The United States of Bailouts

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Back in May I wrote a column about potential circumstances that could stem the housing market's decline. The bulk of the article dealt with the many and varied ways that the federal government could attempt to keep home prices propped up. My opinion hasn't changed much since then, so to avoid rehashing the entire thing here I recommend that those with hazy memories check out the original piece. (I know I had to -- I can't remember what happened a week ago, let alone seven months ago, as all my memory cells are apparenty filled to capacity with a knowledge of early-1980s television that is as vast as it is useless. I don't think I've been able to form a long-term memory since Manimal was cancelled).

Well, not even a year has passed and the government has jumped with both feet onto the bailout bandwagon. The Federal Reserve, those guys and gals who are ostensibly charged with maintaining the soundness of our currency, have slashed interest rates despite serious weakness in the dollar. In so doing they've demonstrated that preserving price stability is lower on the priority list than giving a boost to the housing market. How well it will work is another question, considering that higher inflation would bring a new set of challenges, but they're going for it nonetheless.

Fed head Ben Bernanke then proposed that government-sponsored mortgage securitization giants Fannie Mae and Freddie Mac should have their debt explicitly guaranteed by the taxpayers and that they should be able to make loans up to $1,000,000 instead of the current limit of $417,000. Many other people have proposed raising Fannie's and Freddie's loan size limit, in fairness, though few have been bold enough to suggest that someone buying a $1,000,000 house should be entitled to what is effectively a government subsidy.

The big news of late, however, is that Treasury Secretary Hank Paulson is putting together a plan in which some borrowers who took out adjustable-rate loans will have their rates frozen at the initial "teaser rate" so that they can continue to stay in the homes that, strictly speaking, they could never actually afford in the first place.

Will Paulson's plan work? It might keep some people in their homes, but it doesn't address the real long-term issue, which is that homes are still far too expensive in comparison to incomes. It also doesn't address the real short-term issue, which is that there is a huge oversupply of houses for sale. For as long as homes are both unaffordable and in abundant supply, extending a teaser rate for five years won't really have a big effect one way or the other. There is also a question of how many potentially defaulting borrowers will want to stay in their homes even if they can keep their teaser rates. They are still on the hook to pay the loan off eventually, after all -- given that so many of them owe more than their homes are worth, it stands to reason that many borrowers will bail out of their loans whether they can scrape up the monthly payments or not.

The results may be somewhat in question, but as the following quotes from my May column indicate, these actions were all quite predictable:

The Federal Reserve will want to lower their short-term federal funds rate...

They [our leaders] could force lenders to extend mortgage teaser-rate periods or allow lower monthly payments for troubled owners...

They [same folks] could direct government-sponsored mortgage purchasers Fannie Mae and Freddie Mac to loosen their standards to keep mortgage credit freely available...

A reader of that prior column took me to task via email because he thought, to my amazement, that I was actually advocating the policies I described. So I will be more clear this time around. These policies punish the prudent, reward the reckless, and will in all likelihood cause more long-term problems than they solve. Similar efforts to fight off the effects of the stock market crash earlier in the decade were themselves a huge contributor to the housing bubble and, in turn, to the issues we now face. Policymakers have clearly not learned a single thing, and the most important thing they have not learned is that the systemic risk posed by a bubble can only be truly mitigated (rather than redirected somewhere else) before the bubble gets out of control, not after it has already burst.

Besides, most of these policies amount to an attempt to keep homes unaffordable. How exactly is that a good thing?

-- RICH TOSCANO