Paulson's plan

In theory, this solution is one that lenders could have arrived at on their own. Lenders often lose less money on a renegotiated loan than on a foreclosure, so they should be well equipped to triage bad loans, separating the workable from the truly hopeless cases.

So why did the government need to get involved? One reason is that so many loans are going bad that the companies servicing them don’t have the people or the skills to evaluate them on a case-by-case basis. (A recent study found, for instance, that mortgage servicers renegotiated only 1 percent of loans that reset in the first part of this year.)

And, because most of these loans have been packaged into securities and sold to outside investors, the process of renegotiating mortgages is now far more complicated than just talking to the loan officer at your local bank. Paulson’s plan streamlines and simplifies the process by creating rough-and-ready definitions of creditworthiness.

The Treasury Department’s sponsorship also permits a degree of collusion that might normally be considered illegal—banks aren’t typically allowed to work together to set loan prices. And it reduces, although it certainly doesn’t eliminate, the risk that the investors who actually own these mortgages will sue to prevent the wholesale renegotiation of the loans they own. It’s a powerful example of the way government can shape markets without ever passing a law or a new regulation.

Unfortunately, it’s also an example of the limits of such intervention. Although the plan will provide real relief for at least some homeowners, it’s more like a Band-Aid than like the major surgery that some of the hype makes out. That’s because at this point interest-rate resets are just a small part of the mortgage-market problem. Postponing rate resets doesn’t change the fact that too many people spent far too much borrowed money on houses with prices that were far too high, and that they are now stuck in homes that they can’t really afford and can’t sell.

Even with the interest-rate freeze, foreclosures will keep rising. More important, problems in the credit markets are no longer limited to subprime loans; rather, they involve a wholesale reëvaluation of risk, fuelled by a deep sense of distrust in the way the financial system rates and values assets like mortgages.

For these problems, there’s only so much that even the government can do. In 1907, J.P. Morgan was able to come to the rescue not just because he could get all the people who mattered into one room but because he was facing a clear problem with a clear solution. Those were the days.

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