Project Lifeline: Collaboration or Intimidation?
By Alex Epstein (Riverside Business Press, March 10, 2008)
Since the subprime meltdown began, the Bush administration has pledged to act to prevent foreclosures--but without interfering in the market or bailing anyone out. How is this possible? The administration's answer: by "facilitating" what it calls "private" initiatives to prevent foreclosures. In December the administration announced, in conjunction with mortgage industry leaders, HOPE NOW--a "private sector effort" to give hundreds of thousands of subprime borrowers a free, five-year extension on low introductory teaser rates. Now, the administration has announced Project Lifeline, under which participating servicers (those who collect loan payments for mortgage investors) will offer a 30-day pause in the foreclosure process to borrowers whose mortgage payments are 90 or more days overdue.
The leader of these initiatives, Treasury Secretary Hank Paulson, repeats endlessly that these are "private" initiatives adopted because they are in "everyone's interest"--not government-mandated schemes. But if that is truly the case, why is the government involved at all? What does it bring to the table that the market can't?
Paulson says government is necessary because servicers face an "unprecedented volume of resets that cannot be addressed through individual, loan-by-loan negotiations." It requires, he says, a "streamlined" approach "facilitated" by Washington.
But why? Grant for a moment the dubious premise that the entire mortgage and finance industries can't do one or two million loan-by-loan negotiations (the anticipated volume of potential subprime foreclosures)--even though they process millions of new loan applications a year, and even though individualized processing, by optimally assessing each case, could potentially save $10s of billions. If large-scale "streamlining" is truly necessary to protect investor interests, servicers and investors are perfectly capable of "streamlining" different classes of borrowers as they judge best.
So the question remains: What is the government bringing to the table? Is it as simple as: it came up with an ingenious financial plan? Hardly. Consider the rate freeze, which offers five extra years of low rates to practically any subprime borrower with bad credit (a FICO score of less than 660) and little-to-no equity in his home (less than 3 percent) who bought during the height of the housing boom. Paulson claims this makes sense "because we all know it is in everyone's interest--homeowner, servicer, investor . . . to avoid foreclosures that are preventable." Not true.
There are many cases in which it is investors' interest to foreclose, because the cost of foreclosure is lower than the hit taken on a rate freeze. For instance, it might make sense to foreclose if a borrower shows no prospect of being able to pay his regular rates five years down the line. It might make sense if the borrower's teaser rate is so low (say, 1 percent) that an extension would mean huge losses. It might make sense not to freeze a rate but to negotiate a compromise between the teaser rate and the reset rate. What is certain is that it does not make sense to follow Paulson's cookie-cutter approach, which would lead to billions in unnecessary investor losses--a "private sector" bailout of borrowers that would actually break servicers' contractual obligation to serve the financial interests of investors.
And yet over 90 percent of servicers are in HOPE NOW. Why? Because of the real attribute the government brings to the table in "collaborations"--not mortgage-handling capabilities or financial ingenuity, but the power to coerce and intimidate.
If an ordinary citizen proposed to the mortgage industry that it bail out borrowers through a widespread rate freeze and call it a "private sector effort," the proposal would be dismissed as a joke. But when the government proposes such an initiative to private industry, all participants know that it can do great damage to them if they refuse--and can grant them huge favors if they comply. Today's HOPE NOW and Project Lifeline participants, for instance, can be harmed by the passage of "anti-predatory-lending" laws, which would expose them to huge lawsuits by borrowers who claim to have been in the dark about the contracts they signed. These participants can also be helped with unearned handouts--with cheap Fed money, with Fannie Mae and Freddie Mac taking risky mortgages off their hands, and with a bailout in the future if, say, they face bankruptcy because of sloppy lending practices.
With all these sticks and carrots on the line, is it any wonder that the mortgage industry has walked in lockstep with whatever the administration proposes? It is impossible to know exactly what combination of winking assurances and veiled threats brought so much of the finance and mortgage industry into these "collaborations." What we can know is that nothing resembling economic freedom and respect for property rights is occurring--just coercion, bailouts, and the abridgement of contracts.
What today's market desperately needs is for lenders and borrowers to bear the full consequences of their own bad decisions, and for the government to stop manipulating the market, violating property rights, and inviting future disasters. It is time to stop letting the Bush administration pretend it can have government-dictated economic policy and a free market, too.
Alex Epstein was a writer and a fellow on staff
at ARI between 2004 and 2011.