Last year's debate over cramdown (ie. forcing banks to renegotiate the terms of their predatory loans) highlighted a central philosophical divide inside the Democratic Party. Should the power of the government be used to force banks to the negotiating table when it comes to the foreclosure crisis, or should the power of the government be used to effectively try to bribe the banks into modifying their behavior? As I've written before, this is a question gets to the deeper substantive difference between the term "progressive" and "liberal" - and the last few years gives us clues as to which is a more productive public policy posture.
President Obama quite clearly believes the latter. Despite campaigning for president as a supporter of cramdown, Obama ultimately pressured congressional Democrats to drop their advocacy of the provision. He has also supported the TARP bailout and opposed a serious crackdown on executive bonuses. This is, in short, an administration that believes the best way to confront the financial crisis is to hand over taxpayer money to banks, in the hope that the banks will return the favor with more humane behavior.
But, as the Hill newspaper reports, here's the problem with that concept:
Banks will get the biggest benefit from an Obama administration housing program designed to help unemployed homeowners escape foreclosure...
David Abromowitz, senior fellow at the Center for American Progress, said the main problem with the funding is that lenders will benefit without requiring any concessions or matching of the federal aid.
"My concern is what are we asking from lenders who are going to get the benefits source to pay those loans for 24 months," he said.
Under the program, lenders don't have to make principle reductions on loans or major modifications, he said.
Now it's true - some underwater homeowners may be kept afloat. But only for a time, because the way many troubled mortgages are currently structured, the federal funding infusion will likely only be paying homeowners' mortgage interest, not principle. Which means after the program runs out, the bank will have collected its interest (read: profit) but the homeowner will have no more equity (and thus be no less underwater).
The X-factor, of course, is whether a program like this will compel banks to change their behavior? The Obama administration seems to think they will. But considering the raw economics of it, why would they? If, as with TARP, they aren't forced by fiat/regulation to change - that is, if they can just collect lots of money and not have to change their behavior - why would they be nicer to homeowners?
They wouldn't (and haven't) - nor should we expect them to. Bank executives have a fiduciary and legal responsibility to maximize profits for their shareholders. Expecting them to suddenly decide - exclusively out of the goodness of their hearts - to voluntarily be kinder to homeowners at the expense of profits is ridiculous.
That is why the "bribe them into better behavior" theory is so flawed. Unless government creates a set of ironclad rules and then enforces those rules (as it did, say, in the New Deal), corporations are not going to change their behavior - no matter how much taxpayer money is thrown at them.