worse than the disease
Topics: Regulation
04 Dec 2008
From: Ervan Darnell
Once again, I find myself disagreeing with the professionals. The treasury is floating a plan to guarantee 4.5% interest on new home loans [1]. There seems like all kinds of trouble with this:
1) Part of the problem to start with was the implicit guarantee of Freddie and Fannie that caused people to dump bad loans on them. The treasury is just making that explicit, and will induce yet more bad loans. They claim there will be higher standards for borrowers. Let's hope so. But if they are only going to insure safe loans, banks (or private investors) would already loan the money. The very fact that they are going to insure the loans means they are risky loans. Besides, this is where we started years ago and Congress pressured Fannie and Freddie to take on high risk borrowers out of some misplaced sense of social justice. The political pressure will be the same here.
2) "Credit freeze up". Well, no wonder, why would any bank write a loan today, when maybe tomorrow the government will insure it for you? This kind of regulatory jerking makes it impossible to many any rational economic calculation. Similarly, why would you buy a home today when the government might subsidize it tomorrow? The point was to keep prices it up, but just talking about it makes them drop.
3) The stated purpose is to keep prices from falling. Isn't that ultimately part of the problem to start with, that housing prices are too high and people are stretched too thin to try and buy a house? Yes, many other things contributed. But if housing were 15% of the average budget instead of 30% (or whatever the number is) we wouldn't be where we are. Okay, if housing were cheaper people would buy bigger houses, but marginal disutility of carpeted space says they wouldn't spend all back to where they were. The whole thing seems like an exercise in denying the reality of housing prices, and spending $100G's of to do it.
4) The likely follow on plan (no details yet), will subsidize people in foreclosure, i.e. reward the foolish and punish the prudent. If you punish prudence long enough, you'll succeed in destroying it.
5) And when exactly is the government going to stop this huge hand out? Will it become a subsidy indefinitely.
6) Total outstanding mortgage debt in the U.S. is about $10T [2]. Bailing out all of that bad debt seems inconceivable (I'm not sure what percentage is bad, or will soon become so).
Yes, I really do feel sorry for ordinary people who bought at the top and now cannot afford their payment. But it seems like mortgage companies are already willing to bargain. They don't want a foreclosed home in this market, so they are rationally incentivized to accept lower payments, or possibly even take an outright loss and accept a new lower payment. The latter possibility might entail family A and family B switching homes as they each go from a $300K house to a $200K house to get a lower mortgage (and suffer bankruptcy if they don't have a walk-away loan). That is, everybody has to live somewhere. It's not like 50% of housing is going to be left empty.
I do have some sympathy with the idea that if 25% of all loans (a number I hear as the "upside down" percentage) go bad, most every bank holding a mortgage is bankrupt too. Even just negotiating down to economic reality on the mortgage might kill them. But, in some sense, the money is already gone, it's just about distributing the losses. At this point, the argument for subsidizing mortgages needs to be about breaking some feedback cycle. If the argument is just "these people need help" that's not enough because you have to hurt someone else at least that much in order to make it happen.
At least this makes more sense than bailing out GM, since it's the same standard for everyone and goes to the core of the financial crisis. Also, it makes more sense than the Obama plan of forcing mortgage companies to take a loss (by regulating rates and imposing moratoriums), driving yet more into bankruptcy (if there is a cycle to be broken, clobbering mortgage companies makes it worse).
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[1] http://www.pbs.org/newshour/bb/business/july-dec08/mortgageplan_12-04.html
[2] http://en.wikipedia.org/wiki/Subprime_mortgage_crisis
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