The American people didn't stop working for government until July 11. Cost of Government Day is when we finally paid for all federal, state, and local spending and regulation. But if housing lenders and investors have their way, we will soon be working even longer for government.
When the times were good, everyone wanted in on the housing market. As prices escalated, no one could lose.
If a buyer got in over his head, he could refinance or sell and everyone would still come out ahead. Thus developed so-called "subprime" lending to borrowers with less than sturdy credit -- more than $600 billion worth just last year.
Irresponsible borrowers were only part of the problem. Irresponsible lenders rushed to issue mortgages, bundling many of them into so-called collateralized debt obligations (CDOs). Irresponsible investors rushed to snap up the $320 billion worth of CDOs issued in 2006 alone.
Unfortunately for everyone involved, the real estate slowdown has turned subprime lending into subprime returns. Homeowners are losing their homes; subprime borrowers account for just five percent of mortgages but 60 percent of foreclosures. That's 600,000 homes going back to lenders; many of the properties are worth less than their mortgages. A half trillion dollars worth of mortgages with low initial rates are about to be reset, so the losses will only grow. In fact, foreclosures are expected to jump from 1.2 million this year to 2.5 million next year.
When bankers lose money, investors see red. Two hedge funds managed by Bear Stearns Co. now are essentially valueless. Mutual funds also have taken a hit, spreading the losses to middle class investors.
A lot of money is involved, as much as $100 billion in losses, according to Federal Reserve Chairman Ben Bernanke. But that remains a small hit on a $13 trillion economy. The individual losses are painful, but they are individual, not public, problems.
Yet Massachusetts Gov. Deval Patrick has led the parade to bail out the subprime market -- by, ironically, issuing more subprime loans. To allow homeowners to refinance, he has proposed a $250 million fund, with $190 million from Fannie Mae, the national mortgage agency backed by the federal government, and $60 million from the Massachusetts Housing Finance Agency, through a new bond issue.
The loan terms -- 30-year, 7.75 percent mortgages for 105 percent of the home's value -- aren't merely generous: they're a bonus for irresponsible financial decision-making.
Government policy should not reward recklessness, yet that's what Gov. Patrick's plan does: subsidizing the overleveraging of an asset that the borrower can't afford or shouldn't be buying. It's an understandable but misguided impulse to help that casts the state in the role of enabler and unconscionably throws gasoline on the flames.
The money would go to the borrowers in the greatest trouble, thus guaranteeing substantial state and federal losses. (The State Senate separately voted to subsidize employers who subsidize home-owning employees.)
There's a perception problem to boot. The Massachusetts plan is a sweet deal for lenders--and Governor Patrick sat on the board of one of the largest subprime lenders in the country while they were issuing these loans that are now going bad. Advancing a plan to ding the taxpayers he is supposed to represent in order to bail out subprime lenders like the one of which he was a director doesn't pass the smell test, let alone the common sense test.
But Massachusetts is only the start. New York Mortgage Agency officials are planning a $100 million program. A similar proposal is being considered in Pennsylvania.
Some bailout advocates would prefer that the federal government craft a national program. For example, legislation in Congress would allow the Federal Housing Administration to offer 40-year-loans in an attempt to bail out overstretched homeowners.
These sorts of initiatives are egregiously counterproductive. Difficult though it is for policymakers to step aside, we should allow the market to continue adjusting.
Instead of protecting borrowers, lenders, and investors from their own folly such proposals would make us all worse off. Most obviously, taxpayers would find themselves working longer for government -- well beyond July 11.
More responsible homeowners also would suffer. Only one-in-20 homeowners has a subprime loan; the tail should not wag the dog in the mortgage market.
Unfortunately, credit is not infinitely expandable. Diverting good money to bad borrowers means fewer loans would be available for those who did not buy a bigger home than they could afford. Mortgages will be less available and more costly.
Equally important, a bailout would set an a dangerous precedent. Instead of holding borrowers, lenders, and investors responsible for their actions, the government would be sending the bill for their mistakes to others. Personal accountability is fair and just. It also sends a powerful message: watch what you are doing.
Every time politicians bail out an industry, they encourage more irresponsibility in the future. In this case, everyone in the process -- homeowners, lending institutions, brokerage houses -- would learn that profits are theirs to keep but losses can be palmed off on taxpayers.
Nor would future problems be confined to the homeowners' mortgage market. The federal government has previously bailed out automakers, steel companies, savings and loans, and hedge funds, among many others. We must break this cycle of irresponsibility.
The breakdown of the subprime lending market is going to generate many losers. That's unfortunate. But we should not exacerbate this problem by making it another crisis for taxpayers.
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