Sanity at last? Paulson rejects bailouts

February 28, 2008

Yesterday Barney Frank, chairman of the House Financial Services Committee and therefore a very powerful Democratic voice on the economy, was quoted as saying the government

“is not helping enough people. We’re not going to get out of this [credit] crunch until we stop this cascade of foreclosures.”

Where to start? First of all, the idea that foreclosures are the plague to be eradicated here has it exactly backwards. Foreclosure is a symptom of the disease. The disease itself is irrationally high house prices. And the housing market won’t recover until prices return to normal.

Proposals to stop foreclosure vary from bailouts, like Frank’s own plan to use taxpayer money to refinance as many as one million ‘distressed’ homeowners out of high-cost loans, to price-fixing, like Hillary Clinton’s plan to “freeze” interest rates.

Other bailout proposals include the following:

And just yesterday, Fannie and Freddie won regulatory approval to increase the size of their mortgage portfolios after winning approval to back mortgages on homes worth more than $417,000. With taxpayers implicitly backing Fan and Fred, we’re already on the hook for billions of losses when these two go under. Increasing the size of their mortgage portfolios–the same week that both companies recorded additional billions of writedowns!–simply puts us on the hook for more.


The problem with housing, indeed the problem with ALL credit markets that have seized up is that cheap credit was so widely available that assets bought on credit were, and remain, vastly overpriced. Houses, leveraged loans, junk debt, corporate bonds, and now treasuries–which I will argue are due for a fall in my post on inflation later this week.

Houses just happen to be the most politically sensitive of these assets because their (perceived) value affects tens of millions of Americans.

The Democrats are betraying their socialist tendencies by arguing that the needed fix is simply to stop prices from falling when in fact the only thing that can return sanity to the housing market is for prices to fall to levels that are sane.

Of course this will impact millions who bought too high. And it will affect hundreds of banks who foolishly lent money to those buying too high. But this is the virtuous circle of capitalism folks: markets–eventually–achieve equilibrium. And the people that should lose, imprudent borrowers and lenders, are the ones that are losing.

What do Democrats hope to achieve through price-fixing and/or bailouts? You can’t legislate buyers back into the market. You have to let prices fall. Any serious attempt to actually fix prices would simply bring the market to a grinding halt. Half-hearted attempts, like interest rate freezes for some borrowers, would cause banks to lose more money on those borrowers. To offset this, banks would simply charge the rest of us higher interest rates.

Any legislative effort that would shift costs from the imprudent to the prudent is the very definition of a bailout.

Taxpayers fearful that Congress will put them on the hook for housing losses and future buyers waiting for prices to return to normal should both be thanking their lucky stars for the Bush administration’s (relatively) steady hand here. Secretary Paulson:

I don’t think I’ve seen any scenario where the American taxpayer needs to be stepping in with more taxpayer dollars.


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