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SEIFFE:  The Two-Ended String

Tuesday, December 4, 2007

By Ralf Seiffe

The Bush Administration continues to amaze its friends and thrill its enemies with news that it is considering bailing-out sub-prime mortgagors which market conditions have now embarrassed.  Should this come about, regular folks who manage to pay their own mortgage will be rewarded with the obligations their neighbors are unable to meet.  This is a bad idea but if the Administration abandons principle and frustrates the market, it should extract a price from those it bails because no deliverance comes without some strings involved.  Here’s a suggestion for what those strings might be for these debtors and the government which might induce solvent taxpayers to accept a bail out. 

According to an opinion by Andy LaPerrierre in today’s Wall Street Journal, the majority of the sub-prime borrowers are not naive first-time buyers stricken with home-buying fever.  Rather, they are experienced people who cashed out their equity to finance, one presumes, a better lifestyle.  They are way over their heads in debt and LaPerrierre makes the point that these borrowers are unable to repay—even before the rates on their mortgages rise--and that they cannot repay at any reasonable interest rate.   

This sounds a lot like the problems in Washington.  The government is trillions in debt with little prospect to pay.  Like the sub-prime borrowers who used up the equity that may have taken years to build up, our leaders recognized that the Social Security tax produced more than it actually took to pay the beneficiaries.  Indeed, this was the intent the last time the system was “rescued”--the surplus would be saved and then be available for paying benefits.  But, like the sub-prime borrowers Mr. LaPerrierre indicts, our leaders did not let this extraction from taxpayers accumulate for its intended purpose.  Instead, they quickly spent the surplus to extend their “lifestyle” with current projects.  They delivered benefits with funds the voters thought were accruing in a Social Security account with their name on it. 

An aggravating factor in the sub-prime ordeal is that many borrowers closed their loans with very little proof of their ability to pay even the initial payments, let alone the reset, higher interest rates those teaser rates always imply.  The government has its own brand of documentary fraud when the Social Security Administration regularly sends letters to workers speculating on the specific and personal benefits that will be available through Social Security.  The obvious intent is to create the expectation of ownership of a specific account.  These phony statements are even printed in the color of money!  

Both situations are unsustainable. In the case of the sub-prime borrower, conditions have changed and they can no longer refinance their homes to obtain the cash they need to support their lifestyle.  Likewise, the federal government is fast approaching the point at which the workforce is no longer producing more in social security taxes than they need to pay the beneficiaries.  The Congress can no longer embezzle the surplus to support their lifestyle. 

Why not attack both these apparently insurmountable problems at the same time?  The debtors can’t pay and the government has future benefits these debtors expect to be paid.  So, why not bail out the debtors now, but attach a string that subtracts the benefit from their eventual claim on Social Security?  The condition attached to this bargain would be to calculate the future value of the bailout--when the beneficiary retires--and net it against their benefits, then. 

From the debtors’ point-of-view, a case can be made that they have paid into Social Security and that it’s their money.  Think of life insurance policies which have similar features permitting owners to borrow their own money. 

This suggestion presents no credit risk to the government unlike any bail out forced onto the markets.  Uncle Sam has already promised the benefits--even though the Social Security system is not obligated to pay them--so by making the mortgage payments for debtors, the government is merely paying out the present value of those benefits.  If the sub-prime debtor does not repay the benefit, the government is not harmed because it escapes its future liability to pay Social Security or Medicare benefits. From the government’s point-of-view, this plan would help reduce Social Security obligations in the future when it will really be feeling the pain of the baby-boomers. 

For those who are genuinely in temporary circumstances, simply let them pay the benefit back, at interest, over time, at their option.  By setting a market rate of interest, it becomes a good deal to repay one's bail-out.   What's more, by paying out to the sub-prime borrowers now--and attaching an explicit interest rate--the Social Security Administration would actually do what it wants Americans to believe it is already doing, namely, investing money for the future beneficiaries.   To the extent that the plan allows the government to claim it’s solved the sub-prime crisis, it must reduce other spending. That’s their string. 

This “two-ended string” might also be salable to the real victims of the melt-down--those who are paying their mortgage obligations yet suffer because foreclosures are depressing their property values.  They are not interested in a bail-out because they consider it unfair, correctly, but they are not vindictive.  A quid pro quo like this would be just the sort of compromise that would help change public opinion and allow a softer landing for their busted neighbors.

Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader and Illinois Review.

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