Why A Mortgage Bailout Is A Mistake

Posted In: Bailout, Foreclosures, Home Prices, Homeowners, Housing, Interest Rates, Mortgages, Politicians, Subprime, U.S. Government

This morning I read an article on Yahoo! Finance entitled, “Mortgage Bailouts, Who Should Be Helped, and How.” The author of the piece, David Wessel, argues in favor of “bailing out” American mortgage borrowers who are in danger of losing their homes. At first, I thought the article was a hoax. Then I realized we’re a long way from April Fool’s Day. Wessel says:

While we’re sorting out the big question about the subprime debacle, how to preserve the good (hard-working, bill-paying people once barred from the American dream becoming homeowners) without repeating the bad (fraud, reckless lending and fast-talking salesmen peddling mortgages to folks who simply can’t afford them), there’s an issue that can’t wait: a tidal wave of foreclosures.

My turn. A big deal is always being made about homeownership as part of the “American dream.” The reality is, homeownership IS a dream, NOT A RIGHT. Whatever happened to work hard and earn enough money to afford the initial downpayment and subsequent installments on a home mortgage? Someone forgot to tell this to the 43% of first-time homebuyers in 2005 who acquired their homes through “no money down” arrangements.

Sure, “fraud, reckless lending and fast-talking salesmen peddling mortgages” were an unfortunate sign of the times. But a number of these “hard-working, bill-paying people” were just plain irresponsible. Back on November 6, I noted the following:

A recent study conducted by D.C.-based Peter D. Hart Research Associates discovered the following characteristics among borrowers:

• 51% say they are very informed about their mortgage’s terms and conditions
• 18% say they don’t know their current interest rate
• 25% say they don’t know when their lender will next be able to raise their rate
• 73% say they don’t know how much their monthly mortgage payment will increase the next time their rate goes up
• 40% say they don’t know whom to turn to for guidance if they have difficulty paying

On November 2, Brian Montgomery, Assistant Secretary for Housing with HUD, told a congressional hearing that more than 40% of delinquent borrowers do not respond to contact from their lenders until it is too late. Which is really quite sad, considering that industry sources say 50% of those who seek counseling or go to their lenders for help end up staying in their homes with new mortgage products.

Wessel says that mortgage rate resets will be the breaking point for vulnerable borrowers:

Interest rates on about two million once-popular, subprime mortgages known as 2/28 or 3/27 (because the rate for the first two or three years is lower) are poised to jump in the next year. Many will rise to a range of 9.5% to 11% from 7% or 8%. That would boost a typical subprime borrower’s payment by roughly $350 a month. For many of those borrowers, that’s the difference between affordable and not.

The Chicago Tribune reported on November 18 that:

In a poll of 1,004 mortgage holders commissioned by Bankrate.com, 34 percent didn’t know whether their mortgage had an adjustable rate or not. And in a survey of 500 owners with adjustable rate mortgages commissioned by the AFL-CIO, 49 percent say they don’t know the terms.

So who cares if the rates reset higher, because the borrowers sure didn’t.

Wessel explains that while it was foolish, these homeowners should not be made to pay for their mistakes:

Sure, a lot of these mortgages shouldn’t have been made. It was foolish for lenders and homeowners to bet housing prices would keep rising. But allowing millions of foreclosures to punish the imprudent isn’t smart. It’ll damage entire neighborhoods.

You bet it was foolish to bet housing prices would keep rising. I recall that some time ago a survey of Los Angeles residents revealed that they actually expected home values to keep appreciating at or around 20% every year. That’s just crazy-insane. California is notorious for its real estate booms and busts. What were they thinking? Had housing hit a “permanent plateau?”

“But allowing millions of foreclosures to punish the imprudent isn’t smart.” It might be what the doctor ordered. As I noted in a post on September 3, BusinessWeek discussed different bailout proposals on August 28 in “What Will Fix the Mortgage Mess?” They had this to say:

But foreclosures—widespread foreclosures—are inevitable. The days of easy money meant that many people borrowed much more than they could afford—and keeping them in their dream houses will only penalize other taxpayers and encourage more uncontrolled borrowing in the future. Risk, as Wall Street veterans like to point out, can be risky.

“It’s sometimes better to let the market cleanse itself out,” Kathleen Camilli, a member of the National Association of Business Economics, told BusinessWeek.

Many economists believe that bailouts usually are not the best solution. “Our focus is on liquidity, not a bailout,” said Doug Duncan, chief economist at the Mortgage Bankers Association in the BusinessWeek article. With a bailout, “You’re going to change behavior in the marketplace in ways you hadn’t foreseen.”

Wessel says:

So the public-policy questions are: Who should be helped, and how?…

It’s the folks in the middle who need and deserve help from the industry and, if need be, the government: those who are making payments, would have refinanced easily if not for the housing bust and dysfunction of mortgage markets and can’t afford the reset payments…

It would be nice if all this could be handled with taxpayer money…

In my August 13 post, Jonathan Hoenig for SmartMoney talked about a proposed mortgage bailout by 2008 presidential candidate Hillary Clinton. Hoenig had this to say about bailouts:

But the real reason to oppose a bailout isn’t that it’s impractical, but that it’s immoral.

To live freely means to act in accordance with your own rational beliefs and to accept the consequences of your decisions, no matter how unwise they might seem after the fact. Those individuals who made financial commitments they can no longer afford to honor have no right to demand taxpayers bail them out. In America, we have the right to “life, liberty and the pursuit of happiness,” but not the guarantee we can live in the four-bedroom Colonial that’s priced way beyond our means. It might sound cold, but homeowners who can’t pay their mortgages should not expect to be able to keep their homes.

Forgetting the fact that these individuals willingly took out loans well beyond their means or didn’t plan for a rainy day in which the real estate market wasn’t soaring, politicians on both sides of the aisle say they are entitled to keep their home. So they plan to take other people’s hard-earned money and give it away… not because these individuals did anything to deserve it, but simply because they need it… When Hillary pledges $1 billion in financial aid for homeowners, however, it’s not her money; it’s the taxpayers’, many of whom would undoubtedly prefer to give to any number of other deserving recipients.

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