As rates increased, homeowners sought refinancing only to find there was none, except at rates they could not afford as lenders suddenly became far more circumspect in their lending policies. The result: a crisis in credit that has now led to massive write-offs by leading financial banks, such as Merrill Lynch and Citicorp.
Now there is bank crisis déjà vu and it’s scary. Those financial institutions that overextended will now pay the piper and some of the smaller ones may be forced into insolvency proceedings (just as many savings and loan institutions were in the 1980s).
Demand for housing grew because of favorable mortgage rates leading to a jump in housing construction and values. This in turn encouraged people to use their equity in a profligate way. Everyone across demographic lines got a chance at the “American Dream” of home ownership. For some, it provided a chance at multiple dreams, as they “flipped” homes within a short period of time. But heck, that just made good sense because homes always increase in value, and there would always be willing buyers with ARMs.
Sure they do. Once again, we were abruptly reminded of the age-old lesson: What goes up must come down.
Painful as it is, the plain fact is any struggling borrower or lender who signed a clear, non-fraudulent contract is responsible for making sure it is paid off. The fact that many borrowers were betting on a never-ending real-estate boom translated to taking out risky loans. The same held true for those who expected their adjustable rate mortgages would stay low forever, given the Fed’s longtime manipulation of artificial interest rates.
Still others did not carefully assess the contracts they signed (while, of course, certain lenders lent money without carefully analyzing the borrower’s finances).
What’s the solution? We hear the phrase “bailout,” but a bailout is nothing more than the government using its power to force some people to give up their money (or freedom) for the sake of others. Any government “borrower assistance,” i.e., borrower bailout programs, such as a Massachusetts’ proposal to give struggling homeowners new loans they could not get on the free market, excuse borrowers from the natural consequences of their voluntary risks.
Subsidizing the refinancing of subprime loans for delinquent borrowers wrongly absolves individuals of responsibility for their bad decisions and compels those who did nothing wrong to pay the price. The plan also would apply hardball negotiating tactics to lenders, forcing them to accept a financial hit on the mortgages that the state will refinance.
The Massachusetts approach, no matter how it might be described, is a bailout pure and simple.
The government is not necessarily a savvy lender and does not have the expertise to contribute innovative financing strategies or much new knowledge to the mortgage market. Its proper response to subprime problems should be to commit to no new interventions in the housing market. As well, it should begin to recede from existing intervention designed to influence home ownership, such as artificially low interest rates. What the government should do is protect everyone’s rights by enforcing appropriate laws against theft and fraud, and by protecting the individual’s right to make his or her own decisions and keep his or her own money.
This would send the right message — namely, that individuals are ultimately responsible for the loans they make and for choosing the housing option that is best for them. Any problems they have are their responsibility to remedy — just as any gains borrowers and lenders have made on risky subprime mortgages are theirs to keep. Most importantly, it would allow the market economy to complete the process of self-correction that has now begun.
Ted Sares of North Conway can be reached at firstname.lastname@example.org.
This article appears in the December 21 2007 issue of New Hampshire Business Review