Monday, September 22, 2008

Cognitive Dissonance in Congress on the Proposed Bailout

Some in Congress are demanding that any Treasury plan to buy up hundreds of billions in distressed mortgages at a discount include provisions to protect homeowners against foreclosure. One question raised by these demands is to what extent these provisions will interfere with the government's ability to recoup its investment in the mortgages. As the owner of the loans, it will be in the government's interest to modify non-performing loans by writing them down so home owners will be more inclined to start paying them again1. Obviously, this is preferable from the government's perspective to the costly foreclosure process, but if the delinquent mortgage borrower doesn't have to fear foreclosure, what will be his incentive to start making payments on even a modified loan? I haven't heard anyone address this potential conflict yet. Congress can make a show of advocating for the tax payer here or advocating for the delinquent borrowers, but it's hard to see how it can effectively advocate for both at the same time.

1Presumably, the government will buy the mortgages at a significant enough discount to still make a profit on the modified loans, e.g., if it buys a pool of mortgages at, say, 40 cents on the dollar, and writes them down to an average of 70-80 cents on the dollar.

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