There's one big group of Americans who still haven't received much of a bailout from Washington—homeowners. Now, there's a growing chance the Obama administration may finally do something to help the little guy directly.
Up till now, bailout theory has hinged on helping banks, corporations, and other big institutions, which would then—supposedly—pass the largesse on to consumers through low interest rates, generous lending standards and bounteous hiring. That's why Washington offered trillions of dollars in bailout funds, loans, and guarantees to many of the biggest companies in the world. There was the controversial TARP program, which injected money into banks to shore them up during the 2008 financial crisis. The Federal Reserve has done even more, with a variety of "lending facilities" that provided cheap loans to barons of capitalism such as Citibank, Bank of America, Morgan Stanley, Goldman Sachs, and even several foreign banks. The Fed has also pushed interest rates to record lows, to reduce borrowing costs for everybody and help compensate for a sharp drop in household wealth.
That extraordinary amount of aid has clearly helped U.S. banks—which might still be battling insolvency fears if not for Washington's help—and big corporations, which are remarkably healthy and have been loading up on cash. But it has not trickled through to ordinary Americans the way policymakers hoped, and that is one of the biggest reasons the economy is still gasping for air.
One simple set of numbers helps explain the problem. When the recession began at the end of 2007, the prime interest rate was 7.25 percent. Today it's 3.25 percent. The prime rate is the rate at which the most credit-worthy borrowers—usually big companies—can get loans. Most big borrowers don't get the prime rate, but they do get a rate that's directly tied to prime. So as the Fed has forced rates down, institutional borrowers have directly benefited, with overall borrowing costs about four points lower than they were before the recession began.
Homeowners haven't enjoyed nearly that much relief. The Fed's policies and a variety of other factors have also pushed mortgage rates to historic lows of about 4.6 percent. But few homeowners actually get that rate, because many don't qualify for the lowest rates and some can't get loans at all. The Fed wants to put extra cash in people's pockets by allowing them to refinance their mortgages at rock-bottom rates and lower their monthly payments. But there's a big problem with that: Many homeowners can't refinance. Thanks to the huge drop in home values, nearly 11 million homeowners owe more on their home than it's worth, according to research firm CoreLogic. That's more than 20 percent of all homeowners, a huge proportion. Others can't refinance because they've lost jobs or income and banks won't take a chance on them.
Those problems are reflected in the effective mortgage rate, which is the average rate that all mortgage holders are paying. Before the recession, the effective mortgage rate was about 6.4 percent, according to investing firm Jefferies. Today, it's about 5.2 percent. So while borrowing costs for big companies have fallen by about four percentage points—a huge savings—they've only fallen by about 1.2 points for homeowners, on average. And those savings are skewed toward new buyers able to get loans, along with those who have enough equity and income to refinance. For millions of other homeowners, lower rates have generated no savings at all.
That's one of the reasons the housing bust is now in its fifth year, with the end not yet in sight. The unending woes in the housing sector compound problems elsewhere, since they depress construction, eviscerate household wealth and cut sharply into consumer spending. "This is the single biggest issue for the U.S. economy," says David Zervos, a managing director at Jefferies. "If something gets done to fix it, it would be a game changer."
There have been sporadic attempts to offer more relief to beleaguered homeowners over the last few years, dating to the Bush administration in 2008. But those efforts have turned out to be feeble. As the Wall Street Journal pointed out recently, government programs have only helped modify about 760,000 mortgages, far short of the several million modifications deemed necessary to make a difference. For the most part, the government's mortgage help involves incentives meant to coax banks holding mortgages to do "voluntary" refis. That doesn't even apply to the majority of mortgages that have been carved up and packaged into securities, since in those cases there's no single holder of the mortgage. And up to half of all modifications merely delay a default anyway, offering no real help to homeowners.
The Obama administration may now be poised offer homeowners the kind of aid that banks and big corporations have gotten. The New York Times reports that the White House is considering new plans to back refinancing for millions of homeowners who are stuck paying rates far above today's averages. The idea is controversial, for good reason. Government-backed refis would effectively reward some borrowers who foolishly took out loans they couldn't afford, or who banked on the fantasy that the housing bubble would continue unabated forever. A big government refi plan could also lower the values on existing mortgage-backed securities, a big class of assets held by many investors. Economists also warn of the "moral hazard" that would ensue from bailing out homeowners who never should have bought in the first place.
Those concerns are legitimate—but they also applied to the trillions of dollars in bailouts that corporate America enjoyed. The bank bailouts papered over vast amounts of losses and absolved practically the whole Wall Street firmament of its sins. Investors who might lose a few bucks on mortgage-backed securities have also gained mightily thanks to policies that prevented a financial wipeout and helped pull stocks off the bottom in 2009. Moral hazard remains alive and well on Wall Street. Meanwhile, companies that benefited from government bailouts have largely kept the spoils to themselves.
Besides, the private-sector hasn't provided nearly the lift that many economists thought would be boosting the housing market and the overall economy by now. Tepid hiring has left unemployment sky-high, with many jobless homeowners simply running out of money to pay their mortgages. Some of the very banks that got big bailouts are the ones with dubious foreclosure procedures. The economy is now getting weaker, not stronger, and with the 2012 presidential campaign underway, the pressure is on politicians to do something voters can take to the bank.
So the case for a meaty homeowner bailout package is growing stronger. There's also a way the Obama administration could phase in a mortgage relief program with no cost to the government, which means it wouldn't require Congressional approval and therefore could avert a another political mudfight like the recent debt ceiling fiasco. Under a proposal by three faculty members at Columbia Business School, for example, the government would use housing agencies Fannie Mae and Freddie Mac to back refinancings for as many as 37 million families, many of whom would be able to lock in rates of four percent or lower. The government would back the mortgages, and set qualifying standards meant to minimize defaults and losses. If done right, no taxpayer money would be involved, which would be similar to the short-term loans and guarantees offered by the Fed in 2008 and 2009 that helped keep the banking sector afloat. The authors of the proposal say it would save homeowners about $75 billion per year, at no cost to the government.
There are plenty of risks. Such a huge plan might push up rates for future borrowers who don't need help from the government and wouldn't qualify for subsidies anyway. The feds would have to take other steps to minimize private-sector losses on mortgage-backed securities and assure investors that they're not aiming to steal from the rich and give to the poor. Selling such a plan as a win-win for Wall Street and Main Street alike would require deft political leadership. And all of that market manipulation would give the government even more control of the housing market, at a time when many Americans feel the government is too involved in their lives already.
But if it worked, it might end up as a tangible example of the government doing something to help the little guy, while pushing aside the concerns of Wall Street and corporate America. Many Americans doubt it's possible. President Obama must now decide if it's worth the risk to try to prove otherwise.