What's Wrong with the New Government Plan to Solve the Subprime Mess?

A lot of ink was spilled last week concerning Countrywide Financial Corp. (CFC), and its seemingly magnanimous offer to refinance sub-prime loans as long as the borrowers have a reasonable record of repayment. Essentially CFC announced a "recycled" program that it billed as a "program that will help up to 82,000 homeowners avoid foreclosure by allowing them to refinance or modify their mortgage loans." I call it generating additional origination revenue while avoiding more underperforming loans. I also call it smart business, and PR.

Now let's look at a government effort or as I call it "a drowning man grasping even for a sword." Minnesota Senator Norm Coleman proposed legislation that would allow individuals who are 60 days late on their mortgage payments to withdraw up to $100,000 from their 401(k) or IRA without a tax consequence. There would be no income tax as long as the withdrawals are paid back within three years. It would be limited to borrowers making no more than $114,000, or $166,000 for joint filers.

My questions include: how does the government know where the money is going? Why a bulk amount? After getting their back mortgage paid how do we know they won't lose their house three to six months later? Can the cash be used for whatever they want, since it's their money, isn't it? How will the process work for withdrawals and who pays for it? Who will monitor the pay backs?

Senator Coleman calls it "without a penalty," meaning to the person withdrawing money. Yes, losing one's house is far worse than borrowing from one's 401(k), but perhaps this half-baked idea should go back into the oven to be more thoroughly thought through. A lesson in tax-free compounding will demonstrate the long-term penalty, one to be paid by the up coming generation. The real effect will be felt years from now when participants can't retire or will lose their home to buy necessities. Who will pay for that bailout?

What does this program really do? Many people are aware or can find out by asking, they can borrow against their 401k, frequently at low interest rates. Borrowing requires some paperwork which the plan sponsors already have in place with the processes to fulfill, monitor and administrate all well defined.

The 900 pound elephant in the room is: calculating the odds of a withdrawal under any circumstance ever being paid back! Does the Senator have a fix for Social Security at the same time? We will need it.

Senator Coleman wants to have people bail themselves out with little to no out of pocket expense from the government. I do not believe that the government budgets a lot of revenue from penalties from early IRA or 401 (k) withdrawals. The program sounds good until scratching the surface. The scratch reveals a bad smell. It smells of doing nothing at all and packaging it to look good.

People who borrow from Peter to pay Paul are no better off. They still have Peter or, in this case their 401 (k), to pay back. It postpones a bad outcome, but it doesn't prevent it.

President Bush recently cast a heavy veto preventing people making well less than $114,000, or $166,000 for joint filers to gain healthcare for their children. What make him think the president would help out homeowner?

Perhaps we can create a choice for the government; houses or healthcare? I would choose both, and not based on who has the stronger lobby.

Disclosure: The author is long finding a better way for people not to lose their homes, and insuring children's health.