Foreclosure and the ‘forgotten man’ in Obama’s SOTU speech

Perhaps with the popular reaction to Rick Santelli’s ‘tea party’, in which the CNBC commentator elicited cheers for saying that the thrifty should not have to subsdize foolish borrowers and banks, President Obama took pains in his State of the Union address to argue that his foreclosure plan will not benefit the spendthrift and irresponsible. “It’s a plan that won’t help speculators or that neighbor down the street who bought a house he could never hope to afford, but it will help millions of Americans who are struggling with declining home values,” the President claimed.

Whether it will or it won’t, we’ll see when the full plan is unveiled next week. Regardless, in Obama’s foreclosure rescues there are two overlapping groups that would fall into the category of, in the title of Amity Shlaes’ great economic tome, the “forgotten man.” : they are taxpayers and savers who not only will be at risk for more than $275 billion in tax dollars for the plan (in additon to the trillions for the Obama’s stimulus and the Bush-Paulson-Obama-Geithner bailouts) but will also be at risk for further losses in their pension and mutual funds from the proposed bankruptcy “cramdown” by Obama and Democrats that would radically change contract law regarding mortgage securities.

Because they were rated AAA, mortgage-backed securities sold by the banks were picked up in some degree by nearly all pensions and mutual funds. The losses on loans that politicians were asking, and under Obama’s plan paying, banks to take, are most often not even the banks’ own losses. It’s investors, including middle-class folks with 401(k)s who will take it on the chin.

Yet the bankruptcy “cramdown” –in which bankruptcy judges can reduce payments and modify mortgage contracts in lieu of the foreclosure that both parties agreed to as a remedy for default — as well as policies encouraging banks to ignore their contracts to the investors who own the mortgages will prevent investors from having their contracts honored. Right now, there is a vicious villification campaign targeted at William Frey, an investor in mortgage-backed securities who is suing Countrywide Financial for modifying mortgages without regard to investor interest.

If both borrowers and banks are encouraged to disregard the terms of the contracts they signed, the U.S. will face a longer road to recovery. And the trust badly needed for credit markets to function will not be restored, despite President Obama’s good motiviations and uplifiting speeches.