Free The Memes Archive
December 2007
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7:04pm Thursday December 6, 2007 (link)
Well, they appear to have gone and done it. Paulson's "teaser freeze" plan is now official. I was hoping it would fall apart over objections from lenders and investors, but apparently they are really going to try and do this. Another example of them trying to micromanage the economy, as if their "seat of the pants" intuitions were better than a free market solution.As a libertarian, I'm of course disgusted that the government has so little respect for contracts or the workings of the economy. Even putting that aside, I don't regard this as a good sign. None of the possible explanations are really encouraging.
First, it could be that they are really panicked by the entire mortgage bubble mess. In that case, this move looks like a pretty trivial response. They won't avoid foreclosures by people walking away from houses that are underwater (a huge group.) They won't avoid the ones already past their reset who can't afford their loans. They won't avoid the ones who have lost jobs or just bought more house than they could afford even on the teaser rates. Instead, they will help the tiny fraction that thought they could refinance and now discover they can't. Even those foreclosures won't be avoided, just delayed.
Nationally, housing is predicted to drop by a few percent. In the high-cost areas like California and Florida, 40% drops are being predicted (but we've already seen some new homes discounted that much at auctions.) If that happens, prices will not recover quickly. It could be a decade or more before nominal prices (not corrected for inflation) recover. In that case, five years from now when this freeze ends, all the high loan-to-value mortgages will still be underwater. The borrowers won't be able to refinance, since the house is worth less than the loan. Without another extension, they will just hit foreclosure anyway. This is a recipe for prolonging the housing collapse, not curing it.
This "freeze" could also make things worse, not better, in the short run. I'm not sure what the state of the mortgage market is right now. I have the impression that sales of mortgage backed CDO's has dropped dramatically. I also have the impression that banks have tightened their standards and are no longer offering some products. I don't know if that means there's no such thing as a 95% loan now, or no such thing as an ARM. I still get a fair amount of loan spam in my email (though a lot less than a couple of months ago.)
If the freeze makes lenders and investors shy away even more from exotic mortgages, then it will be that much harder to get a loan. This can only hurt the housing market. Already, I'm reading plenty of stories about people not being able to close on houses because they can't get loans. Or not being able to sell their old house because buyers can't get loans. I would assume that these things affect the low end more than the high end. First time buyers with little money down should be finding it even more difficult to get a loan. A loan with 10% or 20% down is fairly impossible in California, since with the average price at $700,000, a first time buyer would have to have a pretty decent pile of savings (and want to tie it up in a house) in order to get a loan.
Second, I've read some comments to the effect that Paulson isn't panicked by the actual situation, but by what Congress wants to do about it. There's a bill in the works to allow bankruptcy judges to modify the terms of a loan, rather than let it foreclose. The industry is strongly opposed to that. The hope is that this freeze plan, which is voluntary on the part of banks, will satisfy Congress and head off more draconian action.
I can understand being afraid of Congress, but this story doesn't seem to hold water. The President is all on board with this too, and most of the Democratic candidates are calling for even more generous mortgage relief. There must be a fair amount of actual pain out there, in order to produce this quick a political response. Of course, an election year does make Congress panic more quickly, so I can't rule this out as being all political.
Third, this could be the usual response to any economic problem for the last 20 years. Just pump in more money, lower interest rates, or now, easier mortgage terms, and assume we can "grow our way out of it." It's worked before, so why not now?
It's also bizarre to read that politicians want to "head off recession", as if there should never be another one ever again. I think economists would say that without recessions, you won't get growth either. Or that you will bias the economy towards a cycle of bubbles and crashes, rather than small recessions followed by modest growth.
Another opinion is that this is exactly what the Japanese did when their property bubble collapsed. They tried to carry all the bad debt instead of writing it off. They propped up the economy and stock market as long as they could with lower interest rates (down to nearly 0%). They stimulated the economy with lots of public works projects like highways and bridges. They ended up with a 15 year recession.
I could see us doing the same thing, except for a few problems. First, unlike Japan, I don't think major corporations and banks will toe the government line. Someone will bolt for the exits rather than take pain along with everyone else. Second, we don't have the huge pile of savings that Japan did going into their slump. The public will feel the pain and demand more aggressive action by the government (which I would guess will make things worse.) In any case, I don't think our system is capable of a slow, drawn out slump.
Third, within another 4-5 years, the bill for Baby Boomer retirements, both Social Security and Medicare, will start to come due. As soon as the budget starts to show the increased drain, it will become obvious even to Congress that we are out of time on this problem. It will be obvious to foreign investors too. At that point, the future of the U.S. budget will look pretty scary. Finally, because we are so dependent on foreign investment, I don't think we will be allowed to just run the budget into the ground, and borrow what we need to make ends meet. If the future looks really bad, foreigners will stop investing here. At that point, we get a recession whether the government likes it or not.
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