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Mortgage assistance plans don't fix the problem
By George Passantino
It is easy to call yourself a supporter of economic freedom and the rule of law amidst a rapidly rising economy. Now with dark clouds of the recent rise in mortgage foreclosures—and more expected on the horizon—political expediency has eroded the support for free markets in some of its perceived champions.
Even self-proclaimed devotees of the late Milton Friedman, President George W. Bush and California Governor Arnold Schwarzenegger, sound more like critics than Friedman supporters.
In the wake of a perceived mortgage crisis both have attempted to use the coercive power of government to solve the problem. Both plans center on agreements with the largest mortgage servicing companies to "voluntarily" freeze interest rates on adjustable rate mortgages for a set period of time.
Upon Friedman's death, President Bush remarked that "Milton Friedman has shown us that when government attempts to substitute its own judgments for the judgments of free people, the results are usually disastrous. In contrast to the free market's invisible hand, which improves the lives of people, the government's invisible foot tramples on people's hopes and destroys their dreams." Perhaps the President should re-read his talking points and share a set with the governor.
There are several flaws in the approach to "voluntarily" freeze rates. First, it is disingenuous to call the plan completely voluntary. When a government seeks a "voluntary" commitment in one hand, you can be sure that the hammer of regulation is hidden behind the back in the other hand.
Moreover, such a freeze is tantamount to a moral bailout. While it may not necessarily be a financial bailout of the S&L magnitude, it bails out lenders and borrowers from bad decisions and forces someone else to shoulder the cost. Behind each mortgage is a pool of investors that make life decisions, such as retirement planning, based on an expected return of those investments. Forcing these investors to eat a loss by government fiat is fundamentally unfair. Moreover, this tramples the rule of law and the sanctity of a contract. And, of course, as the regulatory feeding frenzy grows, you will no doubt see a host of new efforts to clamp down on lending practices and in doing so eliminate the access to capital that so many families depend upon.
Equally troubling, the proposals seem to try to encourage responsible borrowing by only applying to people that are current on their notes but who can't afford the rate adjustment. It doesn't take a Nobel Prize economist to figure out that thousands of families that actually can afford the rate adjustment, and who made those decisions willingly, will nonetheless seek relief by claiming that they will not be able to afford it. And what constitutes not being able to afford it? Does a family that goes out and finances tens of thousands of dollars worth of home entertainment equipment and luxury automobiles and whose monthly debt obligations have increased dramatically qualify for relief?
Perhaps most troubling of all is that this move to freeze rates and ratchet down the industry with new, tougher regulation completely misses one fundamental reason that so many Californians have turned to adjustable rate mortgages and other exotic loans. The price of housing in California is simply too high.
Is it any surprise that five of the 10 areas with the highest foreclosure rates nationally are in California, or that in some markets there are more foreclosures than new homes for sale?
If Schwarzenegger and Bush want to stay true to their philosophical allegiances to Friedman, they could start by tackling the root causes of the affordability crisis that has driven so many families to secure loans that are a poor fit for their unique conditions.
According to statistics from the California Building Industry Association, California homes were on par with national prices as late as the 1970s. As development became more difficult in California, prices relative to the nation began to shoot upward. Now, California home ownership rates are 10 percent lower than the rest of the nation.
If California really wants to ensure that people have a home to live in, we need to make housing more affordable. New regulations on mortgages or short term freezes will not do that.
The price of regulation—both in hard dollar fees and in the costs of time—can easily add $50,000 to the cost of each home. That can account for $300 or more in each monthly payment. In many jurisdictions, the cost of regulation is much higher than that.
At the same time the costs of regulation are increasing, anti-growth activists have become experts at utilizing the California Environmental Quality Act (CEQA) and other well-intended laws to stop development or force substantial delays which also results in significant costs. The longer a home takes to build, the more it costs in interest and construction expenses. On top of that, finding land that is suitable for development is increasingly difficult, and when land is found, political pressures typically mount against "affordable housing." While such conditions exist in varying degrees around the nation, there is a uniform need to address them.
While it may seem politically appealing for government to directly help people keep their homes, as Friedman said of government intervention, the results are usually disastrous. Both Schwarzenegger and Bush would do well to focus, instead, on underlying cost drivers of the housing market that are truly governmental in origin.
People, faced with home prices they simply cannot afford, have far too often found refuge in loans that probably don't fit their personal economic conditions. While no amount of intervention can eliminate the obligation that anyone has to fully understand and honor the terms of the contract they sign, it would nonetheless be helpful for government to eliminate or reduce some of the cost drivers that they developed and which have helped fuel this perfect storm.
George Passantino is a Senior Fellow at Reason Foundation. This column originally appeared in the FlashReport. Reason's California research and commentary is here.
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