Comment 63: Why the Treasury proposal to artificially push mortgage rates for the purchasing of new homes only to 4.5% may trigger another financial firestorm. (Dec. 4, 2008)

It is reported, first by The Wall Street Journal, that the Treasury Department is contemplating to propose a way to force the mortgage rates for purchasing new homes down to 4.5% by using Fannie Mae and Freddie Mac to purchase such mortgages from mortgage initiators. The reason to exclude the refinancing of existing mortgages from the plan is quite obvious. Most of the existing mortgages carry interest rates substantially higher than 4.5%. If the refinancing of those mortgages is included in the plan, about 15 trillion dollar worth of existing mortgages will rush to refinance. As the consequence, banks and investors holding the existing mortgages will suffer a loss of 1.5% of 15 trillion dollars, or 225 billion dollars a year, and many of them will be pushed into bankruptcy. If the refinancing of existing mortgages is excluded from the plan, the purchase of existing homes must also be excluded from the plan, otherwise owners of the existing homes can use the tactic of selling and repurchasing existing homes to qualify for the 4.5% mortgage rate and thus cause the same havoc on the financial system as discussed above. However, the small tricks in the Treasury plan to exclude the refinancing of the existing mortgages and the purchasing of existing homes from the plan will not be able to fool “mother” economics. If the plan of the Treasury Department is enacted, potential buyers of existing homes will be steered toward new homes, the prices of existing homes will plunge further, the foreclosures on the existing mortgages will increase more rapidly, the holders of securities backed by the existing mortgages will suffer much heavier losses as the result. Of course, it is ridiculous to encourage the construction of more and more new homes when the inventory of unsold existing homes will explode under this plan. If this plan is enacted, the whole financial system that is already backed to the rim of the cliff may well be pushed into the abyss. Sometimes the mad scrambling without knowing the true condition of the surrounding can be much more dangerous than doing nothing.