HOUSING HORRORS

DEMS’ DISASTROUS CRISIS FIXES

By ALAN REYNOLDS

Barack Obama and Hillary Clinton plan to fix the "subprime mortgage crisis" in ways that would greatly worsen the situation.

In a Financial Times piece last August, Obama wrote that "predatory lenders were driving low-income families into financial ruin.ñ.ñ. The real victims in this crisis are the millions of borrowers .ñ.ñ. whose only crime was taking out mortgages that lenders told them they could afford."

He claimed his Stop Fraud Act would stop "mortgage brokers who are hoodwinking low-income borrowers into taking on loans they cannot afford." More precisely, that bill promises "to stop transactions which operate to promote fraud, risk and underdevelopment."

It certainly would "stop transactions." Under it, even people with no authority to decide who gets what sort of mortgage (such as realtors) could face 35 years in prison and fines up to $5 million for anything deemed deceptive. The predictable effect would be to scare lenders into offering mortgages only to rich people with great credit scores.

Obama imagines foreclosures are confined to low-income families with subprime adjustable-rate mortgages (ARMs). On the contrary, a Mortgage Bankers Association study shows that prime mortgages (mostly fixed rate) accounted for 45 percent of all foreclosures in the third quarter of last year, while subprime ARMs accounted for 43 percent. And even subprime borrowers don't necessarily have a low income or even a low credit rating.

Obama wants untold billions for "a fund to help people refinance their mortgages and provide comprehensive supports to innocent homeowners .ñ.ñ. The fund will be partially paid for by increased penalties on lenders who acted irresponsibly." Sen. Clinton proposed a similar slush fund last December, starting at $5 billion but quickly growing to $30 billion.

This approach is sure to appeal to politicians and bureaucrats - who'd have great fun deciding which homeowners or cities would get financial aid.

Obama admits that "some borrowers were also lying to get mortgages or engaging in irresponsible speculation." Problem is, nobody can easily distinguish liars and speculators from "innocent" homeowners.

Obama also supports a bill to let bankruptcy judges rewrite mortgage agreements at whim. Any deadbeat with a $300,000 mortgage and 7 percent interest rate could ask a judge to make it a $200,000 mortgage at 5 percent. If the bill passes, expect a runaway stampede into bankruptcy courts as to take advantage of this opportunity.

The key flaw? Anything that increases the risk of loan losses inevitably increases interest rates. That's why junk bonds pay a higher rate than Treasury bonds. If we let mortgages be rewritten by judicial caprice, we're converting mortgages into junk - and so greatly increasing mortgage rates.

Hillary Clinton has a more heavy-handed approach. She wants a 90-day moratorium on subprime foreclosures. After giving its select beneficiaries an extra three months of rent-free living, this move would drop a huge backlog of foreclosed homes on the market at once - with a nasty crashing sound.

She also wants to dictate an "automatic freeze" for interest rates on subprime ARMs - keeping rates at the below-market introductory rates for "at least 5 years, or until subprime mortgages have been converted into affordable loans."

That has to be unconstitutional - the government can't blithely rewrite the terms of two private parties' contract. But it's also a terrible solution to the wrong problem.

Again, nearly half of foreclosures have been on prime mortgages - triggered by falling home prices, not by rising interest rates. Even for subprime ARMs, the interest rate re-sets after a couple of years based on the 1-year LIBOR (an interest rate on loans between banks). That rate has dropped to 2.8 percent - which means the increased monthly payment on subprime ARMS will be less than 10 percent, not the 30 percent she claims.

In other words, it won't be as big a deal as Clinton thinks when subprime-loan rates adjust. The real danger is if house prices drop below the size of the loan - because many people will then walk away from the mortgage, regardless of the interest rate.

If Congress acts to arbitrarily freeze mortgage interest rates, as Clinton wants, lenders will start guarding themselves against the chance that lawmakers might do the same thing again someday. That is, they'll see mortgages as highly risky investments - so future would-be borrowers will find mortgages scarce and expensive.

Obama gets it. He warns, "A blanket freeze like she's proposed will drive rates through the roof on people who are trying to get new mortgages to buy or refinance a home."

Quite right - yet his proposal to let judges reduce rates and the size of loans would drive rates through the roof for exactly the same reason.

Obama's main concern is that it's been much too easy for low-income families to get home mortgages. He plans to put a stop to that by 1) threatening lenders with fines and prison and 2) letting judges tear up the contracts and write new ones.

Ironically, one reason we got into the current mess is that Washington spent the last few decades criticizing and fining mortgage lenders for not lending to low-income households with imperfect credit records - a practice called redlining. Now Obama plans to punish lenders in criminal and bankruptcy courts until they bring redlining back.

