Is President Obama Proposing That the Government Buy Out the Banks' Bad Mortgages?

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Written by Dean Baker   
Wednesday, 25 January 2012 17:49

That seems to be what the administration is proposing, according to an article in the New York Times. The article says that the Obama Administration wants to let people with underwater mortgages with private lenders refinance into government-guaranteed mortgages.

As described in the article, this would effectively mean that the government will be giving banks 100 cents on the dollar for mortgages where they could have anticipated substantial losses. If this is true, it would mean that the banks and investors who hold stakes in mortgage-backed securities would be getting far more money out of the deal than the homeowners who the policy is ostensibly designed to help.

To take a simple example, suppose a homeowner owes $250,000 on a home that is currently worth $200,000. It is likely that this homeowner will at some point default on the mortgage or need to make a short sale, which could result in the bank losing $50,000 or more. (Foreclosures involve substantial legal expenses and require that the bank pay a realtor to resell the property.)

On the other hand, if the government guarantees a new loan, the bank gets it full $250,000 back. The government would now stand in the same position as the bank had formerly, possibly losing $50,000 or more if the homeowner defaults. On the other hand, the benefit to the homeowner is paying a lower interest rate. If this arrangement results in a 2-percentage-point drop in the mortgage interest rate, the homeowner would save roughly $5,000 a year. In this story, the homeowner is almost certain to get much less out of the deal than the bank or investor.

 

Tags: government | housing | mortgages | private lenders