Reminiscent of a juvenile accepting a dare to do something stupid, the chairman of the Senate Banking Committee, Senator Christopher Dodd, crowed to reporters the other day that committee members had done what many thought would be impossible: the committee agreed to legislation that would rescue homeowners facing foreclosure.
Not to disappoint the senator from Connecticut, but few of us ever doubted the ability of politicians to dilute the risks and rewards of voluntary exchange.
The basis of the proposed legislation is the creation of a new bureaucratic process that would provide government insurance of $300 billion in new home loans for at-risk borrowers. In order to qualify for this insurance, lenders would agree to write down loan balances that are below the appraised value of the house. In agreeing to the deal, Alabama Senator Richard Shelby declared that taxpayers would not be at risk. But since government creates no wealth of its own accord, citizens are always at risk of picking up the tab for a government program either through taxation or through higher prices due to government-created money. Senator Shelby’s premise about risk bearing is the start of several points of failed logic in this plan.
The factors that caused the defaulted loans in the first place still exist. The inability to make timely payments is usually the result of excessive debt exposure or loss of income, which may be due to either unemployment or divorce.
For many facing foreclosure, debt is not just confined to a single mortgage balance. In many cases, multiple loans in the form of second mortgages and equity loans were made against the hypothetical value of the property. This brings to question the part of the legislation requiring loan balances to be reduced. Does this include the balances outstanding for second- and third-tier loans? Of course, debt is not just confined to home loans. By some accounts, current credit-card debt in this country stands at over $1 trillion. It would be safe to assume that those facing foreclosure have hearty credit-card balances as a consequence of trying to make ends meet.
One of the grand fallacies about the nature of foreclosures is that the causes of the financial peril are the upward resets of interest-only real estate loans, which naturally cause the monthly payment to increase. Most believe that if these people had standard fixed mortgages, then the despair of losing their homes would be a passing nightmare. The possessive adjective “their” is itself a fallacy, since it implies a claim to ownership of property in which little or no money was invested. But the believers in this adjustable-interest-rate theory overlook the high probability that many of those in default would fare no better under a standard mortgage. For example, today a 30-year fixed mortgage with an interest rate of 6% on a principle of $250,000 would require a monthly payment of $1,490, and this figure does not include property taxes and insurance, which would increase the monthly outlay by a few hundred dollars more — an amount equal to that of the defaulted interest-only loans.
On the other side of the equation, a job loss or divorce that caused an unexpected drop in monthly household deposits is more than likely still present. New mortgage terms have absolutely no effect on one’s employment or marital status. If Congress ever realizes this fact, then it would come as no surprise to see further housing legislation that would mandate the rewriting of employment contracts and marriage vows.
In order for any housing rescue plan to receive a presidential signature, the legislation must not rescue speculators or lenders. But speculation is inherent in any transaction involving debt. When debt is assumed, we speculate that we will be able to meet the terms and the eventual retirement of the loan. We therefore speculate as to the future status of our income, which consists of factors such as health, employment, and marital status. Without speculation, money would never be lent, and few houses would be built.
Yet this or any other government-guarantee plan relies exactly on the economic forces that posturing politicians publicly abhor. It forces all of us to put our faith in those who failed with their own money to honor the commitments made with the money of strangers. If Congress wants to end speculation, then I would suggest beginning with the deal makers at the Federal Reserve.
