The other bailout: Main Street

If your neighbors couldn't afford their mortgage, would you help them? You likely will, with tax dollars, in the expected federal takeover of troubled home loans. Once the US Treasury buys up such loans from Wall Street, millions of distressed homeowners on Main Street may be offered a break – a bigger one than they might otherwise get from private lenders.

America's financial crisis is throwing Uncle Sam into playing the role of a local banker forced to renegotiate mortgages in trouble, deciding if borrowers can afford homes they already occupy in markets where prices are uncertain.

One question before Congress as it debates a bailout is this: How forbearing should Treasury be toward borrowers who can't afford their mortgages?

Some lawmakers want the government to go easy in renegotiating loan terms. The idea is to stabilize neighborhoods suffering from high foreclosure rates and vacant houses, as well as to put a floor under sinking prices. (Banks now own 16 percent of the inventory of existing homes nationwide.) And in many cases, it would be less expensive to grant better loan terms to creditworthy borrowers than to spend some $50,000 for each foreclosure.

But such mortgage leniency, an otherwise compassionate idea for struggling homeowners, comes with a high price tag.

First, taxpayers may take a hit once these mortgages are renegotiated and then resold by the Treasury. These sales are supposed to recoup the cost of this bailout, which may be up to $1 trillion. But home loans that are reworked to lower the principal owed or that can be paid back over a longer time are worth less to investors.

And Congress risks committing the same mistake it made when it helped to stimulate the 2003-2006 housing bubble. Lawmakers back then encouraged the government-backed firms of Fannie Mae and Freddie Mac to subsidize more "affordable" homeownership with subprime and "Alt-A" mortgages that attract borrowers with low creditworthiness. Now all homeowners and the economy are paying the price as many borrowers go under.

The government already has a track record in renegotiating mortgages. The Federal Deposit Insurance Corporation is doing "workouts" with hundreds of thousands of borrowers whose home loans were acquired by the agency from failed banks. In offering better terms, the FDIC uses a rule that a borrower's costs for a new mortgage – principal, interest, taxes, and insurance – cannot exceed 38 percent of income. And that income must be verified with extensive paperwork. But some lawmakers want the FDIC to be more flexible, a sign of the pressure on Congress from homeowners.

Treasury Secretary Henry Paulson already feels the heat to go easy on mortgage holders. Speaking on a Sunday talk show, he said: "There is no need for legislative provisions to help homeowners, because Treasury will have the power to provide mortgage relief to homeowners once it acquires the loans from banks."

But how much will Treasury, on its own, mark down the principal of mortgages or extend payback periods to help borrowers?

Just as taxpayers want to know the price that Treasury will pay to buy bad loans from Wall Street, they also need to know the cost of rescuing delinquent borrowers on Main Street.