Bailout Treats Symptoms, Not Disease

The bailout is done! Time to breathe a sigh of relief.

Or is it?

As details emerge about the financial bailout package that was jammed through Congress over 10 days of political theater at its most nauseating, there’s still a striking omission from the plan to right American’s economic ship.

The failure of bureaucrats and regulators to propose a realistic solution for the foreclosure problem is emblematic of their inability to treat the root cause of an issue, focusing instead on simply applying band-aids to the visible symptoms.

The bailouts of Bear Stearns, Fannie Mae (FNM) and Freddie Mac (FRE), and AIG (AIG) all claimed to remove the cancer - but all they did was hasten the patient's demise.

Treasury's plan will deliver money into the banking system to sop up toxic assets sitting on the balance sheets of our financial institutions. This is a necessary -- albeit unfortunate -- step, but it still doesn't address the root of the rot: Milions of homes are worth less than the outstanding balance of the owner's mortgage.

Billions of dollars in negative equity are destroying Main Street’s balance sheet even as it devours Wall Street, eroding the value of the very securities Taxpayers are about to start buying.

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As long as Washington tries to fight foreclosures with ineffective loan modification programs that simply prolong the problems, foreclosures will continue to set records. Modifying a mortgage for someone who is barely scraping by is sort of like rescuing him from the side of a cliff, only to leave him on the edge, dangling by one arm.

Foreclosures are often blamed for spiraling home prices and the resulting collapse in value of securities tied to the mortgages used to buy those houses. According to Bloomberg, the government’s aid package is designed to support “financial companies reeling from the record number of home foreclosures.”

Foreclosures don't cause houses to lose their value. Foreclosures happen when a home loses value such that it’s worth less than the mortgage used to buy it, and the homeowner can’t sell or refinance if his interest payments become overwhelming.

Defaults become delinquencies, which become foreclosures, which become evictions, which become repossessions, which flood the market, depressing prices as supply outstrips demand.