BobK

Seems like lots of people are upset about the idea of providing relief to homeowners who are in a difficult mortgage situation. And on the face of it, it’s wrong. Of course, we should not rescue people who overextended themselves, who bought homes they couldn’t afford. Right? Why should taxpayers bear the burden, even indirectly?

Unfortunately, it’s not so simple.

We could just let homeowners go bankrupt and foreclose on their houses. Then the banks would own houses they couldn’t sell. The banks would have a serious problem. It’s tempting to say, “just let the market work it out.” Indeed, that was the prevailing sentiment from 1929-1932. It didn’t turn out very well.

The possibility of widespread bank failures from the mortgage crisis is real, though I suspect we’ll learn from history and avoid it. And preventing widespread foreclosures is one thing we learned from the past. But in order to avoid widespread bank failures, the government will likely have to help somebody. The best help is to provide relief to individual homeowners before the banks start having more problems. Otherwise, we’ll have to bail out the banks. Yuck. Better to provide relief to some homeowners, even if they’re undeserving, than to bail out the banks that hold their mortgages. That seems like a simple moral calculation to me.

It’s easy to say that the homeowners now struggling “made bad investments.” But when did good investing skill become a qualification for home ownership? Home ownership is traditionally such a risk-free investment that it’s considered savings. Young people are encouraged to buy homes. And in the long run, all the homes now facing foreclosure will likely double in price. They’re all good investments… for somebody who can afford to carry them for several years.

Now, there’s a perception out there that everybody who’s in trouble now is a “flipper’ or a speculator, or a poor person who bought a mansion on a 1% teaser rate. There certainly are some of those, though I suspect most of the “flippers” and speculators have already defaulted. The root of the problem was the rapid increase in home prices, coupled with (or caused by) historically low interest rates. The mortgage problem is not limited to sub-prime borrowers, they were just the first to fall.

Think about the terms of the mortgage that the average working person takes out. They put down 10% or so of the cost of the home, and make fixed monthly payments. Saving up $20,000 to buy a $200K home is a big task for working people. Even that 10% down payment is a lot of money to most people. In stable economic times, this is is fine. But if the home value drops 10%… it wipes out that hard-earned down payment. If the home value drops 20%, the person has not only lost all their money, they’re on the hook for the 10% deficit…. or more. Not only have they lost their down payment, they need to come up the same amount again, or face bankruptcy. Again, I’m not talking about people with bad credit. Nearly everybody who bought a house with 10% down in 2003-2004 is stuck in a home that has declined in value enough to wipe out their investment.

There’s a lot of noise about bad mortgage lenders and overly creative loan terms, and there’s some truth to it. But those problems were caused not by a sudden surge of greed and irresponsibility, but by a Federal Reserve that kept interest rates under 2% for a full three years, long after the recession of 2001-2002 had ended. The combination of historically low interest rates and a recovering economy in 2004-2005 was toxic. It made the mortgage and real estate businesses extremely profitable, and that in turn set the housing market on fire. Responsible people bought houses by whatever means available, simply because home prices were appreciating so quickly, they feared they’d be left behind, unable to buy a home unless they did it soon. Professional traders learn to recognize such situations and avoid them. But the average working person simply gets fooled by the rapid price movement, and the last to buy are hurt the worst. Had those people bought their homes two years earlier, they’d be called “good investors.” Instead, they’re portrayed as deadbeats.

Even so… they made a bad investment. Should they be bailed out by the government? Well, strictly speaking, no. That wouldn’t be “fair”. But here’s my problem. What about the people who owned homes before 2003? Those people saw their homes appreciate in price by 20, 30, even 50 percent…. indirectly, this came at the taxpayers’ expense. Should those people give back the profits? How about Realtors who made huge commissions during those years? What about the people who made money originating mortgages? How about Google, who derived huge advertising revenues from mortgage brokers vying for top placement? What about carpenters and plumbers who were in short supply and were highly paid during those years?

Many of the people who are now complaining about “housekeepers in California who bought million-dollar houses with no money down,” are the very same people who sold those houses to them. They are the people who bid up prices so that a “million dollar home” was sometimes a 2-bedroom ranch. Even those who didn’t get a windfall from the Fed’s mistake have benefited from the generally strong economy of the last few years. Moral posturing is pointless, here. Everybody in America benefited indirectly from the run-up in the real estate bubble. Everybody.

So I don’t really have a problem with providing relief to people who bought houses and who live in them; in fact, I’m very much in favor of it, to the extent that it can avoid bailing out bankers. In the end, though, we have no choice but to ensure the banks’ solvency. Far better to do it indirectly, and save some homeowners as well.

Now, the President has a plan, and I’m sure Congress will come up with one of their own. Will they be fair? No. Some people will be on the hook for doing no wrong. Others who deserve relief won’t get it. That’s the nature of government plans. Yes, this is government fixing a problem of its own creation. But I’ll repeat that the lesson of 1929 is that the banking system must continue to operate, at whatever cost. And if we’re going to have to take steps to ensure the system, then it’s far better to try and help undeserving homeowners than to help undeserving bankers, right?

Many who are posturing about the “moral hazard” of a bailout are too quick to forget that they themselves profited by way of an earlier government mistake, specifically, the extremely low interest rates. Yet nobody is complaining that the profits on the home they sold in 2005 were “morally hazardous.” But they were. The moral hazard was that it made other people feel they had to buy a house by whatever means before it was too late.

Underwater homeowners may not deserve relief… but we may be stuck with providing relief somewhere, and everybody else deserves it less.