By DICK ARMEY
For many, the American dream starts with homeownership. Purchasing a home is usually a family's largest financial commitment. A home is not just a personal investment. It is an investment in the community and an affirmation of our fundamental value of private property.
Since we are all touched by the housing market, any turmoil in the housing sector grabs attention and emotions, as evidenced by the recent coverage of the subprime mortgage meltdown and "crisis." But should we be preparing for the next Great Depression, and do we need the federal government to save us?
Unfortunately, the media have a tendency to sensationalize stories, and, by nature, politicians will attempt to get in front of any issue to promote themselves.
When you go beyond the demagoguery and look at the economics, it is clear the mortgage market is correcting itself and that a government bailout would only make matters worse.
Standard home loans (85% of all mortgages) are made after a thorough evaluation of an individual's credit and job history. Traditionally, only those with high credit scores and a stable job history were eligible for these "prime" home loans. But since 2000, lenders have increasingly offered home loans to folks with weaker credit and less consistent job histories who would not qualify for standard mortgages.
Subprime loans have expanded homeownership by introducing new, risk-laden borrowers to the market. As in any market, the price of a loan reflects this added risk by the lender. Even in the best of times, subprime loans are much more likely to go into default, given their greater inherent risk.
Home loans today are typically bundled into mortgage-backed securities and sold to investors. These securities help manage risk for a given pool of mortgages, but they can't identify the specific risk of default for any individual mortgage in the pool.
In the wake of the housing market correction, some subprime mortgages are falling into foreclosure.
Given the slowdown, Wall Street and other investors in mortgage-backed securities are re-evaluating their willingness to buy housing-backed instruments, and uncertainty still exists with respect to the full scope of the problem. Many holders of these securities do not know how many of the subprime loans they own will actually end up in foreclosure, and the market is having difficultly pricing this uncertainty.
Let's put this in perspective. For all of the media's hysteria, less than 15% of the 44 million mortgages in America are in the subprime sector. As a total of all mortgages, foreclosure rates are 0.6%, up slightly from 0.5% last year.
While these foreclosures are often individually difficult, this hardly has the potential for wholesale economic catastrophe. Losses are estimated to be $35 billion at most — equivalent to a stock market decline of 0.2%, according to Stephen Cecchetti of Brandeis University.
The real estate and mortgage markets are a textbook example of a market imbalance and its inevitable correction. Lenders overexposed to subprime loans, such as New Century, lost their bets and are now in bankruptcy. While the subprime market will be painful in the short term, it will inevitably lead to a healthier economy in the long run.
The real threat to the economy is not the foreclosure rate, but that government will overreact, especially if the motives are driven by impulsive populist politics. Chances are, by the time hearings are held and legislation is passed, the market correction will be over. Unfortunately the new regulations would be permanent. A short-term market correction could lead to long-term anti-competitive regulations and slower economic growth.
On the campaign trail, Sen. Hillary Clinton has already proposed a $2 billion federal intervention, and went as far as to actually propose the federal government build more rental housing. This would depress housing prices by expanding the already burgeoning housing stock in a market recovering from the last housing boom.
Plus, a federal bailout with taxpayer guarantees creates what economists call a moral hazard, which would only encourage more risky loans, paving the way for the next financial crisis.
Sen. Chuck Schumer is also going beyond rhetoric and actually authoring anti-competitive legislation to increase regulation of the mortgage market. With this bill's vague language calling for "good faith" and "reasonable diligence," trial lawyers would be the only winners in this piece of "consumer" legislation.
Sentimentality cannot replace the disciplining effects of profit and loss in the marketplace. Lenders, for fear of being exposed to lawsuits, would abandon the subprime lending market entirely, again restricting the chance of homeownership for many individuals.
The Census Bureau shows that homeownership rates stagnated at approximately 60% from the 1960s to the 1990s. Subprime loans opened up homeownership to a segment of the population that did not normally qualify for mortgages, and homeownership rates jumped to nearly 70%. Most subprime borrowers are in fine shape, and we should applaud this massive expansion in homeownership.
One of my axioms is the market is rational and the government is dumb. Let the market find a rational solution to the subprime mortgage correction on its own.
It is not the proper place for government to bail out lenders who made wrong bets or homeowners who made investments they could not maintain.
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