Our catastrophe-obsessed traditional media calls it the subprime mortgage "crisis" or "meltdown." Here's what happened:
Borrowers with shaky creditworthiness received low interest "teaser" rates. No problem, as long as housing prices continue to rise. But with house prices stagnating, if not declining, this places some borrowers and the holders of their "paper" on financial shaky ground. In other words, lenders lent and borrowers borrowed. Some borrowers took on debt only to find themselves unable to pay their mortgages, and the carriers of their debt now find their holdings less valuable.
But what about the responsibility of both lender and borrower? The Media Research Center examined news coverage of the subprime "crisis." Of 156 stories broadcast between November 2006 and August 2007, 62 percent "ignored the consumer's responsibility for debt."
No one put a gun to either lenders' or borrowers' heads, and now both sides of the transaction find themselves in financial difficulty. Lawmakers scream for more laws. Never mind lenders already operate under many regulations including, but not limited to, full disclosure requirements.
Democrats, and many Republicans, cry for some sort of government (read "taxpayer") bailout. A New York Times editorial demands legislation, "including a rule that lenders must verify a borrower's ability to pay"!?
House Speaker Nancy Pelosi, D-Calif., and Senate Majority Leader Harry Reid, D-Nev., seek legislation to make Federal Housing Authority "loans more widely available in order to help both new homeowners and those struggling with abusive mortgages." They also demanded that President Bush fund nonprofit foreclosure prevention counseling, and appoint a senior administration official to oversee federal response to the "crisis."
Instead, the President has offered a sort of middle ground, suggesting a five-year freeze on mortgage rates for some subprime borrowers facing default on their mortgages.
Suppose you stayed on the sideline and rented or stayed in a smaller home in order to move up? Too bad, for the Bush plan artificially props up home prices. The President's plan also enables some homeowners to receive Federal Housing Authority loans in which the government taxpayers pay lenders in the event of a default. The plan also does nothing to prevent lawsuits by investors who hold the mortgaged securities in expectation of a certain return.
George Mason University economist Tyler Cowen says, "We've all heard about the defaults on subprime mortgage loans. But so far, the real story is how little the broader American economy has suffered. … Today, banks usually sell their loans to third parties. … You might have originally borrowed money from Wells Fargo, but now a bank overseas cashes your mortgage checks.
"If a large group of people can't pay their mortgages, they may lose their homes. But the banks don't suffer as they used to local American lenders have already converted those loans into cash and sold off their risk. In fact, German regional banks suffered some of the most significant losses from bad American mortgages. Other European and Asian banks and hedge funds took their lumps as well. American banks essentially bought insurance by exporting their risk overseas."
Let's not minimize the trouble faced by thinly collateralized borrowers and their lenders, given the soft housing market. But the financial difficulties affecting both sides of transactions voluntarily entered into do not warrant a taxpayer bailout.
U.S. homeowners' equity today equals almost $11 trillion. Price declines for this year and next year may amount to $6 billion, or a 0.05 percent decline a worry, but hardly Judgment Day.
Christopher Cagan, of First American Real Estate Solutions, estimates that "the impact of rate sensitivity and subsequent defaults will be … well below one-half percent of total mortgage debt outstanding" and spread out over several years.
Donald Trump, who knows a bit about crisis management, having dealt with his own financial "meltdown," suggested a simple, direct approach: Cut a deal with your lender. Similarly, Treasury Secretary Henry Paulson has already urged banks and borrowers to get together and renegotiate the terms of their loans.
So what would a bailout say to those who avoided the subprime lending fervor? The Wall Street Journal reports that unlike Citigroup and Merrill Lynch, Goldman Sachs "maintain(ed) relatively small holdings of collateralized debt obligations, or CDOs, the complex mortgage-related securities whose rapid devaluation prompted the massive writ-downs at other firms." Should government reward the shortsighted losers and, by extension, punish firms such as Goldman Sachs and Lehman Brothers that had the foresight to protect themselves?
People in the insurance business use a term called "moral hazard." This means actions, however well-intended, that shield people from the consequences of their behavior lead to even more irresponsible behavior. Secretary Paulson recently said, "I have no interest in bailing out lenders or property speculators."
OK, then butt out!