Among the many provisions of the Senate Finance Committee’s stimulus package is a legislative proposal to allow states to issue as much as $10 billion in new “mortgage bonds” to raise money to refinance the mortgage loans of troubled borrowers.
States are already permitted limited use of such tax exempt bonds to provide new mortgages to moderate income buyers, but this plan would expand the privilege to refinancings. Because the interest earned on these bonds would be exempt from federal taxes, they involve a significant federal taxpayer subsidy to investors, and would also encourage state governments to get more deeply involved in the banking and finance business in competition with beleaguered private sector lenders. This is a costly and counterproductive provision, and efforts instead should focus on negotiated solutions between borrowers in lenders in ways that do not raise the tax burden.
Importantly, this provision is likely to soon be joined by an even worse and more costly provision being considered by the Senate Banking Committee. Under its tentative plan, the federal government would create a new financial institution to buy troubled mortgages from private lenders, and write down some portion of the debt to reduce the monthly payment. The bonds issued by this new institution to fund the mortgage purchases, would have the full faith and credit of the federal government, thereby exposing the federal tax payer to potential loan losses. To date, the massive losses in the subprime collapse have been born by the private sector, but this provision would shift that burden to taxpayers.