Meltdown

"The government would buy the existing troubled loans at face value -- absorbing the haircut itself -- and the Federal Housing Administration would issue a new, federally guaranteed 30-year fixed-rate loan, based on the property's present value, at a "manageable" interest rate, the McCain camp said."

WSJ, 10/9/2007

The idea is based on Martin Feldstein's proposal, which would lend homeowners with negative equity 20% of their principal at government rates on their personal credit. This would give them an incentive to keep the house, and reduce their interest payments, without reducing their total debt. I'm not sure it's a great idea, and I wonder how aggressively politicians would enforce those personal notes, but it doesn't give the homeowners a pass on overextending themselves.

McCain would. Homeowners here get government funded forgiveness of excess debt. I haven't seen any suggestion that the government would get a position in any capital appreciation of the house. This might reduce foreclosures and thus downward pressure on housing prices. But that pressure is only temporary anyway -- the long term value of mortgages is driven by the long-term value of the house, and that is driven by real estate economics which are temporarily distorted by the foreclosures. We don't know the "right" level for housing prices, and probably won't for a while -- if they go lower still, are we going fund a second round of principal reductions?

I can't support this. It's a huge incentive to irresponsible financial behavior, added to existing government incentives in health care and disaster relief, and sets an ominous precedent for handling coming problems with retirement savings. Even if it did help with the current situation, we still might well be better off suffering a recession than telling people the government will bail out their stupid decisions. And I certainly don't want to do this without a lot more thought McCain has given this, and a lot less suspicion of political motivation.

McCain is really reaching here. Some of this is panic, some pandering. I don't think he understands economics sufficiently to understand the moral hazard problems of this, or how they differ from those in the proposals of Feldstein and others. But whether its errors come from ignorance or ambition, I can't agree to something this bad.