Blue Collar Muse

Big T over at ConservativeINC wrote in ‘Capitalism’s Sledge Hammer’,

There is a lot that is said about how capitalism is efficient and how it brings freedom to the individual. But I think that another aspect of capitalism should be added to those two to create a free market triumvirate: failure.

Yes, failure is one of the three most important features of capitalism. Failure destroys many hopes and dreams, true. But failure is also responsible for destroying stupid ideas.

I couldn’t agree more. It’s brutally Darwinian. It’s the way the market works. And while it’s not perfect, it beats the next best option by a country mile.

Nowhere is this more currently evident than in proposals for bailouts for borrowers, lenders or both, arising from concerns with foreclosures on subprime mortgages.

For a basic introduction to the problem, FDIC Chairman Sheila Bair offers,

… the best place to begin is by looking at the poor lending standards and weak consumer protections at the root of the problem — in particular, the troubling loans called 2/28 and 3/27 subprime hybrids. They have starter interest rates of 7 percent or more for the first two or three years, and “resets” that raise rates to as much as 12 percent, causing monthly payments to increase by at least 30 percent.

From this it’s clear some mortgage companies marketed bad products. Often, simply because they could. There was demand for the product, too, from broker and borrower alike. This set the stage for loans catering more to the greed of brokers than the need of borrowers. The Boston Globe’s Steve Baily writes in ‘Subprime Cowboys’ that for one lender, its

… own rate sheet for its brokers tells the story. The higher the rate, the higher the commission. In a common industry practice called a “yield spread premium,” mortgage companies pay a fee to a broker based on selling a loan with an interest rate above what a borrower qualifies for. … [the lender] also offered brokers bounties for selling subprime mortgages with expensive penalties for paying off a mortgage early.

These sorts of lenders ought to suffer for their greed. Left to the mercies of the market, they do. The Mortgage Lender Implode-O-Meter reports since late 2006, 170 lenders have gone under or are in serious financial trouble from marketing subprime loans. These firms have no claim to taxpayer funds to bail them out of a mess they helped create. As with 1980s junk bonds, high risks caught up to high returns and they are paying the price. Lenders which refused to offer subprimes or kept a good mix in their portfolio, are doing just fine today. Further, good loans at good rates are available and becoming more so. Lawrence Yun, senior economist at the National Association of Realtors states,

… widening credit availability will help turn around home sales. “Conforming loans are abundantly available at historically favorable mortgage rates. Pricing has steadily improved on jumbo mortgages since the August credit crunch, and FHA loans are replacing subprime mortgages,”

This brings us to the other half of the equation, the borrower. If we fault lenders making bad loans, we must also fault borrowers taking them. The truth is, not everyone can afford a home at any given point. Home ownership is an earned privilege, not a right. Still, some borrowers ignore easily predictable consequences for the “joy of homeownership” at any cost. Now that the cost has come-a-callin’, taxpayers, via government bailouts, should not be the ones to pay.

Oddly, The Globe’s Bailey recounts this story only as an example of bad lending practices.

… a Dorchester single mom with three kids, unemployed, and living on a monthly Social Security disability check, [got] $800,000 in loans to buy not one but two multifamily homes. Her monthly income was $1,800; her mortgage payments were $7,000.

Granted, a loan company approving such loans should be diagnosed as fiscally suicidal. However, the same is true of anyone accepting them. While I feel for this lady’s situation, a government bailout will only teach her there are no consequences to foolish actions.

Responding to this situation by asking the government’s financial cavalry to ride to the rescue is problematic on several levels. From a common sense perspective, bailouts run counter to practical wisdom we all accept when the issues are less emotional. There are reasons your momma advised, “Look before you leap!” and “If it seems too good to be true, it probably is!” We learn the value of those lessons by ignoring them and paying the price. Bailouts subvert the value of that education.

Economically, bailouts prevent the market from doing its job and potentially introduce unknown variables. The problem was caused by bad economic practices. Solving it with additional bad economic practices as opposed to letting the market work risks creating unstable results and unintended consequences. We know the results market forces produce. Multi-billion dollar taxpayer bailouts are unknowns with equally unknown results.

From a political perspective, bailouts are unconstitutional. There is not a single place in our constitution to which one can point to justify using tax dollars for charity – not one. Not that it hasn’t been tried and tried successfully. But bailouts were scams then and remain so.

So what do we we do? Simply put, no one should do what Countrywide can. Borrowers and lenders got themselves, and the rest of us, into this mess. They should get us out.

The easiest course is for each side to give a little and get a little. The borrower’s issue is not that they can’t make the payments, it’s that they can’t make the reset payments. Lenders paid serious money to acquire or make the loans and have responsibilities to shareholders and owners. But if lenders agree to drop their contractual rights to the reset payments to keep payments at an affordable level and borrowers agree to drop their contractual rights to the length of their contract and agree to pay the lower amount for longer, both sides win. But they each have to do their part by losing some as well. It will be painful and it won’t be perfect but it will solve the problem without government getting involved. I’m sure creative legal and financial guys can come up with other solutions. Fine. It doesn’t have to be my idea. It just can’t be financed with my money.

I understand some companies won’t agree and some borrowers won’t either. It’s amazing the capacity for ignorance we all possess. Or maybe it’s just that we’re looking out for #1. But isn’t that what got us into this mess in the first place? Proving we learned our lesson by doing something different is the only way out that also makes sure it won’t happen again. Bailouts, regardless of how noble or charitable their motive, simply make it inevitable we’ll be having this discussion in a decade or so while talking about even more money.

Hoping prudence wins out over passion …

Blue Collar Muse

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