Congress Needs Risk Analysis Class

Congress seems on the brink of making homes harder to finance. It sounds backward, but bear with me. I'll try to explain why I'm concerned.

The mechanism Congress picked years ago to make it easier to get money into the hands of banks for making 30-year fixed-rate mortgages (which in the U.S. are common, but in the world at large are largely a fantasy) was securitization. Fannie and Freddie were set up to guarantee loans, and to repackage them for investors. Between the securitization and the guarantee, the promise of individuals whom investors never met to keep making interest and principal payments for possibly decades was thought to be suitably backed.

Exactly why was the promise of little strangers of interest to institutional investors with the power to buy any debt obligation from any business or government enterprise on the planet? A few points:

• Principal backed by a hard asset -- a home being maintained by its resident
• Timely payment of interest and principal guaranteed by Fannie or Freddie, or an insurer like AIG
  
• History of home mortgages performing at a very high rate of promised performance
• Ability to buy in bulk obligations based on the credit of very small borrowers, meaning investments with yields better than the secured notes of well-known, solvent obligors like General Electric
  

The key to the injection of capital into the home finance system, the lynchpin in the pitch, is that the investments perform as described.

A member of Congress from Houston appeared on C-SPAN recently, demanding to know why homeowners in bankruptcy shouldn't be allowed to have courts rejigger the terms of their home loans in the way bankruptcy judges rejigger other debts. Honestly, I'm not sure what the rationale is for allowing vacation properties' mortgages to be reworked by courts at the expense of secured creditors -- I mean, that's what you expect when you are a secured creditor, right? Security? I tried to imagine what would happen if the bankruptcy code was reworked to allow judges to dictate to secured home lenders the new terms -- principal and interest -- of their debtors' obligations.

Mind you, this change in isolation isn't the kind of opt-in system proposed and defended by officials who point out that offering lenders upside participation in property appreciation is a potentially appropriate quid pro quo for banks who don't want to suffer failed mortgages but don't want to unilaterally forgive debts, either. An opt-in system has problems, too, of course: it makes borrowers' outcomes depend on the whim of banks. On the other hand, government could condition lenders' gurarantees on the ability to step into the banks' shoes, become the secured creditor, and then renegotiate the mortgage so that it can be paid -- and so the government gets participation in the property's re-appreciation to recoup its losses and compensate taxpayers for taking the risk on a failed borrower.

Instead, the proposal to enact a one-way change to make home mortgages malleable in bankruptcy court would wreak havoc -- utter havoc -- in our system of getting thirty-year mortgages off the books of local banks so the banks would be in a position to make more 30-year loans. Who will buy a 30-year obligation that, by law, means only what a judge says a borrower can afford, and has a principal value that can be adjusted downward (but never upward!) when buyers make a bad guess about real estate value trends? What will the obligation of guarantors be for the timely repayment of principal and interest, if the underlying mortgages aren't backed by the security of the home but are subject to being rewritten at will by life-tenured federal appointees who may never have had a business course in their lives? Who will end up holding the bag?

If the answer is that lenders and those who buy mortgages from them will be holding the bag, you can expect the thirty-year fixed rate mortgage to become as uncommon in the U.S. as it is elsewhere in the world. Instead of helping people to own homes, we will price home mortgages so as to prevent home ownership. Instead of enabling people to build equity in homes by offering cheap credit for home owners, we will encourage lenders to price all loans with a skeptical view of borrowers' prospects -- and an even less encouraging view of the value of the collateral.

Maybe, somewhere, a conservative curmudgeon will argue that home ownership is for a privileged few and that some people are just not meant to be home owners because their character and thrift makes them unsuited to creditworthiness. I can see this kind of person eager to make lending scarcer. The people who are arguing that we should rewrite the obligations owed to secured creditors are hoping to make life easier for borrowers, not to limit borrowers to an elite class of Americans.

The solution the government might consider is as ancient as the hills: assignment. If the government wants to prevent a foreclosure, it can buy the offending note from the lender and assume the lender's rights -- security and all. The government can then negotiate as it likes, without harming the market for the notes, and without threatening to take property from its owners. Anything the government can agree with the homeowners -- changed equity, changed interest rates, lender equity participation, you name it -- becomes fair game.

Throwing secured creditors to the wolves will just make it more difficult for people who want to own homes to fulfill their dream.