In last night’s debate, John McCain proposed that Treasury purchase defaulted mortgages, thereby providing relief to distressed homeowners.
“As president of the United States,” Mr. McCain said, “I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished value of those homes and let people make those, be able to make those payments and stay in their homes. Is it expensive? Yes.”
How? He didn’t say. But he’d have to overcome a mountain of contractual and legal obstacles in the “toxic” securities (bonds) that these defaulted mortgages were supposed to back (pay for).
Georgetown Law Professor Adam Levitin has done a good job of explaining why simply purchasing the bonds themselves will provide little relief to homeowners: Unless the government purchases a controlling amount and number of bonds–meaning lots of bonds–it will lack the voting power, among other things, to cause any changes to the underlying mortgages.
It is possible the government could do this already under the Paulson bailout plan. in theory, it could also purchase individual mortgages from the trusts that currently hold them (which, in turn, issued the mortgage-backed securities that are said to be “toxic”).
But I am not sure the trustees of the trusts that now own these mortgages have, or want, the power to pick and choose which mortgages to sell to the government. Nor is it clear that the servicing companies that really manage the mortgages have the power–or the incentive–to facilitate these sales. There is some evidence that it is easier (and perhaps more lucrative) for them to foreclose than renegotiate the mortgage.
The real solution, as many bankruptcy hands have been arguing for years, is amending the Bankruptcy Code to permit bankruptcy judges to modify existing mortgages, bringing them in line with the fair value of the underlying property.
Until recently, banking and financial interest groups (and most Republicans) vehemently opposed this as a bailout of profligate borrowers. Banks would stop lending if Congress made this change, and all commerce as we know it would come to an end.
Now that the banks stand to receive in excess of $1 trillion in federal largesse (and commerce as we know it is coming to an end, anyway), I am not sure where they are on this. I have been informed that the Commercial Law League–not exactly a lobbying organization for profligate borrowers–has come out in support of these changes.
In the meantime, I look forward to learning how the Maverick plans to rewrite millions of pages of bond indentures.