I'm not a fan of the big mortgage bailout that is being cooked up by the White House's Hank Paulson. I feel terrible for the people who overextended themselves. Debt is a dangerous animal and I saw the negative effects a few times at my last job, making loans to startups. But the vast majority of these people knew what they were doing. They were stretching to get into a house they wanted. Again, I feel bad for those folks but sometimes you lose those bets and have to do the best you can after.
I think freezing loan payments and interest rates, like Paulson and Hilary Clinton want to do, is very anti-capitalistic and will do a lot of harm to the banking systems. At the very least, we are creating a monumental moral hazard and the expectation that people should be bailed out of mistakes.
Also, freezing all of these instruments is going to crush the value of the bonds that these mortgages feed into. Yes, people who hold the bonds will lose a lot of money (as the cash flows get pushed out the net present value of the payments is reduced) but it also keeps the market from clearing. Earlier in the week, Citadel, a very powerful hedge fund, bought the mortgage portfolio of e-Trade for about 25 cents on the dollar. Therefore, the rest of the financial system could work off an approximate asset value for other mortgage bonds. Now that the picture is getting cloudy again, uncertainty will return and the capital markets will be tied up trying to figure out what will happen. That just slows down the healing process.
It's a really sad state that we are in, but we should try to protect against future moral hazards so this doesn't happen again and think more creatively about how to help the people who overreached...
