Asked for their thoughts on falling home prices and rising foreclosure rates, the leading Republican candidates for president have said they oppose “bailouts” for irresponsible lenders and borrowers. That’s good to hear. For markets to work properly, imprudent actions must have consequences, and with few exceptions the government’s role should be limited to punishing fraud and enforcing contracts. But the Bush administration has proposed a plan that goes far beyond this — rewarding people who took out loans they couldn’t afford, and encouraging lenders to back out of their contractual obligations to the investors who bought their mortgages. Will any of the Republican contenders have the political courage to call this the bailout that it is and oppose it?
The president’s plan focuses on adjustable-rate mortgages — home loans on which borrowers agree to pay a low, “teaser” rate of interest for a set number of years until a higher rate kicks in. When used responsibly, adjustable-rate mortgages can help young families afford to buy homes while raising small children or completing an education. The idea is that by the time that higher rate kicks in, the stay-at-home parent will be ready to enter the workforce, or the holder of an advanced degree will have a high-paying job. But during the housing boom of the past few years, many borrowers simply assumed that housing prices would continue to go up. These borrowers took out adjustable-rate mortgages thinking that, when the higher rate hit them, they could refinance or sell the home and walk away.
But home prices are falling instead, and higher rates are about to kick in on hundreds of thousands of mortgages. Many of these borrowers will not be able to afford the higher payments; they gambled on home prices and lost. A wave of foreclosures would accelerate the decline of housing prices, and the president does not want Americans to think he is “doing nothing” about this, especially going into an election year in which his party faces enormous difficulties anyway.
Under the proposal the administration unveiled last week, the big mortgage lenders (e.g., Countrywide Financial) would allow borrowers who can’t afford higher payments to keep paying the “teaser” rate a little longer. Responsible borrowers who used the savings from their low-rate period to invest in education, or who went back to work after raising a child, get nothing out of the proposal. It primarily benefits those who imprudently took out mortgages they knew they could not afford unless housing prices continued to rise. How can the market discourage such behavior when the federal government encourages it?
If this moral hazard were the only consequence of the proposed bailout, it would be reason enough for opposition. But the bailout would also hurt renters who hoped that the current dip in housing prices would give them an opportunity to buy. They responsibly waited and saved for such an opportunity, even as others rushed headlong into mortgages they now find themselves unable to pay back. If the president’s bailout succeeds in bolstering home prices, it will punish prudence and reward recklessness.
The bailout would also rewrite thousands of private contracts between mortgage lenders and investors in mortgage-backed securities. In today’s mortgage market, it is common for banks that make mortgage loans to sell them on Wall Street, where they are packaged according to risk (hence the term “sub-prime,” which refers to riskier packages) and bought by investors looking for a reliable rate of return. Many mortgage banks effectively become loan servicers, collecting payments for these investors.
Not all investors in mortgage-backed securities are thrilled with the idea of freezing interest rates on hundreds of thousands of adjustable-rate mortgages, and some have threatened to sue if the deal goes through. They won’t be able to, though, if a bill sponsored by Republican congressman Mike Castle of Delaware becomes law. Castle’s bill would shield the mortgage banks from these lawsuits, giving them a free hand to go along with the administration’s bailout. This would do enormous damage to the reputation of securities backed by American debt.
Defenders of the administration’s plan argue that it would be worse for investors if the mortgage banks were forced to foreclose on thousands of borrowers. But that is beside the point. If it is in investors’ interest to allow mortgage banks more flexibility to renegotiate the terms of certain mortgages, there is nothing stopping them from working out a solution on their own.
What we don’t need is for the federal government to pressure everyone into a one-size-fits-all approach — especially one that rewards irresponsible lending and borrowing, makes idiots of prudent borrowers, and punishes renters for whom a dip in home prices is a big opportunity. Americans who believe in personal responsibility and oppose big-government bailouts need someone to speak for them. Why not a Republican running for president?