Four Reasons to Oppose the Sub-Prime Mortgage Bail Out

Congress seems to be in a rush to bail out speculators in America’s mortgage and real estate markets.  The House has already passed a sweeping new regulatory bill and Senator Hillary Clinton is proposing a $5 billion taxpayer fund to pay individual mortgages.  These proposals come despite the fact that there is little or no economic case for government intervention, and polling shows that a majority of homeowners do not support a bail out.  Further, many of the ideas Congress is currently considering will make the problem worse by reducing available credit or by rewarding irresponsible behavior by lenders and borrowers. 

Members of Congress need to pause before doing more harm to mortgage markets, and consider some of the basic facts about our current real estate situation.

1. The subprime meltdown is not indicative of a larger systemic risk that requires government intervention.  Subprime mortgages comprise a small subsection of the mortgage market, and even within that subset, the majority of loans are being paid on time.  Foreclosures and defaults have increased, and loans with a 2006 vintage are particularly problematic.  Estimates suggest that turbulence could continue through 2008 and the crisis could ultimately cost more than $300 billion.  However, nationwide, the delinquency rates were just over 5 percent in the second quarter of 2007, a small portion of the mortgage market.  Even riskier sub-prime loans, which comprise roughly 18 percent of the overall mortgage market, only had default rates of about 15 percent.  This means that about 85 percent of even the sub-prime market is making payments on time.  Much of the problem lies in a handful of states, such as Florida, Arizona, and Nevada, where speculation in the housing market is responsible for many of the mortgages at risk.

2. The public is not looking for a federal bailout.  A recent poll found that calls for a federal bailout were opposed by a two-to-one margin.  While a majority of those surveyed—91 percent—considered subprime mortgages a problem, only 31 percent saw the need for government involvement, while 62 percent believed that individuals should take responsibility.  The poll, conducted on behalf of FreedomWorks, also found that a majority opposed increasing the size of the loans that the government sponsored-enterprises Fannie Mae and Freddie Mac could purchase.

3. Expanding government-sponsored enterprises poses new risks for taxpayers while failing to provide new solutions for mortgage markets.  Both administration officials and Congress have looked to expand the role of Fannie Mae and Freddie Mac.  But both these government sponsored enterprises have been plagued by scandal, and their implicit federal guarantee potentially exposes taxpayers to the costs of a bailout.  Moreover, there may be little that these government-sponsored enterprises can do considering their own exposure to underperforming loans. Fannie Mae suffered a loss of $1.4 billion in the third quarter of 2007, and Freddie Mac saw a loss of more than $2 billion.  New regulations to prop up lenders who misjudged the market create a “moral hazard,” which encourages additional risky transactions because they know that ultimately they will not bear the downside risk.  Expanding the federal role in the market today sticks taxpayers with a massive liability tomorrow.

4. Markets are quickly responding to the subprime problem; new laws and regulations take more time and will continue to affect the market well after the crisis has subsided.  Given the scope of the correction already underway, rushing in with a new regulatory regime to prop up those ultimately responsible for the crash may be premature.  Research suggests that mortgages with higher loan-to-value ratios are especially troublesome, and the decline in property values has only exacerbated the problem.  Lenders have already revisited lending practices, and there is little that new regulations can do to alter trends in the housing market.  At the same time, new regulations can actually reduce access to credit and make it more difficult for consumers to realize their goals of homeownership.

More Americans own homes than ever before, but clearly some banks and borrowers made mistakes.  Home prices have more than tripled in some markets over the past decade, a pace that was not sustainable.  Now we are in a correction, and from a macroeconomic perspective that should be viewed as a healthy thing.  Markets are quickly responding to the subprime problem.  Given the scope of the correction already underway, rushing in with a new regulatory regime to prop up those ultimately responsible for the crash may be premature.  New regulations can actually reduce access to credit and make it more difficult for consumers to realize their goals of homeownership.  The American people view the market, not the government, as the proper arena for correcting current trends, and Congress would be wise to follow the same path.