February 27, 2008

Blaming Big Real Estate

This courtesy of Jack Kemp:

The New York Post has a wonderful article today by Alan Reynolds of the Cato Institute.  He concludes that Obama's idea of a Stop Fraud Act to penalize lenders giving mortgages to those that cannot afford them, ending risky loans, is nothing more than the reinstitution of redlining.  As you know, redlining was considered discriminatory to minorities years ago and thus became outlaw.  Obama essentially wants to reinstate redlining.  Unfortunately the article is not online, but I recently bought voice recognition software to type in full-page texts, etc. So here goes...
 

 
Jack
 
Housing horrors
Dem's disastrous crisis fixes
by Alan Reynolds

Senators Baraka Obama and Hillary Clinton plan to fix the "subprime mortgage prices" 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...  The real victims in this crisis are the millions of borrowers...  Whose only crime was taking out mortgages lenders told them they could afford."  (JACK's NOTE: Why is there always a victim in a Democratic plan?)
 
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 operates to promote fraud, risk and under development."
 
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 $5,000,000 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 a 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% of all foreclosures in the third quarter of last year, while subprime ARMs accounted for 43%.  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...  The fund will be partially paid for by increased penalties on lenders who acted irresponsibly."  Senator 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 would 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 any $300,000 mortgage and a 7% interest rate could ask a judge to make it a $200,000 mortgage at 5%.  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, where 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 for a 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 Dr. Reid rates for "at least five 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 to 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 resets after a couple of years based on the one year LIBOR (and interest rates on loans between banks).  That rate has dropped to 2.8% -- which means the increased monthly payment on subprime ARMs will be less than 10%, not the 30% she claims.
 
In other words it won't be as big a deal as Clinton thinks subprime loan rates adjust.  The real danger is if house prices dropped below the size of loan -- because many people will then walk away from the mortgage, regardless of the interest rate.
 
If Congress acts to arbitrarily frees mortgage with 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 is 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 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 finding 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, perspective low income homeowners won't need any enemies.

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