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What will Washington do about the Subprime Crisis in 2008?

published on March 1, 2008

The subprime crisis still rocking and rolling these days.  In terms of the crisis’ primary component, it is expected to actually grow in scope during 2008:  The number of subprime-related foreclosures expected to occur this year will actually outpace the numbers from 2007.

The bottom line for the economy, in many ways, is that while the markets finally recognized the scope of the problem in 2007, the actual direct damage from the economy in 2008 will be considerably worse.  Hence why Congress actually worked together on the stimulus package.  And hence why a little progressive legislation might actually be produced by the supposedly left-of-center 2006-08 Congress. 

If it’s going to happen anywhere, it will probably come out of Senator Chris Dodd’s Banking Committee, which will probably be responsible for writing any legislation that would deal with the subprime crisis. 

Fresh off of his unsuccessful presidential campaign, Senator Dodd may be looking to re-establish himself as one of Washington’s real players and key power brokers.  While he is liberal on many policy positions, he is in many ways the consummate insider’s insider.  His father, for instance, held the seat he now holds, and left office tainted with scandal. 

So, it was not clear who Senator Dodd would side with when the powerful interests that his committee oversees and the public good are in conflict.  Not surprisingly, he has come down somewhere in the middle of the two with his proposal for the subprime crisis. 

Central to the proposal is a $20 – $25 billion fund that would buy subprime mortgages from the holders of the securitized debt – mostly large banks and investment firms – and then restructure the loans so that most foreclosures would be avoided.

The proposal would create a Home Ownership Preservation Corporation to oversee the process.  After the initial public investment, the Corporation should be able to be self-funding. 

While the bill would certainly help the economy greatly, there are concerns it will over-value the securities somewhat, thus, in effect, subsidizing the irresponsible behavior of the banks that purchased the debt.  It will also probably encourage some people to actually stop making payments on their loans so as to procure a cheaper federal loan.

While there probably will be some significant waste from both those aspects of the proposal, it nonetheless will go a long way to saving the economy from a very deep and wide recession.

Several commentators have compared the proposal to the Homeowners Loan Corporation, which the government set up during the Great Depression.  In many ways, it is an apt comparison:  It is a mainstream Democratic, New Dealer idea that is not perfect, but without it, the US economy, the global economy and the American people will be in considerably worse shape.

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