers more than $2,000 a year.
Some lawmakers, including Rep. Maxine Waters, D-Calif., praised the bill, saying it would enable the government to "do the kind of loan modifications we've been urging," but the law's vague terminology doesn't suggest that will happen automatically.
The bill says the Treasury "Secretary shall implement a plan that seeks to maximize assistance for homeowners," which would involve encouraging loan servicers to rework mortgages by reducing the interest rate or loan principal.
But the bill doesn't say how or when that will happen.
"The language is fairly passive," says Brenda Muniz, legislative director at the national community organization ACORN. "We'd like them to make it a precondition to say, 'Yes, if we're going to buy [this mortgage debt], we will modify the loans in an aggressive way.'"
One of the major reasons we're seeing a record number of foreclosures is that investors who own most mortgages have been unwilling to do the two things that would help borrowers the most: lower interest rates and reduce the principal or amount owed.
Those are the only two ways to substantially reduce monthly payments or allow borrowers to refinance into more affordable loans.
Many won't. Fewer than 2% of mortgage modifications over the past year reduced the borrower's principal, according to a study done by Alan White, an assistant professor of law at Valparaiso University in Indiana.
The problem is that the federal government may not have full ownership of all that many mortgages, even if it wants to be more aggressive in modifying loans and preventing foreclosures.
Although each mortgage came from a single bank or mortgage company, it was bundled together with thousands of other mortgages and sold to investors. In many cases, that package of loans was divvied up and sold to more than one investor.
So each individual mortgage may now have eight or nine different owners. In order to modify the terms of the loan, all of the owners must agree.
If the government is somehow able to buy all of those pieces and have sole control over a mortgage, the borrower would have a better chance of reworking the terms.
But, Muniz asks, "What happens if [the government] has partial interest?" The bailout bill doesn't give the Treasury Department the authority to force the other owners to accept a modification.
It would have to get the loan's other owners to accept the losses involved in lowering the interest rate or principal. Unfortunately, there's no reason to believe they'll be any more cooperative just because the government now holds part of the debt.
"To the extent that we are able to buy [mortgage debt], we are directing the Secretary of the Treasury to maximize to the extent [it can] the tools that the government has available to it to minimize foreclosures," says Steven Adamske, a spokesman for House Financial Services Committee Chairman Barney Frank. "If there are problems with the servicing industry, we will look into hearings and legislation next year."
It is an incredibly complicated mess for the government to sort through. And it is too soon to tell exactly what help -- if any -- homeowners facing foreclosure will receive.