Arnold Kling  

Helping Mortgage Borrowers, Revisited

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Timothy Taylor takes the wrong side of this issue.

it seems to me that a modest share of the trillions in federal borrowing in the last few years, along with the trillions of assets that the Federal Reserve has accumulated through its "quantitative easing" policy, might have been better applied to assisting the millions of American households who took out a mortgage and bought a house--implicitly relying on the ability of supposedly better-informed lenders to tell them what they could afford--and then were blindsided by the national downturn in housing market prices.

The first part of his argument is irrelevant, in my view. The fact that the government spent trillions of dollars doing other things does not in any way imply that it is now beneficial to bailout mortgage borrowers.

Let me repeat some of the problems with bailing out mortgage borrowers.

1. Not all mortgage borrowers were "blindsided." Many of them knew what they were doing. Many of them were repeating speculative strategies that on previous attempts had generated windfall profits.

2. Many mortgage borrowers lost little or nothing. They put no money down and they never accumulated any equity.

3. Many mortgage borrowers, if given assistance, default again (one reads of re-default rates of 50 percent). They are being set up to fail.

4. The assistance to mortgage borrowers does not create wealth. It redistributes wealth to those borrowers and away from other people. For example, other people who might be able to buy homes if market prices were allowed to fall to their market-clearing level are shut out. People who were prudent during the housing bubble get nothing out of the bailout other than the increased tax liability needed to pay for it.

5. There is a huge deadweight loss in these programs. That is, the transaction costs involved in screening borrowers for eligibility, processing new mortgages, and so on, are quite high. As I have said before, this involves combining and redesigning two different processes--loan servicing and loan origination--and the cost of writing computer systems and training staff to handle this new hybrid process is quite significant.

Overall, I think that borrower bailout programs have done for the housing crisis what price controls did for the energy crisis of the 1970s. That is, they have deepened and prolonged the agony.

Of course, you know that I am even more strongly opposed to the bank bailouts. Again, the argument that "we bailed out the banks, therefore we should bail out the borrowers" carries no weight with me. We should have done neither.

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COMMENTS (8 to date)
Jack writes:

Suppose I borrow $200,000 from the bank to buy some dividend-paying stocks. I spend the dividends as they are paid out, and I'm counting on the stock to increase in value at a higher pace than the interest on my loan. Suddenly, stock prices crash. If I sell my stock, I remain substantially in debt. If I hold on, I might one day recover (if stock prices increase enough to make up for lost time). But the bottom line is that I'm in trouble and I should cut my expenses elsewhere, or find a higher-paying job to pay off the difference.

I don't see any important difference between this scenario and homeownership (or "homeownership", given zero or very low down payments).

One exception: with stocks, I can travel to get a better job. Houses cannot move. This makes it harder to relocate and get a better job (or a job, period, if I have been fired).

John David Galt writes:

Point 3 is the strongest one. If (some) borrowers are deemed as deserving help, it should not be in the form of a loan modification unless it's going to include enough of a principal reduction so that the borrower is no longer "upside down." Otherwise there's no reason for him not to default again.

But then, the only real moral argument for giving borrowers any help is that they were being "set up to fail" when the loan that allowed them to buy the home was written in the first place. Indeed, if the lender or mortgage broker in a particular case knew that the borrower was sure (or nearly sure) to default, then writing the loan was an act of fraud under existing law.

If the courts can reliably tell such victims apart from the kind of profiteers you talk about in points 1 and 2, my solution would be to nullify the loan and award the buyer the home.

But even if we must shun that possibility to avoid moral hazard, there is no doubt in my mind that tens of thousands of bankers and mortgage brokers, who got rich by writing these loans before the bubble burst, ought to be in prison, and their fortunes confiscated and used to pay for the bailouts that have already taken place.

Point 4, I think, is misplaced blame. Home prices have not stayed high because of borrowers being helped. (Indeed, *no* CPA in my city will admit to having met even one person who received a loan modification, and I doubt that any lender is willing to grant any, for the reason in point 3.) Home prices have stayed high because ALL of America's largest banks insist on delaying every potential foreclosure as long as possible -- because if they foreclose, then they have to write one more nonperforming loan off their books, and if they write all of them off, it will mean they (the banks) are legally insolvent and the FDIC *must* shut them down and pay claims. Which it can't do. The day the feds get around to enforcing this law, we will have no functioning banks plus runaway inflation of the dollar.

Which explains why point 5 is being ignored.

R. Richard Schweitzer writes:

What are the underlying, fundamental obligations in these circumstances? To whom are they due? From whom are they due? In each case say why.

Governments have no money. Thus, do the taxpayers have obligations to be performed through governments in these circumstances?

Banks, even the Fed, are intermediaries in providing credit from their fiduciary relationships to depositors and to those required by law to accept legal tender (sound money principle?). To whom are the banks obligated?
To whom are the depositors obligated? To whom are the "users" of money obligated?

Are there other obligations in the commerce of real estate and lending? Yes. But, does that justify creating, asserting and imposing obligations upon taxpayers, depositors and those reliant on value of money when those other obligations have not been fully met?

Think inside the box.

Tracy W writes:

A bit of an aside I know, but:
There is a huge deadweight loss in these programs. That is, the transaction costs involved in screening borrowers for eligibility, processing new mortgages, and so on, are quite high.

Have I misunderstood deadweight losses? I would have said that transaction costs you describe are transfers to people who do the paperwork. Aren't deadweight losses the losses that no one gets because they are from transactions that don't take place.

Seth writes:

As Russ Roberts says, capitalism is a profit and loss system. Profits encourage risk-taking. Losses encourage prudence.

Socialize the losses and you just get risk-taking.

Mike Rulle writes:

Other than that, Tim Taylor got it perfectly right.

mark writes:

I see in his post he quotes the IMF about a New Deal program that is extolled as a model. But the very quote raises skepticism about that program - 20% of restructured mortgages defaulted and went into foreclosure. Not an impressive result.

JimS writes:

"implicitly relying on better informed mortgage brokers to tell them what they could afford"

Why would anyone believe that a mortgage broker knows their financial situation and spending habits better than they do. That assertion is ridiculous. If an individual can't figure out what size monthly payment they can afford they probably shouldn't be buying a house.

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