Abrogating Peter’s Contract to Pay Paul — Mortgage Bailout’s Billion-Dollar Hit to Retirement Savings

Many commentators, such as Open Market’s Hans Bader, have done a diligent job tracking the costs to taxpayers of the mortgage bailout scheduled to be voted on this week. The Congressional Budget Office just came out with an estimate of $2.7 billion for H.R. 5830, the so-called FHA Houshing Stabilization and Homeownership Retention Act of 2008.

But there could be an even greater cost from the bill to millions of middle-class investors saving for their retirement or the education of their children. The bill has the Federal Housing Administration guarantee the refinancing of a mortgage in return from a “haircut” from the owners of the loan. The bill requires loans to be guranteed at no more than 90 percent of the value, meaning a 10 percent loss for investors. But this haircut will “shave” billions of dollars off from funds saved for retirement or education.

This bill not only “robs Peter to Pay Paul,” through taxpayers bailout of bad loans by banks and borrowers. It can also be said to “abrogate Paul’s contract to Peter.” This is because many of the mortgages often aren’t owned by the banks that service them, but frequently by millions of middle class investors through their interests in entitities that have mortgage-backed securities (MBS).

Many middle-class folks who have 401(k) accounts, mutual funds, money market funds or defined-benefit pensions are indirect holders of MBS. In fact, according to investment bank Credit Suisse, 14 percent of MBS are owned by pensions and mutual funds that serve middle-class savers.

So, let’s do some math. The bill authorizes the FHA to guarantee up to $300 billion in mortgages. With the 10 percent haircut, the loans were originally worth $333 billion. So $33 billion represents the potential lost savings by the private sector. Now assume a random 14 percent of the loans in this program represent those owned by pensions and mutual funds. 14 percent of $33 billion is $4.6 billion.

The bottom line is that middle-class savers and investors could be left with almost $5 billion less for retirement and education of their children. Another compelling reason this bailout is not worth the cost.