And Justice For All…

Story Highlights:

• Many have spun the government's reaction to the financial crisis as one-sided, favoring "Wall Street over Main Street." That is, ignoring individuals like homeowners.
• A recent proposal would use nationalized Fannie Mae and Freddie Mac as conduits to aid struggling homeowners by restructuring their mortgages.
• Despite its deficiencies, the proposal isn't as meddlesome or messy as certain other routes we can imagine (i.e., through Congress).

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Parents with a couple kids know how hard it is to be fair. Buy a gift for the eldest, and the younger one wants to know where his is. Try to even the scales by buying the youngster a gift, and his older sibling complains it was more expensive and she wants one too. Harmless family dynamics, right? Not so harmless when those same family dynamics play out between a couple hundred million "children" (US citizens) and a dysfunctional mishmash of bickering foster parents who can't say no (the Treasury Department and Congress).

From the start of the financial crisis, many saw the government reaction as one-sided. After all, there are two sides to every loan, lender and borrower. Some argued the government was throwing money at Wall Street, but forgetting the little guy. Or even worse, that the feds were neglecting the root problem—the housing sector.

Feels like ages ago, but recall there was in fact a "stimulus" package doled out to most taxpayers earlier this year, and a second round is being weighed now. The Bush administration also tried to address concerns by coordinating a coalition of willing lenders (coined the Hope Now Alliance). But amid clamor for more action, would use nationalized Fannie Mae and Freddie Mac as conduits to aid homeowners. Given the opacity of the TARP and sweeping, unprecedented broadness of Secretary Paulson's mandate, it shouldn't take anyone aback that the plan is morphing daily. Paulson has very Mae and Mac will no longer be run "to maximize shareholder returns" and is already the TARP goal of buying mortgage-related securities.

According to the new proposal, Fannie and Freddie would be required to restructure loans where homeowners owe over 90% of their home's value, are 90 days delinquent, and can prove hardship. Options for restructuring would include reducing interest payments over the next five years or lengthening the duration of the loans to 40 years. The goal would be to reduce payments to 38% of monthly household income. The decision potentially affects several hundred thousand delinquent loans, a very modest number when compared to Freddie and Fannie's roughly in all. But it's hoped the plan, if implemented, would be voluntarily adopted by other private sector firms, though many have already implemented plans of their own.

We empathize with well-meaning homeowners who are feeling the pinch currently, but non-market solutions are often rife with loopholes and inefficiencies. To us, one immediate conflict of interest arises from the requirement that loans must be 90 days delinquent. This seems to incent those wanting to qualify for help to stop making payments. More generally, instead of fixing anything on a national scale, the plan seems to prolong one of the crisis' fundamental problems. After all, didn't the government originally use Fannie and Freddie to encourage banks to loosen lending standards for folks who couldn't otherwise afford payments? And weren't the consequences of that policy one spark lighting the financial fire? A chief goal of government intervention should be the provision or renewal of stability—perceived or real. This is one place the government is waffling: Investors still don't know just how TARP will go, who will get the funds, who will keep ownership of assets, and so on. Heck, even the AIG bailout was this week. It's little wonder extreme volatility persists.

The proposal isn't as meddlesome or messy as certain other routes we can imagine (i.e., through Congress), but we wonder at its overall efficacy and have a lurking suspicion more direct intervention could be around the corner. That suspicion (otherwise known as uncertainty) is very likely part of what's bugging markets too.