Posted on 12/08/2007 4:42:53 AM PST by Kaslin
Like obnoxious relatives, the mortgage mess won’t go away. Some two million adjustable-rate mortgages (ARMs) will reset over the next two years, and analysts say that within the coming year alone, $362 billion in subprime home mortgages will experience rising interest rates. This will lead to ever more payment defaults and foreclosures, a horrible state of affairs not only for the affected homeowners and lenders, but also for the financial markets in general.
As is their wont, officials from both parties are rushing to offer “solutions.” The Bush administration is urging lenders to maintain the low teaser rates on ARMs, while Hillary Clinton recently advocated a 90-day moratorium on home foreclosures. Although casting themselves as knights rescuing beleaguered citizens from greedy corporations, in truth these politicians will only make matters worse.
In his classic Economics in One Lesson, Henry Hazlitt said that the good economist looks not only at the obvious, immediate beneficiaries of a government policy, but also considers the long run, hidden costs. We should do the same with the latest mortgage proposals. Although particular homeowners may benefit in the short run, such government tinkering will ultimately harm average Americans by distorting the mortgage industry.
To understand the downside of the recent proposals, we need to step back and ask ourselves why ARMs and foreclosure clauses exist in the first place. They are obviously advantageous to the lender, so it’s no surprise that banks favor them. But why do the borrowers agree to these terms? Why doesn’t everybody simply take out a conventional fixed rate loan, and moreover one that is unsecured—so that the bank can’t seize one’s house in the event of default? Is every borrower just plain stupid for failing to insist on loans of this nature?
Of course not. The reason borrowers agree to adjustable rates (which have the possibility of skyrocketing) and to pledging their home or other assets as collateral, is that this allows them to receive concessions from the bank—in particular, it allows them to borrow a great deal more money than would otherwise be possible. Very few people would persuade a bank to lend them money to buy a house, if the bank didn’t ultimately have the right to take ownership of the house in the event that the borrower couldn’t make the mortgage payments. Yes, borrowers would prefer that they get a $300,000 mortgage with no strings attached, but lenders wouldn’t be too happy with this arrangement. The beauty of a capitalist system is that property owners must compromise to reach mutually beneficial arrangements, since private transactions are voluntary.
Now after individuals enter into these voluntary arrangements, what happens if the government swoops in and invalidates them? There will be short term winners and losers, naturally. And most Americans have no problem with this, because it seems fair to help struggling homeowners at the expense of Wall Street fat cats.
Yet this conclusion is very superficial. Lenders will learn the lesson that their contracts aren’t safe; contrary to popular belief, the government will not serve to enforce the law. (Or rather, the “law” can change on a dime, depending on the public’s mood.) Lenders won’t simply shrug their shoulders, say “aww shucks,” and continue with business as usual.
No, lenders will rationally respond to the new environment, by being much pickier in giving new loans. After all, it becomes much riskier to grant a mortgage to a young couple with little job experience, if the government will shield them from the consequences of default on the loan. Many people say that “the American dream” involves homeownership, yet this will be harder to achieve if the government introduces yet another uncertainty for lenders.
I am aware that the real world process of home buying and financing has its share of shysters and shady practices; every human enterprise does. But the recent proposals aren’t merely about prosecuting outright fraud; no, the politicians want to grant a mulligan to hundreds of thousands who bought homes they couldn’t afford.
If true, then the true culprits are the brokers who finagle these deals. They do so without any regard to the validity of the loan.
Everyone wants to make money regardless of the future consequences.
Dittos.
I think you put some blame on brokers, but only a modest amount. Reports of bait and switch and application altering have certainly been in the news. They only got away with it because nobody else involved in the loan process was asking any questions. That goes for people borrowing the money and the institutions buying the loans.
PMI is now deductible for loans written after 1/1/07, provided that the household gross income is less than 100K.
The PMI helps to blunt the cost of a foreclosure. PMI companies are in trouble due to the large amount of claims; I assume this will lead to higher PMI rates but I don’t know that for sure. As far as I know the PMI companies are still ok, but they have been hit really hard.
Interesting puzzle. I would think the fundamental problem lies with the scattering of buyers in such fashion that nobody has authority to make necessary decisions. To what extent is the government making the decisions, and to what extent is it giving the mortgage bond service companies the authority to do so?
Suppose that the government hadn't acted, but a mortgage bond service company unilaterally decided to accept a point lower interest rate from someone and had rock-solid proof that the alternative would be a foreclosure which would have cost the bold holders more. Would the bond holders have standing to sue for breach of contract even if the service company could demonstrate that they came out better than they would have if the contract had been adhered to precisely?
What would happen with a conventional corporation if its shares became so widely distributed among non-voting entities that it became impossible to establish a quorum? Would the quorum requirements be waived, or what?
Perhaps the best remedy in the mortgage situation would have been to provide that certain actions could be undertaken on mortgage bonds by less than a full quorum of bold holders. In that case, bond holders who would have reason to object to a particular course of action could make their objection known; those who declined to object could be deemed to have given at least tacit acceptance.
Looks like it is for homes purchased or refinanced this year unless the law is extended..
A billion ain’t what it used to be.
1 Billion dollars equals the value of only 1500 homes in California. In a state with 40 million people it just doesn’t amount to much.
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