With friends like Clinton and Obama, prospective low-income homeowners won't need any enemies.

Alan Reynolds, a senior fellow with the Cato Institute, is the author of "Income and Wealth."

Colombia's FARC Frees Four Hostages in Chavez Deal (Update3)

Feb. 27 -- Colombia's biggest guerrilla group released four hostages today in a deal brokered by Venezuelan President Hugo Chavez, ending six years of captivity in remote camps for some of the prisoners.

Two helicopters in the Chavez-led operation to free the former Colombian lawmakers reached a meeting point in southern Guaviare, Colombia, where a rebel patrol escorted them out of the jungles, Red Cross official Barbara Hintermann said on Caracol TV. All four lawmakers are healthy enough to travel, she said.

The prisoners, held by the Revolutionary Armed Forces of Colombia, are at the center of a diplomatic dispute between Chavez and Colombian President Alvaro Uribe, who pulled backing for the Venezuelan leader's mediation efforts in November. Chavez deepened the rift by pledging support for the rebels and urging Latin American and European nations to grant the FARC, as the group is known, formal political recognition.

``The FARC has prioritized the release of civilian hostages in poor health, trying to counter recent images of the captives living in inhumane conditions,'' said Patrick Esteruelas, Latin America risk analyst with Eurasia Group in New York.

Colombia suspended military operations in the area where the release was expected. The FARC holds as many as 750 captives and has a policy of executing them if troops approach the camps or attempt any rescue.

The former hostages include former Senator Jorge Eduardo Gechem, who suffers from a bleeding ulcer and heart problems and is said to be in 'grave' condition, according to Colombian government intelligence.

`Double-Edged Sword'

The helicopters, bearing Red Cross emblems, will return after the pickup to Venezuela, where family members are waiting.

The former hostages are getting medical attention from doctors on the flight, which will make at least one stop in Santo Domingo, Venezuela, said Jesse Chacon, the minister of the president's office, in comments broadcast by state television.

``We want the families to know that their loved ones are already in our hands,'' Chacon said.

The release of hostages today is the second this year. Last month, Chavez received two prisoners, former vice presidential candidate Clara Rojas and former congresswoman Consuelo Gonzales. Chavez has said he will maintain contact with the rebel group in a bid to negotiate a swap of captives for 500 jailed rebels.

`Double-Edged'

Colombian Defense Minister Juan Manuel Santos, speaking live on Caracol TV, called on the rebels to release all hostages they hold.

``Releasing hostages becomes a double-edged sword for the FARC,'' said Stephen Donehoo, Latin American specialist at Washington-based Kissinger McLarty Associates. ``They retake center stage in the world's press and pay off political debt to Chavez, but it also serves as a reminder of the conditions in which it keeps hostages for so many years.''

Armed with modern weapons and financed by drug funds and ransom payments, the 8,000-strong rebel group drew anger over the past months in Colombia when letters and videos from the hostages were released, including images of former presidential candidate Ingrid Betancourt and three U.S. contractors.

Betancourt was chained and looking emaciated. Others, mostly soldiers and police, were chained by the neck.

The four hostages freed today are part of a group of about 43 high-profile captives used by the FARC to gain international recognition and as bargaining tools to force the government to free jailed fighters and set up a demilitarized zone.

Safe Zone

Uribe has repeatedly said he will never allow the FARC a safe haven like the Switzerland-sized free zone set up by former President Andres Pastrana in 1998 to promote peace talks. Gechem played a role in dismantling that experiment.

Gechem, then the president of the Colombia Senate's peace commission, was kidnapped on Feb. 20, 2002, when guerrillas hijacked a commercial jet and forced it to land on a highway.

The government at the time had aerial photographs that showed the FARC had built more than 25 illegal airstrips to fly out drug shipments as well as training camps and a prison.

Gechem's capture brought an end to peace talks and marked the start of an offensive by Uribe, who replaced Pastrana in August 2002, to crush the rebels after more four decades of violence.

Easing Violence

Congresswoman Gloria Polanco de Losada was seized in 2001 along with her two sons. Her husband, former lawmaker and governor of Huila province, Jaime Losada Perdomo, was killed after paying a ransom for the boys who were each held three years.

Lawmakers Orlando Beltran Cuellar and Luis Eladio Perez, a diabetic who fell into a coma while in captivity, have both been held about six years.

Donehoo, who worked for U.S. military intelligence, said repeated captive releases may foster confidence on both sides, which could in turn improve the likelihood of a wider hostage swap for jailed rebels.

Since his election in 2002, Uribe has launched a military crackdown on the FARC and on the smaller National Liberation Army as well as their rightist paramilitary foes.

