This article, from the New York Times by Peter S. Goodman, frustrates me. This is a good illustration of how bad economic policies have come back to bite us. At first, while reading it, I actually had some hope. This sounded like good-faith effort on everybody’s part to try to reach a deal and keep people in homes. If the lender and borrower could reach a deal on their own, then it was obviously in each party’s interest to make the deal. When freedom of contract is upheld, everybody wins.
But then I read this:
“Those outcomes are similar to the ones produced by the Obama administration’s $75 billion program aimed at stemming foreclosures, which gives cash subsidies to mortgage companies as an inducement to accept lower payments. But in Philadelphia there is one crucial difference: the mortgage companies have no choice but to participate. They have to attend the conferences and negotiate in good faith or they cannot proceed with a sheriff’s sale.”
Both policies are bad. Obama’s policy of providing subsidies to mortgage companies to help stave off foreclosures may sound like a good thing, but its economic consequences are very real. In economics, we should only give subsidies in very specific circumstances, that is, to encourage more behavior that results in a positive externality.
While staving off foreclosures certainly sounds like something that is positive and should therefore be encouraged, we must recognize the foreclosures in the first place are the market’s attempt at correcting the housing bubble. By intervening and not letting the market go where it wants to, we are just drawing out a bad situation. Recovery will be no faster or less painful if we continue to try to stifle necessary forces.
Philadelphia’s program is similar. If both parties agreed on their own, that would be one thing. But forcing one party to agree to terms that are not in its interest to agree to is damaging from an economic and a liberty standpoint. A major reason the mortgage crisis happened in the first place is because mortgage companies were forced to lend when it did not make financial sense to do so. As a result, some creative financing was born, resulting in very bad programs like adjustable-rate mortgages and interest only mortgages. Nothing good can happen by again forcing banks to loan when it doesn’t make financial sense to do so.
It’s easy to empathize with the homeowners who are in this regrettable situation. Surely nobody wishes a foreclosure on anybody. Houses are homes and to be forced to give that up can be devastating one’s family life. But the fact remains we won’t get out of this mess until some hard necessary corrections are allowed to happen. In the long run, it’s in everybody’s interest for the market to correct itself. By not allowing the short term pain in the meantime, we’re just assuring our economy remains in a perpetual state of uncertainty.
“…three years ago, Mr. Hall committed the sort of mistake that has upended millions of households. At the recommendation of a for-profit credit counselor, he took out a new mortgage — a variable-rate loan from Countrywide Financial, which is now owned by Bank of America. He paid off some credit card debt, and he borrowed an extra $15,000 to renovate his home, expanding his mortgage balance to $63,000.
The loan began with manageable payments of about $500 a month. But Mr. Hall’s interest rate soon soared — something he says was never explained to him — lifting his payments to $950 a month.
“When I got the mortgage, I didn’t really understand it,” he said. “They told me this would improve my credit and that was it. It was just, ‘sign here,’ and ‘initial here.’ ”
No More Construction Work
He might still have managed had construction not come to a halt. By 2007, Mr. Hall’s employer was cutting work hours. In August 2008, it shut down, turning his $1,000 weekly paycheck into an $800 monthly unemployment check.
Every day, he set the alarm clock and headed to the union hall at 5 a.m., waiting and hoping for work. Every day, he went home, still jobless and discouraged, now confronting the displeasure of his wife, who worked as a nurse, and who he said never came to terms with their diminished spending power. After months of bickering, she left him last December, taking their daughter.
“She was saying, ‘How are we going to have Christmas? How are we going to go on vacation?’ ” he recalled. “She just seen it getting worse instead of better, and she got depressed.”
In January, his truck was repossessed, leaving him to walk through the winter dawn to the union hall for his daily ritual of defeat.”
This is a tragic situation, but one that could have been easily avoided. Had Mr. Hall not borrowed against his mortgage, had he refinanced right away to lock in a low rate as soon as his mortgage started climbing (as millions of others did), had he taken the time to understand his mortgage as any responsible borrower should have done, perhaps he wouldn’t be in this situation.
This also illustrates the economically damaging role unions play. Because of the high wages demanded by unions, it makes it infeasible for construction companies to pay them their wages in tough economic times. Instead, the company was forced to go out of business (which might have happened anyway, but unions certainly took away any competitive advantage it might have had).
Now, Mr. Hall depends on the union to find him another job, but since unions worked to destroy his job, how can they be expected to find him another? I’m sure the unions of other trades are quite effective at keeping outsiders out, ensuring a high wage for them, while ensuring joblessness for everybody else. Unions are very very damaging to an economy.
Of course, all this criticism is easy to see in hindsight, but that’s the point. Mr. Hall was just playing by the rules of the game at the time, he was just responding to the incentives that were in play. People respond to incentives. That’s why it’s imperative that we let the market work. We must pay the painful price of foreclosures and lower wages. If we continue to subsidize the risk, thus lessening the impact, our hindsight might not be 20/20 and we could easily make the same mistakes again. Indeed we’re already making them.
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