Rationality is Officially Dead

My jaw nearly dropped while reading THIS ARTICLE advocating special privilege to low-income people in expanding home ownership efforts (presumably through government subsidy).

To quote:

The timing is right. Now that prices have collapsed in many areas, low-income Americans might be able to afford to purchase homes for the first time in years. Sales of new homes in June were down 21 percent from last year. This would seem an ideal time to encourage low-income families to buy homes.

Huh??? Am I the one who is brain dead or is this really happening again?

If you think the Federal Government is capable of managing any of this, then watch the video:

Who in their right mind could actually suggest that we as a society go back to “encouraging” risky mortgages? And before the author of the article freaks out at my intimation that these mortgages are a VERY BAD IDEA just because I “demonize” the poor, let me walk through this…again.

All mortgages, like all loans, carry risk of default. The mortgage business, like any other business, has to account for this risk in financial terms. In short, all potential losses must be fully funded by the interest payments of the “good” loans, plus a bit of profit for the ones’ whose money is being doled out to fund the loans. Period. No way around this.

Even if the loan funds come from banks who, in turn, borrow the money from the government or the the cheap credit from the Federal Reserve, loan losses MUST be covered by someone. Period. No way around this.

So, how does the mortgage market limit it’s financial risk of loss? Two ways (and a government third).

1. Interest Rates – the more risk of default, the higher the interest rate – just like any other loan. I know that people feel that this is unfair to the poor (because they have to pay higher interest rates) but the simple reality is that risk of default is higher. Unexpected job losses, more difficulty in re-employment, lower savings rates all add to this risk as income declines. It is fundamentally not modifiable, except through raising income.
2. Down Payment – If a default occurs, then the property must go through the foreclosure process, which is expensive, time consuming, and always depresses the market value of the property. Down payments, now passe, help to cover these potential costs.
3. Government subsidy – Either in direct loan guarantees to lenders in the event of default or actual direct government lending (Fannie Mae/Freddie Mac)

The simple reality is that the lower the income of a borrower, the greater the probability of default. Period.

Few people would argue at this point that the proximate cause of the Great Recession , as it is being called, was the housing boom of the 2000s. The housing boom began in the 1990’s in the Clinton Administration and continued in the Bush Administration in a government push to expand home ownership. Government subsidization of risk and cheap credit from the Federal Reserve were the direct mechanisms whereby the market was skewed (and skewered) leading to the bubble in lending. The private market as well was partially to blame through the derivatives market that few people understood.

Can we not learn our lesson?

Stop government subsidization of market risk (ANYWHERE), stop cheap credit from the Federal Reserve system, and reform the banking sector by increasing the fractional reserve requirement (preferably to 100% for demand deposits) and you would see a period of financial stability with slow, steady growth like never before. Let the market work. Make the market work.

Stop applying feel-good subsidization of poverty through government intervention and focus on protecting the poor through entrepreneurship, education, and most of all stopping inflation. Don’t forget that, by far, the worst thing we can do as a society is strap ourselves with inflation, which hurts us all, but disproportionately those at the lower end of the income spectrum. Promising a deficit-spending government-run subsidy program to “help” the poor is no help at all.