McCain’s ‘new’ mortgage proposal resembles current law

John McCain, looking to shake up a campaign that has faltered in recent weeks, attempted early on in the second presidential debate to advance a radical new proposal to fix the ongoing mortgage foreclosure crisis:

As president of the United States, Alan, I would order the Secretary of the Treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes — at the diminished value of those homes and let people be able to make those — be able to make those payments and stay in their homes…

I know how to do that, my friends. And it’s my proposal, it’s not Sen. Obama’s proposal, it’s not President Bush’s proposal.

Unfortunately for him, it’s not his proposal either. And not only is it not a new proposal, this radical plan is already the law. It passed in July, a bill called the Housing and Economic Recovery Act of 2008 (HERA). Perhaps McCain didn’t know about it because he wasn’t there to vote on the bill.

Let’s compare that bill to the one McCain is proposing. Here’s how the McCain website explains the proposal:

The McCain resurgence plan would be available to mortgage holders who:

* Live in the home (primary residence only)

* Can prove their creditworthiness at the time of the original loan (no falsifications and provided a down payment).

The new mortgage would be an FHA-guaranteed fixed-rate mortgage at terms manageable for the homeowner. The direct cost of this plan would be roughly $300 billion because the purchase of mortgages would relieve homeowners of “negative equity” in some homes. Funds provided by Congress in recent financial market stabilization bills can be used for this purpose…

And here is how HERA works, according to the Department of Housing and Urban Development website:

Q: How will the law help struggling homeowners keep their homes?

A: Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. The program offers government insurance to lenders who voluntarily reduce mortgages for at-risk homeowners to at least 90% of the property’s current value.

It’s even implemented in exactly the same manner. In a conference call Wednesday morning, McCain adviser Doug Holtz-Eakin explained the proposed process:

“Mechanically, the initiative is very simple. A homeowner would initiate the process by calling a mortgage broker or other originator and basically saying ‘I’d like to refinance my home’ and they would start the underwriting process, verify incomes. This is an opportunity as well to make sure the program has in it appropriate checks to make sure that government money is not being given to folks who are not primary homeowners, who don’t have adequate income or otherwise in the initial purchase of their home didn’t provide valid information. These authorities could then be used to retire the existing loan, the FHA would issue a guaranteed 30-year, fixed-rate mortgage at a manageable interest rate, the homeowner would stay in the home, their financial burden would be relieved, the valuation of the existing loan would be resolved, there would be no longer a threat of default or diminished capacity to repay, that would stabilize financial markets and the taxpayers’ contribution would be, in some cases, the difference between the values of those two loans, something which would be the necessity of the taxpayer contribution.”

And from the HUD’s HERA website:

Q: How can a homeowner access this new program?

A: Homeowners or a servicer of an existing eligible loan need to contact an FHA-approved lender. The FHA-approved lender will determine the size of a loan that a borrower can reasonably repay and that meets the requirements of the program. If the current lender or mortgage holder agrees to write-down the amount of the existing mortgage and make the new loan affordable, the FHA lender will pay off the discounted existing mortgage. Loans provided under this program must be 30-year fixed rate loans.

Even the amount of spending authority given to this program is identical. In fact, Holtz-Eakin said explicitly in the conference call that they intend to use the same $300 billion spending authority that was already given to the FHA for this very purpose:

In the Hope for Homeowners Dodd/Frank legislation there was $300 billion in authority for refinancing given to to the FHA. That would certainly play in this.

Asked about the difference between the already existing legislation and McCain’s proposal, Holtz-Eakin said:

“The previous plan relied on the original mortgage lender taking a voluntary haircut on the original loan. This bypasses that step and uses the powers that have been given the government agencies to go and refinance these loans directly, buying out the original loan.”

Here we get to the one key difference between what McCain is proposing and the Dodd/Frank portion of HERA passed in July. As Sen. Dodd explained when the bill was announced:

Lenders have a strong incentive to participate. Even though the program is voluntary and lenders will have to take significant losses to benefit from the program, these losses would be far less than they would incur if the property enters into foreclosure.

The one real difference between the current law and the McCain proposal is that the Republican candidate wants the taxpayers to foot the bill to pay the mortgage companies the difference between the current principle on the loan and whatever reduced principle amount is determined by the current value of the home by a new appraisal.

Let’s say someone has a mortgage with a principle of $110,000 on a home that was valued at $125,000 originally. Now the FHA buys up the existing mortgage and pays it off, then gets a new appraisal and finds that it’s now worth $100,000 and sets the principle of the new mortgage at $90,000 (90% of the value of the new value).

Under the Dodd/Frank bill that is already existing law, the lender has to take a hit on that $20,000 (but since they typically only get less than 65% of the value of the home in a foreclosure sale, this is still better for them financially). But under McCain’s proposal, the taxpayers have to pay the $20,000 difference between the principle on the existing loan and the new principle to the mortgage companies. The current law bails out the homeowners. McCain’s plan bails out the lenders.