Since the mortgage mess began unfolding two years ago, homeowners losing their homes have been asking: Can nothing be done to stop this? Now, with the government spending or committing trillions of dollars to rescue the financial system, hundreds of readers are asking: Where's my bailout?
With the Obama administration set to announce details of a comprehensive foreclosure prevention plan Wednesday, their wait may soon be over.
I have been waiting patiently for some sign that there might be some relief for my daughter and others like her who are in danger of foreclosure. To date, I’ve seen a lot of money doled out to corporate America but have seen not a drop trickle down to the taxpayer. It’s been too long – what’s the president waiting for?
— Karen, Springfield, Mass.
Since the housing bubble burst two years ago, the government’s response — supported by a substantial segment of the public — was that lenders and borrowers made this mess and that they should work out solutions on their own. Judging from the Answer Desk inbox, many readers still think that should be the government’s policy.
But it’s rapidly becoming clear that the collapse of the U.S. housing market is taking the rest of the economy down with it — both here and around the world. It’s a vicious downward spiral.
Home foreclosures create big losses for banks, which no longer collect monthly payments and have to sell the foreclosed house at a big loss. Those forced sales push everyone else's home price lower.
Homeowners squeezed by bad loans with exploding interest rates might be able to make those payments if they could refinance to an affordable rate, but their home is now worth less than their mortgage. Rising unemployment is expanding the pool of homeowners losing their homes. Anxious consumers across the board are cutting spending, pulling the economy lower, forcing more layoffs.
Everyone — homeowners, bankers, community groups, federal, state and local officials — now agrees on one thing: The measures we’ve tried so far just aren’t working. The new administration met last week with many stakeholders to try to work out more aggressive solutions, details of which are expected to be announced Wednesday. Some banks, along with government-owned lenders Fannie Mae and Freddie Mac, have stopped foreclosing on homes until that plan is finalized.
One of the most contentious elements has been the issue of fairness to those homeowners who are struggling but still managing to make their payments. Why should my taxes, these homeowners ask, go to pay someone else’s mortgage when I’m having trouble paying mine?
It’s a fair question, and one the White House is also trying to answer as it works out the details of its plan.
As we reported last week, one idea being considered would involve the government buying up mortgages that are bigger than the underlying value of the home, getting a discount from the banks or investors who hold the loan. The government would then refinance the loan, based on the current, fallen home value, allowing the homeowners to make more reasonable payments. The new, less risky loan would then be sold back to investors.
If the government paid fair market value, it wouldn’t lose taxpayer dollars. True, banks or investors would have to book a loss, but since home prices aren’t going back to boom-era prices any time soon, they’ve already suffered that loss.
We'll know more Wednesday. No matter what's in the plan, it won't be a quick fix. Given the scope and complexity of the mess, it's going to take a lot more time and inflict a lot more pain before it's cleaned up.
If the banks are nationalized, does that mean that any stockholders, such as I, lose their money forever, because the government is buying the stock for i.e. $0 and we then have no stock left? … (Is the government) simply waiting for the banks to lose so much more that they have no choice but to take them over?
— Bill H., New York, N.Y.
To date, the various plans and programs to rescue the financial system have avoided at all costs a true nationalization, in which the government takes over banks and runs them. If the current plans don’t work, there may be no other choice.
Part of the rescue effort to date has involved government guarantees for the biggest, most troubled, "too big to fail" banks to calm investors and customers and keep money flowing. But because such a big chunk of these banks' assets are backed by bad mortgages, the government decided to invest most of the first $350 billion of the financial rescue package directly in banks to shore up their crumbling capital foundations.
But it wasn’t exactly a handout. In return for the money, the government got back a special class of interest-bearing, "preferred" stock and, in some cases, warrants which give the holder the right to buy more stock at a set price in the future.
So the government is paying a lot more than $0 (of our tax dollars) for the bank shares it's getting in return for that money. The problem for existing shareholders is that any new ownership stake sold to a new investor diminishes the value of shares already that have already been issued. If you've got six people sharing a pizza and someone else comes along and offers to help you pay for it, the only way to share with them is for everyone else to take a smaller slice.
Whenever an investor comes in and provides new capital to a distressed company, it is almost always "dilutive" of the stock already issued. The government has tried to avoid this by swapping cash for classes of stock or warrants that don't dilute common stock. But there are limits to how much more capital can be pumped in without becoming dilutive.
That's one of the reasons bank stock prices are so low — investors are fearful and uncertain about what the government may do next. Nationalization is the biggest fear. In that case, it's hard to see how common shareholders would not get wiped out.
One possible outcome would be a "good bank, bad bank" scenario — take the bank’s bad assets, tie a rope around them and put them in a warehouse hoping they recover value over time. It's possible you could include in that plan a stock split —so shareholders like you now get two shares for each one you’re holding — one in the Good Bank and one in the Bad Bank. But we haven't heard anyone talking about it.
There are two schools of thought about nationalization. One says don’t do this until the bank is completely insolvent, at which point the FDIC has to take over the bank anyway to protect depositors. Some analysts believe there are a number of banks that — if they fully booked their losses based on the net present value of their mortgage-backed assets — are insolvent today. With job losses still at such high levels, it’s hard to see how the value of those assets going anywhere but lower.
The other argument against the need for nationalization is that the Fed’s “zero interest rate” policy will allow banks to raise the fresh capital they need on their own. With money so cheap, banks are making profits on the new loans they’re making. The question is whether those profits can offset their losses fast enough to keep them from going broke.
That’s the main argument for having the government step in now, take over the weakest banks, remove the bad assets, get them back on their feet and sell them back to investors. Those who support this idea point to the savings and loan mess in the late 1980s and the meltdown of the Japanese banking system in the 1990s. They argue that lesson from those crises is the longer you wait, the bigger the mess you have to clean up later.