Mortgage Bailout

The mortgage bailout has earmarked $75 billion to go to approximately 9 to 10 million households, but the real dollar extent of the bailout is probably going to be in the neighborhood of at least $200 to $300 billion. Like all the other bailouts, no one really knows the true dollar magnitude of what it will cost the American taxpayer. Unfortunately, it has already been proven that more than 60% of mortgages that were modified previously failed within six months. That is the problem, and this bailout will have the same likely consequences. Is Congress really incapable of thinking through all the negative ramifications of this dire bailout? I know, what a stupid question!

Let me get directly to the point why this bailout is bad for potential homeowners and lenders alike. Here it is: "President Obama said he will support revamping U.S. bankruptcy rules to let judges reduce mortgages on primary residences to fair market value as long as borrowers pay their debts under a court-ordered plan." Why is this proposal bad? Let me respond to my rhetorical question with an example. Let's assume as a private lender, I had loaned you $250,000 to purchase a home back in 2006. Today, you file bankruptcy and petition the bankruptcy judge that the home is no longer appraised at $250,000 but $150,000. You tell the judge that you can afford the P&I payments on $150,000 but not $250,000. The bankruptcy judge agrees and reducing the mortgage to $150,000. Who is the loser on this financial arrangement? Of course, I am, as the lender, not you, as the borrower. I have just lost $100,000, but you get to keep the house and have your principal balance outstanding reduce from $250,000 to $150,000. As a lender, do you think that I am going to make any more home loans? Probably not. In other words, availability of credit for mortgage money will be greatly reduced. If I do decide to lend, I will want to be compensated for the increased risk of some bankruptcy judge reducing the principal that is due me. This simply means that mortgage rates will go up dramatically! There you have the consequences of this bailout: reduce mortgage credit from the private sector and higher mortgage rates. Great isn't it? But then again, there is any such thing as a "free lunch."