Oh, oh it's magic

Henry Farell at Crooked Timber reads this FT article about the Bush administration mortgage plan:

Mortgage service companies, which are responsible for calling on Americans to keep up with their loan payments, have assumed a pivotal role in President George W. Bush's market-oriented strategy for dealing with the pending wave of foreclosures in the subprime mortgage sector.

An estimated 6m high-risk subprime loans, worth a total of more than $1,000bn, are outstanding, which will in many cases reset to higher interest rates in the next 18 months, putting more than 2.5m Americans at risk of foreclosure.

"It is sort of like being in New Orleans a month before Hurricane Katrina hit when you know there is a storm coming," said Guy Cecala, of Inside Mortgage Finance.

Economists fear that a wave of evictions of borrowers unable to afford the higher payments will blight neighbourhoods, hit home prices, deepen the worst housing downturn in 16 years, and harm the wider economy.

The response to this crisis outlined by the president places considerable faith in the ability of mortgage servicers to mitigate this blow by helping distressed borrowers to stay in their homes.

Edward Lazear, chairman of the Council of Economic Advisers, said: "I believe, and I think the president believes, that markets are very good at finding ways to solve problems."

But many experts claim that the mortgage service sector is not fit for this purpose.

They argue it does not have the capacity to perform this role, and lacks the personnel, financial resources, technical tools, experience, incentives and oversight to deal with an economic crisis of this scale.

"Theoretically, it makes sense, but not in the real world," said Scott Syphax,a director at the Federal Home Loan Bank of San Francisco.

"These institutions are not built to handle this scale and volume of problems."

"The notion that federal regulators can urge services to reach out and contact borrowers who may face distress is unrealistic," said Mr Cecala.

And concludes:

There’s very little that I find more annoying than the “magic of markets” arguments that various right wing hacks and ideologues spew at the drop of a talking-point. It makes me want to forcibly enrol the responsible parties in an economic sociology program until they see the errors of their ways. Markets can indeed do extraordinary and impressive things, but they rather obviously depend on previously existing institutions, expertise and social conditions if they are to work. Not to mention proper incentive structures. These can’t be whistled out of thin air. The claim that a business sector composed of small firms specializing in foreclosure and themselves terrified of bankruptcy will have the appropriate motivations and expertise to stave off this crisis is self-evidently bogus, if you look at it at all closely. But sprinkle some of that schmeconomics 101 pixy dust on it, and you can get away with it, thanks to the supine US journalism industry (I don’t know of any US publication which has even mentioned this as a problem; perhaps I’m wrong).

I read it a little differently. Mortgage service companies would rather the federal government paid for subprime defaults than them. They would therefore like a straight bailout, rather than a program in which the Treasury helps them do workouts with homeowners.

It seems obvious that the securitization of loans has made workouts considerably more complicated, which is why the Federal government is getting involved; but it's not clear to me that it's made them less financially feasible, which is what the experts, all of whom seem to work for mortgage servicers looking for a bailout, are claiming. I see the Bush administration as feeling its way cautiously, trying to put together a package that will avert financial disaster without:

1. Creating moral hazard


2. Costing the government a scary enormous amount of money


3. Outraging voters as the government taxes people in modest homes in order to allow people who bought more home than they can afford in those houses. Whether or not you think that this is common among those who have gotten themselves into subprime trouble, or even admire the redistributive justice of it all, this is a real sentiment out there, and politicians have to deal with it.

These are reasonable goals. Against this, one has to weigh the fact that major crises are better averted earlier than later. But I am not yet clear on whether the mortgage market requires massive intervention, or just continual finesse.