Tuesday, August 30, 2011

Today’s glut of unwanted homes on the market, with unending foreclosures in some parts of the country, is a serious drag holding back any chance of economic recovery. Instead of eating our peas - as President Obama lectured Americans to do - and letting the market find its equilibrium, the administration is looking for an easy, temporary way out of the problem through modified mortgages for underwater homeowners. It won’t work.

The Obama administration wants to let millions of homeowners with government-backed mortgages refinance their loans at current low rates, which are about 4 percent. A very large percentage of those loans are underwater, and the homeowners couldn’t get lower rates without government intervention. The White House is acting as if forced refinancing is a free lunch. It’s not. Reducing the interest rate that Fannie Mae and Freddie Mac get paid on these loans will cost the government-sponsored enterprises tens of billions of dollars a year.

The reality is that Fannie and Freddie are effectively part of the government, and they hold $730 billion and $680 billion worth of mortgage securities respectively. The Federal Reserve System has $900 billion worth of securities insured by Fannie and Freddie. The Treasury held about $80 billion of those securities in July. What all this means is that taxpayers are investors in mortgage-backed securities whether they want to be or not. Don’t believe the Obama administration’s populist rhetoric that it wants to reduce the costs of borrowing for homeowners at the expense of big investors in mortgage-backed securities. In this case, what Democrats really are trying to do is redistribute wealth from all taxpayers to underwater homeowners, not from fat cats to the starving homeless.

This is a Hail Mary pass that won’t work. There is little evidence that lowering payments reduces the risk of default and foreclosure. If that were indeed the case, private lenders would have an incentive to modify mortgages, which they aren’t doing on a massive scale. It’s also not clear why irresponsible people who bought larger houses than they could afford should be rewarded with cheaper mortgages than the market is willing to provide. Once again, the thrifty will be asked to bail out the profligate. The moral hazard and perverse incentives created by such a system are symbolic of an Obama economy that inhibits smart investment and growth.

The bottom line is, unemployment has a far greater impact on default risk than monkeying with mortgages. If millions of jobless Americans had work, they wouldn’t be defaulting on their loans. To create jobs, government needs to cut spending and red tape so the private sector has the confidence to invest in new hires. Washington bureaucrats won’t outsmart the market. Instead, they need to let the housing market find its bottom, which is when recovery can begin. Anything else simply prolongs the pain - and this Great Recession.

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