Giving credence to the big lie - " I'm here from the government and
I'm here to help you"
December 6, 2007
The Mother of all Bad Ideas
Without question, the Bush administration's mortgage rescue plan will
exacerbate, not alleviate, the problems in the housing market. As the
plan will sharply reduce the ability of new buyers to make purchases,
it really amounts to a stay of execution and not a pardon.
Although there are mountains of uncertainty as to how the plan will be
structured and implemented, there is no question that as lenders
factor in the added risk of having their contracts re-written or of
being held liable for defaulting borrowers, lending standards for new
loans will become increasingly severe (higher down payments, mortgage
rates, and required Fico scores, lower loan to income ratios, and
perhaps the death of adjustable rate loans altogether). The result
will be additional downward pressure on home prices, despite the fact
that in the short term fewer homes will be sold in foreclosure than
what might have been without the rescue plan.
Most homes temporarily saved from foreclosure will continue to
depreciate as new buyers fail to qualify for loans. As a result,
lenders will be on the hook for more losses than had the foreclosures
taken place sooner. Of course, as these chickens will likely come home
to roost after the next election, that's a trade-off incumbent
politicians will happily make.
Compounding the problem is that subprime borrowers with frozen
payments on loans that exceed the values of their homes will likely
choose not to pay property taxes, condo or homeowners fees, or
maintain the condition of their properties. Were these properties to
be sold in foreclosure now, at least their new owners would have
financial incentives to maintain the value of their investments.
Upside-down subprime borrowers will have no incentive to throw money
down a rat hole: why make additional payments on properties in which
they have no equity and which they will likely lose to foreclosure
anyway? When these homes do go into foreclosure, back taxes and other
fees on dilapidated properties will inflict even greater losses on
lenders.
Also, subprime borrowers with frozen resets will be unable to either
borrow additional money against their homes or sell them. As rising
credit card payments, higher food and energy bills, and stagnating
wage growth or unemployment make even paying the frozen rates
increasingly more difficult, this lack of flexibility will prove
fatal. Also, the moral hazard inherent in offering help to only those
who can demonstrate an inability to afford the reset rates, or
restricting the bailout to borrowers with low credit scores,
guarantees that borrowers will alter their circumstances to qualify
for the aid. Therefore more loans will be frozen than are currently
forecast, and the financial circumstances of the borrowers will be
that much more impaired as they endeavor to pile on added debt or
reduce their incomes to conform to the requirements of the bailout.
Lost in current discussion is the fact that few subprime borrowers
have any skin in the game in the first place. Having put nothing down
or having extracted equity in previous refinances, most subprime
borrowers will lose nothing if their homes go into foreclosure. In
some cases the teaser rates were so low that borrowers actually paid
less than what they might otherwise have paid in rent. In fact, those
who have already extracted equity have received huge windfalls from
their homes and will leave their lenders holding the bag.
Also missing from the dialogue is the fact that those individuals and
companies that sold these homes to subprime borrowers in the first
place pocketed large sums of money they never would have received if
these exotic loans were not available. Is anyone going to ask them to
give some of that money back in order to compensate the lenders for
their losses?
Finally, it's the camel's nose under the tent that is the most
troubling. Delinquencies on auto loans are now at record highs, and
with no home equity left to extract and a weakening economy, this
problem can only get worse. What is next, a moratorium on car
payments? Of course if the government can "require" private parties to
rewrite contracts, what about the government's obligations to re-pay
its debts? After all, the Federal government is the biggest subprime
borrower of all and it has committed the American taxpayer to the
mother of all adjustable rate mortgages. With the majority of our near
10 trillion dollar national debt financed with short-term paper, what
happens when interest rates rise? Will the government extend the
maturities of one-year treasury bills, tuning them into 10-year
treasury bonds, forcing holders of government debt to accept below
market returns for extended time periods? These are real risks that
will not go unnoticed by a world already saturated with depreciating
U.S. dollar denominated debt.
Ostensibly, this plan is being offered in an attempt to stem the tide
of foreclosures that might otherwise cause further weakness in home
prices. The reality of course is that current home prices are still
too high, having been a function of the lax lending standards and
rampant real estate speculation that got us into this mess in the
first place. A return to prudence in lending also means a return to
prudence in pricing. Everyone seems to agree that a return to
traditional lending standards is a good idea, but no one seems willing
to accept a return to rational prices as a consequence. The
government's attempt to orchestrate such an outcome is doomed to
failure, as it is impossible to maintain bubble prices after the
bubble has burst!
The final absurdity is the Government's attempt to portray their plan
as voluntary. Of course the authorities point out that if their
"suggestions" are not adopted by lenders, much more draconian
legislation will surely follow. Let freedom ring.