McCain's original plan called for lenders to write down the value of these mortgages and take those losses. But the Republican presidential candidate unveiled a new $300 billion plan in response to the first question of the debate.
He said, "I would order the Secretary of Treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes, at the diminished values of those homes, and let people make those - be able to make those payments and stay in their homes."
The government would convert failing mortgages into low-interest, FHA-insured loans.
"Millions of borrowers" would be eligible for the program, dubbed the American Homeownership Resurgence Plan, according to McCain economic advisor Doug Holtz-Eakin.
To qualify, homeowners would have to be delinquent in their payments already, or be likely to fall behind in the near future. They would have to live in the home in question - no investment properties would be eligible - and have had demonstrated their credit-worthiness when they purchased the property by making a substantial down payment and by providing documentation of their income and assets - no liar loans.
Holtz-Eakin said on a conference call Wednesday that the McCain plan could be put into place quickly because the groundwork and the authority for it has already been provided by last week's $700 billion bailout bill, the Hope for Homeowners program authorized by the housing rescue bill passed in July and the government takeover of mortgage giants Fannie Mae and Freddie Mac.
A change of heartThis proposal is strikingly different from both McCain's original idea, and from the housing rescue bill adopted by Congress in July.
Congress struggled for months to pass the Hope for Homeowners rescue plan for mortgage borrowers - a bill that neither McCain nor Democratic candidate Senator Barack Obama voted on. To make it palatable to both conservative Republicans and ordinary taxpayers, Hope for Homeowners requires that lenders write down mortgage balances to 90% of a home's current market value to qualify for a FHA-insured refinancing. The lenders would then take the loss on the difference between the current value and the mortgage balance.
"[McCain's] original plan relied on lenders taking the hit," said Holtz-Eakin. "This bypasses that step."
Instead, taxpayers pay for it, with the funding already provided by the $700 billion bailout bill.
That could prove to be very unpopular with homeowners who aren't in trouble, as well as ordinary Americans who objected to the Hope for Homeowners plan as a bailout for delinquent borrowers and irresponsible lenders.
The Obama campaign issued its response to the plan Wednesday afternoon.
"Last night . . . [Senator McCain] threw out a proposal that appeared to give the Treasury authority it already has to re-structure troubled mortgages. But now that he's finally released the details of his plan, it turns out it's even more costly and out-of-touch than we ever imagined," said the statement. "John McCain wants the government to massively overpay for mortgages in a plan that would guarantee taxpayers lose money, and put them at risk of losing even more if home values don't recover."
The statement claimed the biggest beneficiaries would be the "same financial institutions that got us into this mess, some of whom even committed fraud."
"Since this beginning of this crisis, Barack Obama has demanded that any rescue plan must protect taxpayers and ensure that they share in any profit once the economy recovers, and he worked to include that principle in the plan that passed Congress," said Obama's economic policy director Jason Furman.
Parsing the detailsSome Washington analysts were perplexed by the McCain proposal.
"The proposal is hard to understand," said Dean Baker, co-director of the Center for Economic and Policy Research in Washington. For one thing, Baker pointed out, it provides even less help for targeted borrowers than the Hope for Homeowners program does. In that plan, lenders must lower mortgage balances down to 90% of the home's current value, while McCain's plan will reduce loans to 100% of a home's current value.
And, of course, under McCain, the cost of the write-down is picked up by taxpayers rather than by the lenders. That is a radical departure from McCain's earlier responses to the housing crisis.
"We have a very different set of risks facing the nation now, including the crisis in financial markets," said Holtz-Eakin, "and it calls for a much more aggressive response."
The plan is supported by Lawrence Yun, chief economist for the National Association of Realtors, who says it could help stabilize housing markets.
"It's certainly a positive for the foreclosure problem," he said, "although it was already embedded in the Treasury's bailout plan."
Indeed, the bailout passed last week authorizes the Treasury to buy up as much as $700 billion in mortgage backed securities - but the bill also authorizes Treasury to buy mortgages directly.
Christopher Mayer, Paul Milstein Professor of Real Estate at Columbia Business School, isn't convinced that the McCain proposal makes sense.
"As the plan stands now, it helps the people who got into the most debt, and it helps the lenders, but it doesn't really help the housing market," he said.
To help the market as a whole, according to Mayer, a plan has to target all mortgage borrowers rather than just at-risk homeowners. In an op-ed piece in the Oct. 2 Wall Street Journal, he and his Columbia colleague, R. Glenn Hubbard, he proposed that the government allow all residential mortgages to be refinanced into 30-year, fixed rate loans at 5.25% interest.
That would bring down payments for everyone, not just the borrowers most at risk, which would in turn help prop up house prices by lowering the monthly cost of homeownership. Many more people would benefit.
"A rescue has to be broad enough to help a great many Americans," he said, "not just the ones that took on the most debt."
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