Is Bush Embracing the Dodd-Frank Sub-Prime Bailout Plan?

Treasury man Henry Paulson’s ideas to remodel the regulatory system governing financial markets are dominating the headlines today. But there may be a bigger story coming down the road, one that is of much greater immediate significance to economic policy.

Namely, there are lots of rumors out of Washington that the Bush administration is going to capitulate to the Chris Dodd–Barney Frank FHA bailout of sub-prime mortgage holders.

This could run up to $400 billion of FHA guarantees. And even though lenders would take up to a 15 percent haircut on discounted loan values, and borrowers would have to give back a percentage of their future capital gains if home prices ever rise again, this would be the most sweeping housing-assistance plan in history. It could include as many as 2 million homeowners, and a big chunk would go to rescuing delinquent homeowners now in foreclosure.

Though President Bush told me in an interview a couple of weeks ago that he didn’t like the Dodd–Frank plan, it seems that the Fed/Treasury effort to sell Bear Stearns to JPMorgan and pour a $30 billion backstop loan to cover sub-prime collateral has a lot to do with what is apparently a major shift in White House policy.

In other words, Main Street is up in arms over the appearance of a Wall Street bailout.

The deal is not done yet, but the rumor mills are heavy. It seems like nowadays in Washington nobody is allowed to fail at anything. Of course, as Friedrich Hayek taught us years ago, free-market capitalism is about success and failure. But that view is very unpopular in this election year.

As for Mr. Paulson’s regulatory-reform plan, the Federal Reserve would be the big winner. But nothing’s gonna happen for years as the regulatory bureaucracy fights among itself and its chief lobbyist backers.

One deregulatory measure that is lacking from anybody’s plan is a sharp cutback or outright elimination of the Community Reinvestment Act (CRA), which essentially puts a gun to the head of all lenders unless they issue mortgages to various minority groups, low-income folks, and both legal and illegal immigrants. Lenders out of compliance would be penalized as regulators would disallow any new business plan for mergers, acquisitions, or new products. Community groups like Acorn could rat out lenders by showing data to the regulators who then would step into action.

Along with the Fed’s easy-money housing bubble, CRA is one of the prime movers in the sub-prime housing mess in which we find ourselves today.

But no one wants to touch CRA.