Friday, March 07, 2008

How to Stop the Mortgage Crisis Another Government Backed Solution

I will be honest, my family got into a mortgage crisis. We made a decision related to our mortgage based on some assumptions regarding salary and income that did not come true. Ours was not an irrational decision and like most decisions, we had to make it with less than perfect information available. We are now in the process of refinancing our home with a different, more stable type of loan. Out loan to value ratio of the mortgage to the market value of the house is pretty high, but given that my income is almost sure to rise over time and my wife's a little less steep in growth, the current decision is the best we can get. We made better inquiries and have now learned a lesson in home mortgage economics we are unlikely to make again. (Oh and under the terms of the new mortgage, I don't have a payment until May--cool, huh).

There are lots of problems with the so called mortgage/foreclosure "crisis," many of them caused by governments themselves and others by a market that simply ran wild for too long without a correction. The latter is generally unsolveable by anyone but market place participants. The former shouldn't be solved by another government program. Martin Feldstein, a former economic advisor in the Reagan Administration, has a proposal to help solve the "crisis" with a loan substitution program. The plan sounds complex and I will admit tries address some negative incentives of allowing a home to foreclose with some disincentives. But it is another government program designed to correct for a problem caused by a government program. The Community Reinvestment Act encouraged lenders to grant loans to homebuyers they normally would not have lent to due to credit risk or too high a loan to value ration. But the CRA helped create a real estate boom based on inflated home values (also caused in part by government regulation). Feldstein's proposal will not add to the government debt (so he says) over time. But the program essentially gives money to people who would otherwise be a credit risk.

As I stated before in a post about Maryland's plan to prevent foreclosures, there are three probable outcomes of Feldstein's loan substitution program:
  1. The debtor will be able to get back on their feet and get their finances cleaned up, thus repaying the substitution loan and their regular mortgage. I suspect this will happen in less than a quarter of the cases, and probably less than ten percent--but again that is a guess.
  2. The recipient will not be able to get out of foreclosure trouble in the long run and their house will be foreclosed upon. All the substitution loan did was stave off the inevitable for a couple more months. The reasons are likely many, but the crux of it will be they have more house than they can afford and/or more debt than they can service. However, this scenario assumes that the individual homeowner will still pay off the substituion loan.
  3. The recipient will be unable to stay in their house, default on their mortgage and the substitution loan, get foreclosed on and also not be able to repay the governemnt. In this case, the debt is either written off by the government or remains uncollected for a long period of time. In short, the government will have given away tax money to a homeowner who was a bad credit risk to begin with and the consequences of that bad lending decision come to fruition.
So in essence, Feldstein's plan is really a bailout and a hand up for just a few people.

Why do I have no heart when it comes to people facing foreclosure? Two reasons. First there are usually private, charitable resources that can help in a short term crisis. Some of these pending foreclosures might happen regardless of the current "crisis," happening for reasons related to death, injury, loss of job or changes in employment. My father volunteers for one charitable source, Catholic Charities. Government should not provide the solution. Charitable organizations or other private entities are more likely to get paid back because people don't see those entities as giving them a "right" so much as an assistn. Start giving out taxpayer money and people will start to view it as a right, which leads us to the other reason. Second, if we are to foster a nation that is not dependent on governmental saviors, we have to stop giving them salvation from their own bad decisions. My family is paying the consequences of our decisions and it would be a very chilly day in Satan's parlor before I would ask the government for help to protect me from my own poor decisions.

There is also a segment to all this that is rarely raised. The connection to governmental revenues and expenditures.

What I think is missing behind all this concern about the foreclosure crisis is really the govnerment concern that housing prices and land values will fall, thereby decreasing the governmental revenues (at least those parts generated by property taxes and transfer/title/real estate fees). If revenues drop, that means government would have a smaller budget and smaller budgets don't make for enriched constituencies, which means some politicians lose their jobs. Thus, in order to stave off declining governmental revenues, the government needs to spend more taxpayer money on a program that prevents foreclosures and thereby declining property values. The result of which is of course, increased governmental expenditures. A vicious never ending cycle. Add to that another "constitency" now dependent or further dependent upon the government largesse.

Thus, smaller governmental revenues means a smaller government and in my book that is all the more reason not to permit programs like Maryland's or Feldstein's to go forward. That is why I have little heart for people who make bad decisions. I make them and I suffer the consequences because I believe govnerment shouldn't be in the business of bailing out people (and corporations) who make bad decisions. Maryland's plan is bad and Feldstein's is not as bad, but it is pretty close.

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