Kidnapping has fallen by 83 percent since 2002 and homicides are down 40 percent, according to government figures. Terrorist attacks are down 76 percent.

Bernanke Signals Fed Prepared to Lower Rates Again (Update5)

Feb. 27 -- Federal Reserve Chairman Ben S. Bernanke signaled the U.S. central bank is prepared to lower interest rates again even as inflation accelerates.

The Fed ``will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke said in testimony to the House Financial Services Committee in Washington.

Bernanke's remarks may reinforce investors' expectations that policy makers will lower rates further to shore up the faltering economy. While officials have expressed concern that inflation is accelerating, Bernanke indicated he shares Vice Chairman Donald Kohn's view that financial-market turmoil and slowing growth pose the ``greater threat.''

Bernanke's testimony came as government reports today showed the U.S. expansion, now in its seventh year, is in peril. Durable-goods orders fell 5.3 percent, more than forecast, in January as companies cut spending. New-home sales fell last month to the lowest level since February 1995 and house prices slid by a record 15 percent from a year ago.

``The Fed is in full risk-management mode, which means it has to prioritize financial market stability and growth over inflation,'' said Diane Swonk, chief economist of Mesirow Financial Inc. in Chicago. ``The discussion of inflation and inflation expectations, however, effectively sets the stage for a fairly quick normalization of rates once growth stabilizes.''

Regulatory `Mistakes'

Lawmakers have accused the central bank of failing to protect consumers and supervise mortgage lending adequately. Committee Chairman Barney Frank, a Massachusetts Democrat, said yesterday ``excessive deregulation'' was the ``single biggest cause'' of the downturn. In today's hearing, Bernanke acknowledged ``mistakes in terms of regulation and oversight.''

Bernanke referred to ``downside'' risks for the economy four times in his testimony, and noted that data since the last Fed meeting in January pointed to ``sluggish'' growth. Policy choices have also become more complicated as energy and commodity prices rose in recent weeks, he indicated.

Stocks and Treasuries were little changed. The Standard & Poor's 500 index was down 0.06 percent to 1,380.50 at 3:22 p.m. in New York, while 10-year note yields held at 3.85 percent.

Inflation Concern

Inflation is picking up and the public's expectations for prices may also be rising, Bernanke said. He reiterated remarks made to a Senate hearing on Feb. 14 indicating the Fed will increasingly take account of the inflation outlook later in the year as the economy stabilizes.

``Further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month,'' Bernanke said.

Consumer prices last year surged 4.1 percent, the most in 17 years, spurred by higher fuel and food costs. A government report yesterday showed the 12-month increase in wholesale costs accelerated to 7.4 percent in January, the biggest jump since 1981.

Risks to the outlook include ``the possibilities that the housing market or the labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further,'' the Fed chairman said.

Offsetting Impact

Bernanke said pressures in credit markets have offset some of the impact of the Fed's interest-rate cuts.

``Even as the Fed has lowered interest rates and as the general pattern of interest rates has declined, the pressures in the credit markets has caused greater and greater spreads, particularly for risky borrowers,'' Bernanke said in response to a question from Representative Luis Gutierrez, an Illinois Democrat.

Traders anticipate the central bank will lower the benchmark rate by at least half a point by the end of the next meeting, on March 18, futures prices show. Officials have lowered the rate by 2.25 percentage points since September, to 3 percent.

A half-point reduction to 2.5 percent would bring the rate adjusted for inflation, less food and energy, to almost zero.

Bank Losses

Bernanke, 54, is in the seventh month of a credit crisis that began with rising delinquencies on subprime mortgages, while also grappling with the economic impact of the worst housing recession in a quarter century. Banks are making it tougher to get loans after financial companies posted $162 billion in asset writedowns and credit losses since the beginning of 2007.

In its separate monetary-policy report released with the testimony, the Fed said near-term inflation expectations, measured by surveys, ``rose somewhat in 2007 and early 2008, presumably because of the increase in headline inflation.'' Longer-term expectations ``changed only slightly.''

``A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability,'' the Fed chairman said.

Economic reports since the Fed last met on Jan. 29-30 showed the first decline in U.S. payrolls in more than four years in January and a slide this month in consumer confidence to the lowest level since 2003.

`Less Favorable'

``The economic situation has become distinctly less favorable since the time of our July report,'' Bernanke said. Still, the $168 billion stimulus package enacted by Congress and signed by President George W. Bush this month and continued gains in exports should help growth, he said.

In the semiannual report, the Fed said that the U.S. economy ``seems to have entered 2008 with little momentum.'' Labor demand ``has slowed further of late,'' it said.

Bernanke focused the final pages of his testimony on the Fed's efforts to strengthen consumer protections and prevent foreclosures. He said in answering questions that the final rules will be released before July.