The Rescue: How Congress Should Fix the Paulson Plan

F. Block: Fixing the Paulson Plan

George W. Bush, the most ideological “free market” president since Warren Harding, has finally acknowledged today that a massive federal government initiative is necessary to rescue the nation’s—and the world’s—collapsing financial system. The plan is that a government agency would use taxpayer funds to buy up the bad mortgage debt that has wrecked the balance sheets of major financial houses. But Congress must insist that the rescue package provides major relief to homeowners and communities that were the initial victims of the systematic irresponsibility created by the deregulated mortgage-lending markets. Both sound economics and justice require that the final legislation include two key measures—a moratorium on foreclosures and tens of billions of dollars of low interest loans to cities and states so that they might buy and retrofit vacant housing.

The current financial tsunami that has now brought down Bear Stearns, Lehman Brothers, and Merrill Lynch—and which threatens to destroy many other financial institutions—began with the explosion of irresponsible mortgage lending that included a huge expansion of predatory sub-prime loans directed disproportionately at African-American and Latino homeowners. The mortgage-lending boom was like a giant game of musical chairs. The upward movement of housing prices was the music; and as long as prices were rising, it didn’t matter if the homeowner couldn’t pay. The lender could simply foreclose on the house, sell it to somebody else at an even higher price with an even less sustainable loan, and still make a tidy profit. But when the music finally stopped, almost every financial institution in the country was suddenly stuck without a chair to sit on. These firms had huge portfolios of mortgage loans whose value was now uncertain. With falling housing prices, foreclosures only pushed more houses onto the market, driving prices even lower, so that the loan portfolios of financial institutions were turned into toxic sludge that nobody wanted to touch. The federal rescue is like a Superfund project designed to mop up the sludge.

It is essential that the plan include a moratorium on new foreclosures because that is the core underlying problem. There are now literally millions of people whose homes are under water–worth less than the mortgage they are paying. Many of them cannot afford their current payments or are one period of unemployment or one medical crisis away from losing their homes. But at this point, kicking them out of their homes is as counterproductive as letting major financial institutions collapse. More foreclosures simply mean more houses on an oversupplied market and more downward pressure on housing prices. That is the wrong direction; the recovery of both households and financial institutions won’t happen until housing prices stabilize and begin to rise again. That is the key condition for detoxing the hundreds of billions of dollars of sludge.

Once they are deprived of the foreclosure option during the moratorium period, lenders will have to agree on workout plans that allow homeowners to stay in their homes on reasonable payment terms. A halt to foreclosures and fewer vacant homes will stop the bleeding. There will be some homeowners who will game the system during the moratorium and pay nothing, but kicking them out can wait until later—after housing and other markets begin to recover.

But to stop the fall in housing prices, it is also important to deal with the huge backlog of vacant houses that are on the market, currently estimated at something like an eleven-month supply. In addition to those on the market, many hard hit cities have acquired thousands of properties through abandonment, but they have no funds to do anything with those buildings. With a program of low interest loans to state and local governments, they could buy up some of the excess housing and begin a full-scale retrofitting of vacant and abandoned houses. Old housing stock can be made energy efficient through insulation, putting in new windows and appliances, and placing solar panels on the roofs. Funds can also be used to demolish unsalvageable houses that attract criminals and accelerate neighborhood decline

This effort would be a quadruple win. First, it would immediately put people to work and counter rising unemployment. Second, it would start to create the skilled green workforce that we need for the transition away from fossil fuels and which will ultimately require the energy-efficient retrofitting of the entire housing stock. Third, it would help revitalize some of the neighborhoods that have been devastated by predatory lending and have experienced the most dramatic declines in property values. Fourth, and most importantly, it would help to put a floor under declining housing prices and start us towards an environmentally sustainable recovery of the housing sector. Of course, there have to be safeguards to make sure the loan funds are well spent and that cities and states ultimately repay the funds when the revitalized housing stock is gradually resold. But with such safeguards, this initiative would support the bailout agency’s mission of transforming the toxic sludge back into well-performing loans that are backed by a sound and sustainable housing stock.

Once the bailout measures are in place, we need to face the difficult task of restructuring the financial system so that we don’t endlessly replay, as in Groundhog Day, this script of irresponsible lending followed by government rescues. But the immediate task is to insist that Congress add these key provisions that are essential to solve the immediate housing crisis. The right wingers will insist that we cannot prioritize helping homeowners and neighborhoods when the urgent need is to bail out irresponsible lenders. But it is an argument they cannot win; the public is getting wise to this pattern of privatizing the profits and socializing the costs.

Fred Block is an economic sociologist at the University of California at Davis. Some of his critiques of market fundamentalism are posted at www.longviewinstitute.org. Photo: Ramy Majouji / Wikimedia Commons / Creative Commons.