President’s Housing Bailout a Big Mistake
By Michael E. Chadwick, CLU, ChFC, CFP®

You can tell an election is scheduled for 2008. The Congress and President Bush have recently proposed a plan to “rescue” the slumping housing market by prohibiting mortgagees from raising interest rates on variable-rate mortgages (bona fide legal contracts between consenting parties). Does the government also think that real estate prices should continue to appreciate by 15-20% annually and never stop? $300,000 for a starter home that five years ago cost $100,000 is acceptable, reasonable and prudent? It’s unfortunate for our Social Security recipients that the COLA (cost of living adjustment) applied to their Social Security payments (historically 3.1%) didn’t reflect the apparently acceptable appreciation levels for home price increases. A house isn’t your biggest asset, it’s a financial liability and a lifestyle decision. If it were indeed an appreciating asset, would banks sell them off when they foreclose? Wouldn’t banks be excited about the current state of the real estate market if houses were truly appreciating assets? They could just sit and wait knowing that a few million foreclosures are coming down the pike, buy them cheap, and make tidy profits. The reality is banks sell houses when they foreclose on them, often at deep discounts.

Many presidential hopefuls are also devising their own illustrious plans for “rescuing” the housing market. Why?! Is our system a democratic, capitalistic system where people have free will to make choices, take risks, make mistakes, and things work out based on Economics 101 principles of supply and demand? Or are we a Communist regime where prices and business practices are dictated by the government? Should those who act prudently be called upon to bailout, forcibly by the hand of government, those who act foolishly? This plan sounds great for those who bought houses they couldn’t afford in the most overheated housing market in history. True, in a very limited number of cases unscrupulous mortgage brokers and banks took advantage of borrowers, and these scoundrels should be held accountable, just like Enron executives were. But the American public shouldn’t be forced to pay the bill for those who were cognizant of the risks they willingly assumed.

Underwriting standards have already changed in the wake of this summer’s credit crunch but there are millions of people who made poor decisions and they need to work their way through the system. Letting the free market work this out will teach many consumers, who are all participants in the free market, a worthy lesson that hopefully will spur them to change some bad habits. Most American consumers simply carry too much debt because they don’t live by the old adage of “don’t buy it unless you can afford it”. Make sense, doesn’t it? Why do so many not wish to hear it? Our society has become one of instant gratification and no discipline. People need to learn how to make good decisions and if they choose to be foolish they need to be held accountable by being allowed to endure the harsh consequences of their actions.

The government plan is to alter the terms of existing adjustable-rate mortgages (legal contracts) by prohibiting them from adjusting their interest rates upward for a period of five years. Ostensibly this is all that is needed to help homeowners avoid foreclosure. Do you think this plan will stop foreclosure? It may slow them down over the next two to three years, but energy prices are still increasing, the economy is slowing and people are going to get laid off because the segment of the population this rescue is aimed at are those who don’t behave responsibly with their money or simply don’t earn enough to comfortably afford a home; they simply shouldn’t have had houses in the first place (in other words subprime should not be a sector of the market). These people in the subprime sector bought homes with no safety measures built in; they don’t have six months worth of income saved and they’re living paycheck to paycheck. So they not only have a mortgage but two car loans and credit card debt. If anything goes wrong, such loss of employment, it’s a house of cards that must come crashing down.

This rescue plan, if implemented, will likely slow the number of new housing units entering the market via foreclosure in the next two to three years by spreading it out over 5-10 years, but it certainly won’t stop it. The real solution is to make people pay for their mistakes and learn lessons. This is what makes people better, stronger and smarter- not rewarding their foolishness with bailouts. If this plan is implemented, what investor will ever buy a mortgage bond again knowing the rate of return they’ve been promised can be altered altogether at the stroke of a government pen!? The tight credit dilemma facing us now is due to the fear people have about willingly putting their money at risk in a system where things are fuzzy at best. This government intervention will make bond markets tighter than two coats of paint in the future. This market is going to correct, whether the government throws out a life preserver or not; markets always find an equilibrium. As time unfolds we also will have to wrangle with auto loans and credit card delinquencies – they’re farther down the pike but the writing is on the wall. Will the government just keep bailing out the bubbles or will they install a real solution – free markets and financial education for the masses. Financial literacy should be a requirement to graduate high school, but it’s not even an elective.