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Thursday, October 30, 2008

Op-Ed: A Different kind of Bailout. Cambridge Chronicle

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A Different Kind of Bailout

Martin G. Evans

Several weeks after Congress passed a $700 billion bailout bill, the world=s financial system is in chaos. Banks have stopped lending, stock markets are in free fall or fluctuating widely, and the rot is starting to infect the Areal economy@ where firms are unable to get their usual credit to carry out their operations. Layoffs and short time working seem to be inevitable.

The problem with the Administration=s original plan, buying the derivative debt of the banks to build up their balance sheets is that they are dealing with the phantom derivatives (monetized mortgages, credit swaps, and insurance contract) built upon the shaky foundation of bad mortgages. The Administration recognized this and last week moved to Plan B. They made direct investments in nine major banks. It now appears that the banks have used this money to reduce their leverage rather than to start making new loans to their customers. There is still a credit strike by the country=s bankers.

The place to intervene is with the mortgages themselves.

Senator McCain is partly right. The mortgages must be supported at their face value, not at the discounted value that many now have. Anything less and the banks would not be helped. They hold the monetized, sliced and diced mortgages at their face value and that face value has to be restored if the financial system is to be shored up effectively.

The small HOPE or H4H plan included in the bailout bill has it partly right but takes too big a share of any built up equity in the house and gives the lender only the discounted value of the mortgage rather than the full amount.

Senator McCain is wrong in his suggestion that the government buy up these mortgages. Rather like H4H plan, the government should enter into partnerships with the current mortgage holder. The current mortgage holder will pay an affordable amount each month; the government will become a co-owner of the mortgage and of the property and will pay the balance each month. Over time, both the property owner and the government will build up a proportionate share of equity in the property. Homeowners will be able to stay in their properties. This will contribute to stabilizing the housing market. The continuation of residence in the same neighborhood will reduce the possibility of foreclosure blight that is beginning to afflict some streets in our towns and cities.  For those homeowners with children, their education will not be disrupted by a move to a new school catchment area. Finally, it will maintain a flow of property tax money to the local governments who are already in dire straits as more and more foreclosures occur.

The one problem with this plan is what to do if the house is sold before the price reaches a state of profitability. There are two alternatives: the new owner should be able to take over the existing mortgage and the federal government’s partnership in paying the mortgage and ownership of the property; or the new owner can negotiate a new mortgage without the government’s involvement but the government will retain the percentage share of ownership that it has already accumulated and will benefit once the house price is “above water.”

Yes, this plan is more expensive than either Senator McCain=s or the H4H plan. But it will do the job of making the lenders whole and it is more generous to the homeowners when they have built up some equity in their homes. This will help them in their retirement years. Unfortunately, the plan will bail out the predatory lenders and the other scoundrels who have deceived us all, but that may be a small price to pay to save the world=s financial system.

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