Mortgage Insights Blog

While many Americans may be absolutely blown away by the shear size of the latest economic stimulus proposal, most understand that the package is not only justified but essential to restore the credit markets, our real estate market, and thus our economy. As the Chairman of the Federal Reserve sees it, “I welcome a comprehensive plan to stabilize our financial system and support our economy. This legislation should help to restore the flow of credit to households and businesses that is essential for economic growth and job creation, while at the same time affording strong and necessary protections for taxpayers.”

Why such a plan?

With U.S. financial institutions currently unable to raise any capital because of illiquidity of suspect or poorly performing mortgage backed assets on their books, and no way to remove these assets, which may put the institution at risk, investors have refused to invest or extend new capital to US financial institutions. The result has been a near collapse of the U.S. financial market and a spike in the cost of credit that makes it nearly impossible for even qualified people and businesses to obtain or expand a line of credit. Under these circumstances, Californians will find it very difficult to obtain home loans, student loans, and other financing for the foreseeable future.

What does the plan call for?

The Emergency Economic Stabilization Act of 2008 (EESA) will provide up to $700 billion to the Secretary of the Treasury to buy mortgages and other assets that are clogging the balance sheets of financial institutions and making it difficult for working families, small businesses, and other companies to access credit, which is vital to a strong and stable economy. EESA also establishes a program that would allow companies to insure their troubled assets.

The EESA requires will also require that the Treasury modify the terms of any troubled loans purchased wherever possible to help American families keep their homes. It also directs other federal agencies to modify loans that they own or control. Finally, it improves the HOPE for Homeowners program by expanding eligibility and increasing the tools available to the Department of Housing and Urban Development to help more families keep their homes.

Will it work?

The more important question is--will it work? This is a crisis of confidence. If loans of any kind could be sold more easily, then financial institutions are theoretically more apt to increase their lending capacity. There is no doubt that tightening by lenders is a major factor in the crisis and that they will not loosen up until they can be assured that there are takers for the loans they have on the books that are not performing.

One negative response to the proposal has been an increase in oil prices and interest rates. Why would that happen? Well if the markets feel the proposal will work and that the economy will recover and a stronger economy would produce higher oil prices and rates. Of course, if there is no increase in economic activity, there is also no reason why rates and oil prices will not just adjust back to where they were. Speculation may be interesting--but there is no way to understand what will happen even in the near future in this case.

One major point should be made: The government is not necessarily spending $700 billion. Rather they will be obtaining an asset that could increase in value, especially if the proposal contributes to a recovery in the housing and financial markets. As a matter of fact, the government could wind up in a profit situation. That would be very good with our annual deficit soaring.