McCain's Mortgage Bailout Plan

The GOP candidate wants to spend $300 billion to buy out "underwater" homeowners at the original value of their mortgages, a plan sharply criticized by a top Obama adviser

by Jane Sasseen

Anyone sitting down to watch the second Presidential debate on Tuesday night, Oct. 13, had to wonder what answers the two candidates would have for the nation's unfolding financial calamity. Earlier that day the Dow Jones industrial average had crashed another 508 points (BusinessWeek.com, 10/7/08), and stocks were on track for their worst year since 1937.

There was really only one new proposal offered in the debate, though, and it came in Senator John McCain's answer to the first question. Asked how he would deal with the housing and economic crisis, McCain said he would order the Treasury Secretary to "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."

The notion of having the government buy up mortgages directly and play a more active role in reworking troubled homeowner loans has been discussed since the early days of the financial meltdown and has generally been backed by Democrats. Senator Barack Obama has backed similar efforts in Congress and recently argued such moves should play a key role in the Treasury's $700 billion rescue efforts as well. But for McCain, the idea is new—and it's a big shift. He clearly meant to use it to position himself as different from both President George W. Bush and Obama on dealing with the average American's woes. It's also a huge ideological shift for a man who is running as a fiscal conservative and who was far slower than his Democratic rival earlier in the year to argue that the federal government should step up to aid homeowners facing foreclosure.

Breaking Down the Proposal

Given the way the sentence was phrased, it wasn't immediately clear what McCain meant—or what the financial implications of his idea might be. Was he saying the government should buy up every bad mortgage at its original value and then refinance the homeowner into a lower-priced, affordable mortgage? That would stick the government with the difference between the original loan values and current, much lower values. Or did McCain mean that the Treasury should negotiate first with the lenders or investors holding the mortgages to reduce the values of the original mortgages to realistic current values before buying them out and refinancing the loans? In that case, banks and investors currently holding the loans (or the mortgage-backed securities they've been packaged into) would have to agree to take that immediate loss in hopes of avoiding the greater loss that could come from foreclosure.

In a conference call Wednesday morning with reporters and in a follow-up call, McCain's top economic adviser, Douglas Holtz-Eakin, made clear that the Arizona Senator is proposing the first option. Under his plan, the government would buy the mortgages from banks and investors at the original value of the loan, no matter how overinflated that now appears to be. "We're [proposing] buying back the original mortgage at the original value and then giving [the homeowner] the new mortgages" at current values and more affordable interest rates, Holtz-Eakin told BusinessWeek. "Obviously the taxpayer is on the hook for the difference."

That could be a huge sum: Enormous numbers of homes are now "underwater"—no longer worth the value of their mortgage —and are no longer worth anywhere near the value of their current mortgages. Indeed, The Wall Street Journal reported that 1 in 6 homes is now underwater. Moreover, buying out mortgages at their current values would essentially mean bailing out the lenders who made those loans, or the investors who now hold them, at what have proven to be highly inflated values. (These are values that were often inflated with the complicity of the lenders and appraisers who made the loans.) They would essentially be made whole on those loans.