Sub-Prime Rescue Ups & Downs

The stock market verdict on the Bush/Paulson sub-prime borrowers’ rescue plan is thumbs up.

At the time of President Bush’s speech, the Dow was up about 65 points. As of this writing, it’s up 150. Financial stocks are leading the charge, up almost twice as much as the overall index. Homebuilder stocks are up huge, posting a 12 percent gain. Banks are also up, while the big brokers are up almost 3 percent. So investors so far are voting with their money in a positive way.

There are a lot of issues yet to be resolved about this plan, and I will be writing more about it tomorrow. In the meantime, some Wall Street analysts I spoke to believe this plan could do some small good. But it also possesses significant downside risks. Unfortunately, the history of these kinds of rescue efforts shows that borrowers on the verge of default/foreclosure may be saved temporarily, but they wind up defaulting and foreclosing anyway, over the longer run.

And since home prices are destined to fall much more in the next year — or two, or three — future foreclosures will come at much lower prices to be recouped with lower cash flows by investors holding sub-prime mortgage paper. Not good for the investors. Many analysts would have preferred a refinancing process that relied more heavily on existing government agencies such as FHA, Fannie Mae, and Freddie Mac.

All that said, in political terms, President Bush and Treasury man Paulson had to do something.

The pure, free-market option that may make the most economic sense — letting markets adjust along with the winners and losers — is just not an option in this intensely political season. In this environment, the president chose the least worst option, one that has no direct bailouts using federal budget money (which of course is taxpayer money). Senator Hillary Clinton would put up a quick $5 billion and maybe as much as $7 billion, whereas Mr. Paulson is avoiding that expenditure.

If the economy stays afloat (which I still believe is the likeliest outcome) then perhaps the interest-rate freeze will buy some time for the working poor to refinance. It’s a big maybe.

More to come . . .