Bailing out the American economy: Banks vs. mortgage-Holders
In 2008, the United States teetered on the brink of an economic crisis. If the United States were to suffer a financial meltdown, the global economy could spiral downward in a manner unprecedented since the Great Depression. The crisis had begun in the U.S. subprime mortgage market but had rapidly spread to other sectors of the economy. The remedy of the U.S. government was the creation of the TARP (Troubled Asset Relief Fund) ("Troubled Asset Relief," Investopedia, 2012). Almost every major banking institution, deemed in the infamous phrase 'too big to fail' was given some form of relief. However, homeowners who were behind on their mortgages were angry that they received relatively little support from the government even though they perceived themselves as far less culpable than the banks. Even the plan proposed by Jeffrey Fuhrer (Foote et al. 2009) on the Federal Reserve Bank of Boston website ascribed more moral censure to certain homeowners than others affected by the crisis. No such differentiation was made regarding the banks. The TARP did not subject banks to the consequences of their moral hazard; the proposed Boston plan created a contrast between worthy and unworthy homeowners unlike the TARP which extended relief to all banks; banks were given additional, continuing assistance under the TARP unlike homeowners even after they recovered; the government did not acquire homeowner's toxic assets under the Fuhrer plan while it did acquire the banks' toxic assets; the government made it easier for banks rather than homeowners to obtain future loans and banks were not subjected to additional market regulations.
"The TARP gives the U.S. Treasury purchasing power of $700 billion to buy up mortgage backed securities (MBS) from institutions across the country, in an attempt to create liquidity and un-seize the money markets" (Troubled Asset Relief Fund) ("Troubled Asset Relief," Investopedia, 2012). By some estimates, the TARP was a resounding success. The U.S. economy, despite its slow job growth, is no longer in the peril it was pre-TARP. Credit is now accessible for homeowners and others seeking to obtain loans and the day-to-day transactions of microcredit lending that fuel the economy are once again functional. Of course, not everyone is pleased with the banks' success. They feel that the 'moral hazard' on which the economy depends, or the idea that one must reap what one sows is thwarted by the sense that government bailouts will buffet banks from potential crises. This argument suggests that the financial industry will continue to take great, unsupportable risks, if it is not allowed to suffer the consequences of its actions. "As a bank bailout, TARP was if anything too successful. The banks were largely responsible for causing the global financial crisis which left millions of people kicked out of their homes, laid off from their jobs, or both. But then, with the TARP bailout, they rapidly bounced back; the bankers who remain -- and that's most of them -- are now anticipating bonus checks to rival what they were receiving at the height of the credit bubble. The little guy was hurt hard; the fat-cat bankers are smiling, unremorseful, and back to their old ways already" (Solomon 2010). In the words of Alan Blinder, a Princeton University economist: "The TARP spread a security blanket, tamping down risk spreads, and so in that sense it was successful. But it didn't prevent a wave of foreclosures, didn't result in the promised buying-up of toxic assets" and left the mortgage market in many areas of the country in profound distress ("How effective was the TARP," The Economist, 2010).
To help some of the innocent victims of the mortgage crisis, a policy proposal was advanced by Jeffrey Fuhrer and his colleagues (Foote et al. 2009) on the Federal Reserve Bank of Boston website to provide greater relief to homeowners. While some homebuyers were criticized for attempting to capitalize upon the housing bubble by 'flipping' houses, this proposal would help individuals in their principal residences "afford mortgage payments...because they have suffered a significant income disruption and because the balance owed on their mortgage exceeds the value of their home. These homeowners represent a subset of the population of distressed homeowners, but according to our research they face an elevated risk of default and are unlikely to be helped by current foreclosure-reduction programs" (Foote 2009:1). The stress upon principal residences in the language of the plan underlines its 'moral' character -- these were not, the plan stresses, people who took on more than they could afford, but who were negatively affected by the crisis in a market that had gone out of control. Had there been no crisis, they would not be 'underwater' on their mortgage. Unlike the banks, these individuals are not 'too big to fail' and thus the concept of moral hazard is still operational regarding home owners.
The plan would reduce the monthly payment of homeowners by 25% or more, as the government paid a significant share of the mortgage payment to the bank (Foote et al. 2009: 5). The principal owed would not be affected, merely the borrower's monthly payments. The borrower would also have to present evidence of significant negative event that had disrupted his or her ability to pay like a job loss and negative equity in the home (and by 'significant,' this would be an income loss of 25% or more) (Foote et al. 2009:5). Unlike the provisions of the TARP for the banks, no 'toxic assets' would be acquired by the government. The borrower would continue to hold all responsibility for the home. Two suggestions were made for implementation: "In one version, the assistance comes in the form of a government loan, which must be repaid when the borrower returns to financial health. The second version features government grants that do not have to be repaid. In either case, the homeowner must provide evidence of negative equity in the home and of job loss or other significant income disruption" (Foote et al. 2009: 2). Once the borrower's income stream resumed, he or she could resume payments to the bank (Foote et al. 2009: 10).
The demand for a significant life event disrupting the life of the borrower once again underlines the perceived need for a moral hazard to determine who is deserving of aid. One of the great criticisms of the housing bubble was that people with little or no stable income were granted mortgages for homes they could ill-afford. These subprime loans were tied to adjustable rate mortgages. Once the mortgage payments began to increase dramatically, these borrowers could not make their monthly payments. The Federal Reserve Bank of Boston program, in contrast is intended to help borrowers who could pay their mortgage and were faithfully doing so until a job loss or the economy's souring affected them. In other words, they were trying to do the 'moral' thing but were unable to do so because of historical circumstances.
In terms of the TARP's efficacy, one of the greatest criticisms leveled against the program was its inability to help homeowners, versus the banks that had constructed the 'toxic assets in the first place. The independent Congressional Oversight Panel faulted the TARP for its "failure to articulate clear goals or to provide specific measures of success for the program as it has morphed over time from rescuing financial institutions to propping up securitization markets, auto manufacturers and home mortgages in danger of default. The panel also described the program's foreclosure mitigation efforts as inadequate" (Calmes 2009). However, overall it found the program to be effective in achieving its objectives of stabilizing the economy, even though it could hardly be pronounced as 'fair' in terms of the lack of penalties it imposed upon the banks that had precipitated the crisis.
Once the banks in the program received funds and began to stabilize their revenues, many were equally eager to leave its confines. "The TARP money comes with a lot of strings attached. Although the government said it won't cap salaries, firms receiving bailout money are likely to be subject to limits on bonuses...Plus, the TARP funds are expensive. Banks pay a hefty dividend to their government shareholders since the bailout funds come in the form of preferred debt. It's among the most costly ways to finance their operations" (Carter 2009). The large bonuses and competition that were such an integral part of Wall Street were not permitted by banks receiving TARP funds.
The proposed Federal Reserve Bank of Boston plan was not clear if homeowners were required to pay back the government's assistance in the form of a loan. However, unlike the banks under the TARP, once the homeowners remained solvent they would be required to leave the program and would receive no further assistance. The banks, in contrast, even after repaying TARP money would still be part of preferred government programs. "Banks are aggressively issuing debt guaranteed by the Federal Deposit Insurance Corp., the banking regulator. Since late last year, banks have…