Here's a Housing Bailout Plan that I can support

Let me start by saying that I am opposed to a housing bailout.  In theory, at least.  My basic opposition to a housing bailout can be summarized in two words:  Moral Hazard.

Far too many of the homeowners who are now going into foreclosure or in danger or doing so were speculators/investors, or buyers who bought way more house than they could afford with the expectation that prices would continue to rise.  In other words, they were also speculators.  The fact that prices stopped rising should not mean that taxpayer money comes to the rescue.  This would violate everything I believe about free capital markets.

Moral hazard simply means that risk, when taken with the hope of reward, must actually bear the consequences of that risk.  If government intervention prevents that from happening, an increasingly high level of risk taking will take place next time around, to the extent that the systemic consequences will be too high for all of us to bear.

But here's my take.  There is a lot of talk going on about how the housing crisis will bring the economy down to its knees if left to its own devices.  Not sure I buy that, but it seems that our leaders have.  Due to this, there appears to be bi-partisan support for a bailout of some form.

While, I remain philosophically opposed to a bailout (and don't try to rename it, any government action to aid failing homeowners is a bailout), if one is going to happen anyway, here is what I would support.

Recently, Fed Chairman, Ben Bernanke urged lenders to help distressed owners by lowering the amount of their loans.  In order to reduce the rate of "preventable foreclosures" Bernanke suggested that banks and other lenders should reduce the principal amount of outstanding loans for distressed homeowners.

My initial reaction was complete outrage.  Like Diana Olick at CNBC, I thought, "hey, my car isn't worth what I paid, how about asking Honda to reduce my loan!"  Of course, the words "Moral Hazard" kept dancing around my head.  The goal of any housing bailout should be to:

• aid homeowners who actually live in their house, and intend to do so going forward
• only help those were in a position to afford the house at time of purchase based on income/price metrics, but may not be now due to loss/reduction in income.  If someone bought way over their head in hopes of a quick gain before payments adjusted, they are a speculator, not a homeowner, and should not be helped.
• avoid helping speculators and investors who took a risk in hopes of gains
• avoid punishing homeowners who bought within their means using conservative financing and are not in danger of foreclosure.
• avoid punishing those who did not buy during the mania in prices, expecting the "bubble" to burst and prices to level or even fall.

Among the outrageous bailout proposals that have been offered, including various forms of foreclosure moratoria, interest rate freezes or government loan purchases, this is the one that I could stomach.  It still does not remain consistent with free market capitalism, but with the proper restrictions this could accomplish the above goals, thereby prevent economic catastrophe, as the bailout proponents would like you to believe will otherwise occur.

The restrictions that I would place on the bailout are:

• In order to be eligible, you must be an owner occupant.
• In order to be eligible, your household income must have declined by more than 20% since the date of purchase.  If you are making as much now as you did when you bought your house, what do you need a bailout for?
• The amount of the loan reduction is not "forgiven" but "set aside."  This means that if, in the future, the house is sold at a price higher than the reduced loan amount, the full original amount of the loan must be repaid before the homeowner receives any profit.
• Also, If the house is transferred via gift, inheritance, or change of title, the set aside loan amount must be repaid.
• If the loan is refinanced, the amount set aside must be repaid in full.
• The loan becomes full recourse.  This means that if, after the generous reduction in loan amount, the homeowner still defaults, they still owe the money.  In the event of foreclosure it would be based on the reduced amount, not the original loan amount.
• The reduced loan amout may not be discharged in bankruptcy.
• If you currently own any real estate other than your principal residence, you are not eligible.
• If you have owned three or more real estate properties within the last three years, you are not eligible.
• You must continue to live in the property, otherwise, the full amount set aside is due.
• This is voluntary on both the part of the banks and the borrowers.  But if you choose to play, these are the rules.

I realize the list of restrictions is lengthy, but I think it addresses the issue of aiding speculators, punishing cautious homeowners or those who avoided the mania and aids those whose goal is to actually live in the house for a long time.  Nobody who benefits from a bailout should profit from it.

I am not opposed to people making money.  I am all for it.  Greed and speculation play an important role in capitalism.  However, when greed and speculation lead to losses, investors should not ever expect government intervention.