The $700B Plan vs A Homeowner Plan

On September 23rd I wrote about "The $700B Quagmire". I suggested that the fund should be managed by experts who understand the assets being purchased and also have the ability to structure the right deal for each company. Congress can not use one set of guidlines that will apply to all the assets being purchased. If those assets are bought very cheap, then it will be a good deal. In other situations, if the purchase price is above fair market value, then the taxpayers should expect to get additional value in the form of debt or equity from the selling financial institution. As Paul Krugman discusses in today's NY Times Op-Ed section, we need Grown-Ups to manage this process. The oversight of this process is best served by hiring a team of experienced professionals that are incentivised to work for the taxpayers by profiting themselves on the returns of the $700B Fund.

The other large topic up for debate is how should the government help those on Main Street who can't afford their mortgages. The editorial in the NY Times today suggests the bankruptcy Court should be allowed to restructure the mortgages to reduce foreclosures and make homes affordable again to those who live in them. Wall Street may be blamed for providing the liquidity for the growth in the housing market but many people used this opportunity to take out oversized mortgages and home equity loans. In addition, speculative buying of homes helped to propel prices of homes higher and many people enriched themselves in the process. Others refinanced their mortgages and took out cash to feed their lifestyles. Wall Street is the culprit but Main Street enjoyed the ride while it lasted.

Of course, the government needs to find a solution to the housing problem but I think the NY Times editorial does not accurately explain the bankruptcy process. If a corporation has secured debt, similar to a home mortgage, and the company goes bankrupt, then the loan needs to be paid off or restructured. A restructuring will likely give the mortgage holder a lower coupon or a smaller loan. That is what the editorial is suggesting bankruptcy judges should have the ability to demand. However, in a corporate bankruptcy, the mortgage lender will also retain some if not all of the equity in the business as compensation for reducing the principal on the loan or for accepting a lower interest payment. If we apply an analagous principle to homeownership, then the financial institution whose loan is being restructured should also be compensated with an equity stake in that home. Perhaps a mechanism can and should be set up to allow the homeowner to pay back the financial institution over time to regain their equity stake in their home.

The $700B Bailout is similar to the Homeowner Plan. Both situations need to be managed by Grown-Ups and unique deal need to be structured but in the end, there is no free lunch.