The Mortgage Crisis

 

Some questions about the mortgage crisis:

 

• Can the government stop the decline in home prices?

•Can they avoid more loan defaults?

• Can they engineer a soft landing for the mortgage loan industry?

• Is the crisis already over?

• Where are we in the process?

• Can the government actually manage the situation?

 

Ben Bernanke, Chairman of the Federal Reserve, recently “endorsed the need for government intervention, saying that letting markets take their own course could destabilize communities, reduce the property values of nearby homes and lower municipal tax revenues.” He is asking lenders to consider “cutting the principal of some customers’ loans to prevent foreclosure, noting, ‘When the source of the problem is a decline of the value of the home well below the mortgage’s principal balance, the best solution may be a write-down, perhaps combined with a government-orchestrated refinancing.’ ” (“Bernanke pushes government help to curb foreclosures,” Los Angeles Times, May 6, 2008).

Bernanke also recommended legislation permitting the FHA to “increase its scale,” along with U.S. Rep. Barney Frank, D-Mass., and U.S. Sen. Chris Dodd, D-Conn., who are calling “for up to $300 billion in loan guarantees from the Federal Housing Administration to refinance loans that homeowners can’t afford as long as the original lender reduces the principal on the loan to 85 percent of the home’s current market value.” (“Many problems with mortgage bailouts,” CNNMoney.com, April 22, 2008).

 

This plan to induce lenders to write off a portion of loans that “homeowners can’t afford,” is a very bad idea. In exchange for taking an immediate 15 percent write-down, the federal government will provide replacement financing, thus effectively transferring the remaining risk of loss to the taxpayers. It would favor borrowers who foolishly took larger loans than they could afford or on terms they could not handle and lenders who knowingly made high-risk loans to unqualified applicants. If property values continue to drop, it would simply result in another round of defaults and losses. To his credit, President George W. Bush has threatened to veto this legislation if Congress should pass it.

 

Who would we really be bailing out, anyway? Lenders or borrowers? And where would the $300 billion come from? Certainly not government reserves, because there are none, which leaves more borrowing as the source of funding. 

Warren Buffett, of Berkshire Hathaway fame, currently ranked by Forbes magazine as the wealthiest man in the world, recently told Bloomberg.com, “The worst of the crisis in Wall Street is over.” However, “in terms of people with individual mortgages, there’s a lot of pain left to come.” Mr. Buffett’s conclusion was echoed by Alan Greenspan, former Federal Reserve Chairman, who is reported also to have said that the worst of the credit crisis is over.

According to Cyril Moulle-Berteaux, writing in the Wall Street Journal (May 6, 2008), it is very likely that the housing crisis is already over, pointing out that the current “bust is nearly three years old.” He further notes, “New home sales are down a staggering 63 percent from peak levels of 1.4 million. Housing starts have fallen more than 50 percent and, adjusted for population growth, are back to the trough levels of 1982.”

We should not be influenced by media sob stories about people losing their homes and avoid any attempts to have the government further interfere in the market. Real estate cycles have occurred many times before, and we should simply let this one finish playing out, especially since it looks as though it may have already bottomed.