Morning Bell: Steps to Halt Future Bailouts

Conn Carroll /

The Pew Charitable Trusts released a study yesterday surveying state action on the recent wave of increased foreclosures. Pew senior officer Tobi Walker told the Washington Post: “The states are experiencing this pain more directly than the federal government is.” This is partly true. A more accurate statement would be some states are feeling the pain more directly than the federal government is. As this map of Mortgage Bankers Associaiton data shows, subprime foreclosure rates exceed 10% in only 13 states, including California, Nevada, Florida, Ohio and Michigan.

The Post goes on to report that “in some ways, states and cities are better positioned to tackle the fallout than the federal government.” This is undoubtedly true. The subprime foreclosures in Nevada, California and Florida are largely due to a speculative bubble that has just popped, while foreclosures in Ohio and Michigan are the result of more fundamental weaknesses in those state economies. The different causes behind these problems call for local solutions, not one-size-fits-all federal action.

For example, the New York Times reports that efforts by Ohio to work with nonprofits and loan servicers to modify troubled loans have led to results “visible on the ground.” Coalition on Homelessness and Housing in Ohio executive director Bill Faith told the Times: “Up through the end of 2007, counselors and homeowners said, ‘We call these companies and we get the runaround, we can’t get through the maze.’ We weren’t seeing any significant modifications. That’s beginning to change. When I talk to the nonprofits, they say they’ve had as many loan modifications in the first quarter of 2008 as in all of 2007.”

Despite the success of voluntary programs at both the state and federal level, enough momentum still exists on Capitol Hill for new federal legislation. For principled conservatives, the best way to protect the American taxpayer now is to push for amendments that will limit the risk that this latest federal bailout will not encourage future risky behavior. Ways to improve the current housing package winding its way through Congress include:

  1. Any losses to the taxpayer from a refinanced loan cannot be forgiven in bankruptcy. This is a strong and necessary incentive to ensure borrowers do not walk away from FHA-insured refinanced loans.
  2. All refinanced loans must require some down payment by the homeowner. The loans currently defaulting at the highest rates are those that had no down payment. The FHA should not be taking on these risky borrowers at a time when the agency is already on the brink of insolvency.
  3. No mortgage where the borrower made a material misstatement on the application should be eligible for refinancing. As much as 70% of recent early payment defaults had fraudulent misrepresentations on their original loan applications, according to one recent study. The federal government must not be in the business of abetting fraud.
  4. No 100% federal guarantees. This both ensures that mortgage owners are honest about the quality of the loans and keeps lenders from escaping all liability.
  5. Houses with second mortgages will not be eligible for refinancing. Refinancing should not be available to borrowers who have acted irresponsibly and gotten into trouble as a result.
  6. Limit FHA refinancing to principal residence only. Any federally insured mortgage should only be available for homes that the owner actually lives in for all or most of the year. Under no circumstances should refinancing assistance be available to vacation homes or investment property.

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