Paulson on Housing: "Let Them Eat Cake"

The origins of the phrase “Let them eat cake” are uncertain, but it is generally attributed to Marie Antoinette, and at the time, her proposal wasn’t as loopy as it sounds now.

The French peasantry was hungry due to high bread prices resulting from a flour shortage. The queen urged the poor instead to eat brioche, which was made of eggs and butter as well as flour and was required by law to be sold at the same price as bread. In other words, her suggestion was an early form of regulatory arbitrage. But in the retelling, she sounds woefully disconnected from reality and dismissive, and her execution seems a logical result of her (misread) callousness.

Image management and the use of Newspeak has advanced considerably in the last 300 years, so Paulson’s latest proposal for what to do about the housing crisis isn’t as inept-sounding as the ill-fated queen’s remark. But it is likely less sincere.

Yesterday, both Bush and Paulson acknowledged that the economy isn’t looking too rosy, although both insisted that it would not fall into recession (Felix Salmon noted that Paulson was particularly downbeat, but he has upon occasion made surprisingly blunt remarks).

There has been speculation that the Bushies will Do Something, namely propose more tax cuts for the rich, which won’t sit well with newly emboldened Democrats (this is of course a no-lose bit of political theater, since the Republicans either get to reward a core constituency, or complain that the Democrats have yet again been obstructionist and anti-growth).

And we have the spectacle of Paulson acknowledging further stress in the mortgage markets in a rather peculiar fashion, In a speech at the New York Society of Securities Analysts, he said that housing market conditions were bad enough to warrant taking ” an industry-wide effort to prevent this market failure,” namely the Hope Now Alliance plan to freeze certain subprime mortgages at their introductory rates. Nearly everyone who has looked at the plan has concluded it won’t help many borrowers. Estimates of the eligible range from 15,000 to 145,000, versus the 2.2 million that the Center for Responsible Lending says is at risk of losing their homes over the next couple of years.

The first half of Paulson’s speech was about what the Administration is doing about the housing market. None of it was new except an update of motion, um, progress to date on the New Hope Alliance initiative (as far as I am concerned, telling me how many letters have been sent to troubled borrowers is irrelevant. The only stat I care about is how many mortgages have been modified, and that was not forthcoming). There was also a rehash of the Bush proposals for raising Freddie’s and Fannie’s ceilings to include jumbos, and on FHASecure. Paulson also defacto took credit for the somewhat controversial move of the Federal Home Loan Banks to extend credit to member banks, particularly Countrywide.

Slipped in this discussion was this key tidbit:

We need to see all servicers reporting results to HOPE NOW to measure effectiveness and then make adjustments as needed. This may include using elements of a systematic approach for adjustable-rate mortgages other than subprime if it will benefit homeowners and investors.

So here we have a program that was carefully crafted so as to stay within existing laws, which had the effect of limiting what borrowers might be eligible. So now we have a program that is widely expected to be more show than substance, and now it is being trotted out as the possible savior of prime borrowers who are also under water.

Lest you think I am overreading this wee remark, the American Securitization Forum (an industry lobby whose members include rating agencies, originators, mortgage brokers, banks, and investors, but has been presented as if it “represents” investors, which is a stretch given its many constituents) jumped on the bandwagon. As reported in the Wall Street Journal:

The secretary’s suggestion drew immediate support from a key mortgage-industry player, the American Securitization Forum, which represents investors who have bought mortgage-backed securities. Without the investors’ approval, mortgage-servicing companies that collect the checks from borrowers run the risk of litigation if they relax the loan terms.

“To the extent that servicers can develop and apply systematic approaches to assist them in their efforts to identify appropriate loss mitigation outcomes for adjustable rate mortgages other than subprime, we support those efforts,” George Miller, the group’s executive director, said in a statement released after Mr. Paulson’s speech.

I take Miller’s remark as code for “don’t blame the servicers.”

The Japanese have different notions about regulation than we do, but as America seems to be going down the Japan path, these Japanese approaches appear increasingly relevant. The Anglo-Saxon version of regulation is that things are either permitted or they aren’t. The Japanese construct, by contrast, have a lot more tolerance for grey areas. The authorities will tolerate a lot of boundary-pushing activity as long as it stays small scale. If it becomes significant or too visible, then they shut it down.

For reasons that are legal rather than regulatory, the New Hope Alliance program, despite its profile, is very much a Japanese experiment. If only a few loans are modified, no investor will be discomfited enough to challenge it legally (and as we have discussed at length, we think it could be contested). But if mods are done on a large scale, investors in the lower-rated tranches will lose out relative to investors in better-rated paper, and if enough mods are done, they may decide to act.

So despite Paulson’s and Miller’s encouraging words, this program is bound to remain small scale precisely because everyone recognizes that, Japan-style, there is no risk of stirring up trouble so long as the results are modest.

As we said, Marie Antoinette was at least sincere….