President Bush and Treasury Secretary Hank Paulson announced recently a plan to “freeze” interest rates on so-called “sub-prime” mortgages, at taxpayer expense (of course), so that rates won’t reset higher on these debt instruments as provided for in the respective mortgage agreements. In other words, contracts freely entered into by mortgage borrowers and their lenders are now to be broken by government fiat so as to prevent them from facing the consequences of their own bad judgements. This is not only bad economics (it amounts to throwing good money after bad), it is also immoral, forcing responsible borrowers and lenders to foot the bill, i.e., rewarding bad behavior and punishing the good. Said Peter Cohan of A. Peter Cohan & Associates, “This has the perverse effect of punishing those with good credit who follow the rules, and rewarding those who don’t.”
The push for a bailout is being led by big mortgage lenders looking to the government to save them from their own mistakes. Henry Killinger (CEO of Washington Mutual) and Angelo Mozilo (CEO of Countrywide Financial) both called for greater government intervention into the housing market through increased taxpayer funding of Fannie Mae and Freddie Mac, the government-backed mortgage finance companies, which purchases mortgages from private lenders. Mozilo, reports the New York Post on 12/04/07, “wants the government-backed agencies to increase the number of troubled loans they hold”… loans originated by irresponsible private lending practices, thus foisting the risks and costs onto the taxpayers. And you thought big business is pro-capitalism! (To be fair, many mortgage lenders were pressured into unsound lending practices by liberal politicians who wanted to increase homeownership among low-income [i.e., high risk] borrowers. Nevertheless, it is wrong to force others to pay for any bailout.)
Yet as bad as this sounds, the negative long-term consequences of this preposterous Bush administration scheme could border on the disastrous as government intrusion into the private financial markets advances. In a hard-hitting piece by Nicole Gelinas published in the New York Post, there is a proposal buried in this bailout plan that can lead to “problems [that] are almost too painful to describe”. She writes, “Treasury Secretary Hank Paulson will propose to Congress to let cities and states issue tax-exempt debt to bail out even more borrowers.” Thus, in addition to federal tax dollars, “do-gooders” all the way down to the local level will be able to grab tax money at multiple levels of government to bail out their constituents, ultimately enabling these “homeowners” to “use the [taxpayer] money to pay off the mortgages they can't afford - and take out new, more affordable mortgages with their city or state government.” Taxpayers- the ones who “play by the rules”- will be left holding the bag for a risk burden “no private investor will touch.”
The market, left alone, will sort out the sub-prime mortgage mess, through the free, uncoerced decisions of the lenders, investors, and homeowners. Homes will be re-possessed and resold, money will be lost by banks and investors, home prices will decline to attract new, responsible buyers. Lenders and borrowers, as well as the investors who bought the mortgage securities backed by the bad loans, will face the consequences of their actions. Credit market conditions may temporarily tighten up. There is nothing in the current housing downturn that hasn’t happened before.
But interference by government with the free market will have negative and unforeseen consequences, as it always does. Indeed, the severity of the current downturn as well as the pain of the borrowers and lenders was exascerbated by government policies that artificially encourage homeownership among people who really can’t afford it. President Bush’s plan will only prolong the correction by allowing the irresponsible to evade the consequences of their actions, while saddling the rest of the taxpayers with the bill.
Alex Epstein of the Ayn Rand Institute, in a post on the blog Principles in Practice titled The Injustice of 'Doing Something' about Subprime (11/12/07), offers the only real “solution"… the government should essentially do nothing. “The proper response of the government to subprime problems,” he writes, “is simple; commit to no new interventions in the housing market, and cease all existing intervention designed to influence home ownership—from programs like Freddie Mac and Fannie Mae to artificially low interest rates. Such a move would send a message befitting a free people: a message of responsibility. Individuals would be responsible for the loans they make and for choosing the housing option that is best for them. The government would protect everyone's rights by enforcing laws against theft and fraud, and by protecting the individual's right to make his own decisions and keep his own money—even when others make bad use of theirs.”
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