The “agreement in principle” on a $700-billion mortgage bailout turned pretty quickly into a disagreement Thursday night as House Republicans revolted. Not being a Capitol Hill Kremlinologist, I can’t really tell you how significant this is: This summer’s big housing bill was opposed by 149 of 199 House Republicans, and that sure didn’t stop it. What I can offer a halfway informed opinion on is whether the two Republican counterproposals floating around make any sense.
One, that of the House Republican Study Committee, seems to be a joke. It calls for a two-year suspension of the capital gains tax to “encourag[e] corporations to sell unwanted assets.” But the toxic mortgage securities clogging up bank balance sheets are worth less now than when they were acquired. Meaning that no capital gains tax would be owed on them anyway. If you repealed the tax, banks would have even less incentive to sell them because they wouldn’t be able use the losses to offset capital gains elsewhere. Seriously, where do these people come up with this stuff?
Eric Cantor, the Republican chief deputy whip, has a more reasonable-sounding if still pretty vague plan to insure more mortgages rather than buy mortgage securities. Taxpayers already explicitly insure several hundred billion dollars worth of mortgages (it was $400 billion at the end of FY 2007, but I imagine it’s a lot more by now) through the Federal Housing Administration, and have now also taken responsibility for the $5+ trillion in mortgages held or guaranteed by Fannie Mae and Freddie Mac. Add a couple trillion dollars of troubled private-label mortgages to that, and you don’t have the big up-front expense or direct government involvement in the banking system that the Paulson plan calls for. Cantor also seems to think Wall Street would pay the premiums on the insurance (with FHA-insured loans, homeowners pay the premiums).
I’m no expert in this, but my initial thought is that Cantor’s plan wouldn’t be a markedly better deal for taxpayers than Paulson’s. As the insurer of all mortgages, the government would still be stuck with hundreds of billions in losses. That would be partially recouped by premiums, but not fully. And this strikes me as significantly more complicated to administer than Paulson’s bailout fund. As part of the July housing bill, the FHA is already supposed to start offering next week to guarantee up to $300 billion in renegotiated subprime mortgages, and I doubt it’s really ready to do that yet.
Update: Robert Waldmann isn’t an expert in this stuff either, but at least he’s an actual economist. And he pinpoints something that had bothered me about the whole charging-premiums thing:
[T]he problem is the price, in this case the premium. If it is vastly less than the probability of default, the House Republicans have found a way to throw money at bankers and financial arsonists instead of just bankers. If it is actuarily fair, it will force liquidity constrained firms to unload the securities — they could wait and hope for no default, but they can’t pay actuarily fair premiums. When you are insolvent, risk, variance, double or nothing is your only hope of survival. Thus aside from the contribution to financial arson (which I guess will be huge) the plan would also force distressed banks etc to unload mortgage backed securities at fire-sale prices. Now I don’t think the current problem is mainly due to systemic margin calls due to mark to market and capital requirements, but making that problem vastly worse would hasten the collapse of the US financial system even without financial arson.
Update 2: Another post on the same topic here. And the abridged version here.