The Politics and Policy of McCain's New Mortgage Proposal

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If your proposal for a new, $300 billion government program falls in the middle of a presidential debate and no one cares to hear it, does it make a sound?

John McCain sure hopes so. 

Although most observers ignored the moment in their post-Nashville analyses--Stumper included--John McCain did, in fact, make some substantive news last night, announcing that as president he would "order the Secretary of the Treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the... diminished value of those homes." After weeks of faltering on economic issues--and watching his poll numbers plummet as a result--McCain is clearly hoping that his dramatic plan to bail out struggling homeowners will help him reconnect with the all-important middle class.

At the time, however, few analysts knew what to make of McCain's revelation. For starters, last week's $700 billion bailout bill had already given the Treasury Secretary the authority to buy the mortgages of homeowners in financial trouble and replace them with more affordable loans--a move that Barack Obama recommended at a news conference in early October. So it didn't seem especially novel. Second, McCain didn't provide much in the way of specifics on stage at Belmont. "Is it expensive? Yes," he said. "But we all know, my friends, until we stabilize home values in America, we're never going to start turning around and creating jobs and fixing our economy." A nice sentiment, sure. But not exactly the sort of entree that experts could sink their teeth into. 

Thankfully, McCain policy guru Douglas Holtz-Eakin elaborated on the American Homeownership Resurgence Plan during a conference call this morning with reporters--revealing, for example, that the proposal would cost taxpayers about $300 billion. (Team McCain hopes that by purchasing mortgages directly, the government "wouldn't have to buy as many distressed assets from big banks, thus reducing the net cost.") Overall, Holtz-Eakin made it clear that McCain's plan is both more aggressive and more expensive than the similar provisions set forth by Congress and Obama. With everything out in the open, then, only one question remains: Will McCain's newer, bolder proposal work--either as policy or politics?

I'm no economics experts, but here's my best attempt at an answer.

In terms of policy, McCain's plan represents the most direct attempt to date to rescue struggling homeowners, lower skyrocketing interest rates, stabilize the unsteady housing market and solidify home values.

Still, he seems to be on shaky ground for at least three reasons. One concern is redundancy. As the National Review's conservative columnist Stephen Spruiell notes, "Congress just enact[ed] major legislation"--the Housing and Economic Recovery Act of 2008--that "created a federal mortgage-insurance program for lenders who agree to reduce mortgage payments for struggling borrowers." McCain's plan, of course, is different; while the government currently guarantees your mortgage if your lender agrees to work out a deal with you, McCain would order the Treasury Secretary to buy your mortgage from whoever owns it and then deal with you directly--becoming, in effect, your loan servicer. The problem with this, Spruiell explains, is that it "would pose enormous logistical challenges" and "create significant new responsibilities (and costs) for an already-beleaguered agency"--without necessarily producing better results than the current federal mortgage program.

Another policy problem relates to what economists call "moral hazard"--that is, the idea that "wrongheaded risky behavior that goes unpunished begets even more wrongheaded risky behavior." As Politico's Victoria McGrane has reported, the landmark housing bill that passed Congress on July 31 made sure that neither lenders nor borrowers got off scot-free. To participate in the $300 billion program designed to help distressed borrowers refinance into cheaper Federal Housing Authority mortgages, for example, "lenders and mortgage investors would have to reduce the mortgage principal, thus taking a loss on the loan" and protecting taxpayers from paying for an overpriced property. Meanwhile, homeowners would be required to "share any future profits from the resale of their homes with the government." Both parties, in other words, would be punished for making bad business decisions. McCain's plan, meanwhile, would require Treasury to purchase the mortgages and then write down the principal--without any price reduction.

The point of this is to get more lenders involved: under the current FHA plan, lenders must voluntarily agree to forgive the rest of the debt for borrowers who have no equity, but many have resisted, leaving homeowners who owe more than their homes are worth to fend for themselves. Unfortunately, McCain's plan would require taxpayers, through the FHA, to "directly pick up the tab for the difference in cost between a homeowner’s old, too-expensive mortgage and the cheaper one provided by the government"--a move that means (as the Atlantic's Marc Ambinder puts it) "a loss upfront to taxpayers and more default risk" if house prices continues to decline.

Finally, as the Associated Press reports, "the vast majority of the toxic home loans that are clogging financial markets and freezing up credit have been sliced, diced and repackaged into complex investments that the government would be hard-pressed to unravel and buy." 

Fortunately, the politics of McCain's proposal are slightly less complicated. There are two difficulties to consider. First, by proposing a massive new government bureaucracy that's more Lyndon B. Johnson than Ronald Reagan, McCain not only risks enraging fiscal conservatives but exposing himself to charges of hypocritical pandering--and, even worse, erraticness. Earlier this year, McCain questioned whether federal money should be spent to help homeowners, and it's hard to reconcile an (arguably redundant) $300 billion federal program with the Arizona senator's frequent attacks on excessive government spending. Predictably, the Obama campaign has seized on the announcement as yet another opportunity to portray McCain as (you guessed it) recklessly impulsive. "Erratic policy-making at its worst," said Obama economic-policy director Jason Furman this afternoon.

Second, the fact that the McCain plan would force taxpayers to shoulder an even greater initial burden--even if troubled homeowners would receive additional financial assistance on the back end--allows Democrats to stoke the sort of populist resentment that made the overall bailout bill unpopular in the polls. As Furman put it today, "McCain’s plan [is] to overpay for bad mortgages by handing taxpayer dollars over to big financial institutions." Phrased that way, it's hard to see how anyone would support the proposal.

That said, none of this will matter if McCain can convince struggling middle-class swing voters that he--and only he--has been willing to take bold action to increase their economic security. "It's my proposal," he said last night in Nashville. "It's not Sen. Obama's proposal. It's not President Bush's proposal." He's right; neither Obama nor Bush has floated a plan designed to directly help homeowners. As Ambinder notes, this is "a real opportunity for [McCain] to get economically anxious voters to associate something positive with his candidacy." We'll see soon enough whether he seizes the opening--or simply reverts to guilt-by-association mudslinging. The American Homeownership Resurgence Plan is unlikely to vault McCain back into contention--to become, in other words, the McCain Campaign Resurgence Plan. But its injection into the race could kick off a serious--and long-delayed--conversation between the candidates about how best to steer the nation out of dire economic straights. And that, at least, would be better than nothing.