Floor-through

20 May 2008

The Senate s $300bn political figleaf courts disaster. Slashing principal on underwater mortgages and refinancing homeowners into cheaper loans may sound good. But it could push house prices down rather than supporting them. And it provides perverse incentives.

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The Senate Banking Committee approved a bill on May 20 that would offer $300bn in Federal Housing Administrationbacked mortgages for homeowners whose current mortgages exceed the value of their houses.

The bill, sponsored by senators Christopher Dodd and Richard Shelby, would require lenders to reduce the principal on their existing loans by 15% or more.

Dodd and Shelby estimate the total losses from defaults on the FHAinsured loans might reach $500m, less than a third as much as the Congressional Budget Office predicts. The bill's sponsors say it will cost taxpayers nothing, since losses will be covered by Fannie Mae and Freddie Mac.

The bill also creates a new regulator for Fannie and Freddie.

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