Friday, November 14, 2008

Don't Bail Out Homeowners

Talk is increasing about a government bail-out for home owners who cannot handle the burden of their mortgages. This annoys me no end. My regular readers know that I have previously written strongly in favor of the government bail out of financial institutions. Why then do I object to a bail out for individual home owners and how can I justify this seemingly inconsistent position? Here goes:

No Win for Taxpayers - when bailing out financial institutions, government, for the most part, received an equity stake in the banks or received other assets that once the markets stabilize will become more valuable and may actually provide tax payers with a substantial return on their investment. The proposed bailout of homeowners will not provide tax payers with any upside or assets in return for their gracious intervention. It will simply make the problems of overwhelmed home owners go away by a wave of the magic wand, at our expense.

Picking Winners and Losers - I am a renter. My wife and I made the decision to rent for a combination of reasons, the most important of which is that we simply cannot afford to buy a house in our town, nor did we think that stretching to buy one would be a good or safe investment. On the other hand, many other folks have made a financial bet on the supposedly permanently rising prices of real estate and decided to gamble their life's savings to buy a house.

A specific example I have in mind is one of the people that worked for me in my previous company, who bought a million dollar house in San Jose, California, even though his household income was dramatically lower than mine, and who did so through an aggressive ARM with a 5 year teaser rate.

Why would government take my money, to reward those homeowners who made bad financial decisions? Not only does such a decision hurt me and millions like me directly by wasting our tax dollars, it also penalizes us by artificially putting a price floor under the housing market, thereby keeping houses out of our reach while letting those who made irresponsible decisions reap financial rewards for their financial recklessness.

By bailing out homeowners, government would be making winners out of irresponsible home buyers, and doing so by penalizing responsible renters and (to a lesser degree) responsible home owners.

Moral Hazard Galore - even though we have all taken to calling it a bail-out, financial institutions were not really bailed-out in the common sense of the word. AIG shareholders were completely wiped-out in the government take-over, BearStearns share holders were very nearly wiped-out. Banks who are now receiving equity infusions from the government are receiving this cash infusion in exchange for shares which dilute the value of shares held by other shareholders and which will hopefully yield a profit to tax payers in the long run. What I am trying to say is that the government may have bailed out the financial institutions themselves, but shareholders have been duly penalized.

However, the government is now proposing a true bail-out of homeowners. It is not talking about wiping out the equity of home owners and turning them into renters or of letting them walk away from their loans without going through bankruptcy, it is talking about improving the terms of their loans so that they are better off. Seriously?

The System is not at Stake - With all due respect to home owners, the financial sector was on the verge of complete collapse, one that would surely have dragged down strong industrial companies and small businesses along with it. This was not a question of saving Wall Street, it was a question of saving all of us. The boat was sinking. The same is not true of individual homeowners. Yes, collectively homeowner losses are a drag on the economy, but no one is even claiming that this will bring a complete meltdown of our economic system. The situations are simply not comparable.

Worried about the economy? Let's talk economic stimulus. Let's talk tax cuts, let's talk public works and infrastructure improvements. Hell, let's even talk a second stimulus check to individual tax payers. BUT don't go and reward exactly the sector of the population whose financial irresponsibility and greed is a major reason for the current economic trouble!


Anonymous said...

I completely agree and am outraged. I do think that banks were out of line and irresponsible in their lending, and as someone who was just got a mortgage two weeks ago, I can say that if when the bank says you can afford a $X,000 payment per month but you thought you could only go as high as $Y,000 it makes you wonder if perhaps their formulas and knowledge know better than you.

Luckily my better sense told me to go with my initial gut instinct and I bought well below what the bank said I could borrow. But I can see how many people would go for the higher price tag, after all, the professionals say you can afford it...(tongue in cheek)

What makes me most upset about this 'bailout' is that is does nothing for all those out there who are a little over their head but have made sacrifices so that they act responsibly and stretch to make their payments. They may be in too much house, but they are doing all they can to pay their bills: working 2 jobs, cutting back on other expenses...

If someone is going to get a 3% loan because they messed up, why can't I get one? Doesn't that just encourage me not to pay so I can reap the benefits?

I'm sure many people who would benefit need it due to the state of the economy, losing jobs etc, but two many would benefit who don't deserve it in my opinion.

frugal zeitgeist said...

Yup, I agree. Personal responsibility counts. When I bought in 2001, my co-op board had way more stringent financing requirements than the bank did. The bank approved me for almost a half million dollar mortgage. I ran the numbers and realized that the payments would kill me!! I ended up taking out less than half of that.

That wasn't rocket science. It's common sense. Granted, there are some unsophisticated borrowers who were flim-flammed by unscrupulous lenders, but I think they are a relatively minor part of the mortgage population.

Rusty said...

While i hate big government and bail outs for greedy people, i have to disagree with your reasoning. Why? A few things.
The first reason is why the gov't screwed up with the big company bail out and how it could have been better.

The second point is what they should have done.

A) Banks... We only need to save a few banks, not 30. A true capitalist nation (which we claim we are... sometimes) encourages competition. If we let the greedy bad banks fail, Joe Banker from Rapid City, South Dakota has an opportunity to grow since he was responsible. But now, how is he supposed to compete when these banks are getting an extra 6-30 billion dollars? It is garbage.

2) When i first read... strike that. the only time i read your blog i sensed a vendetta against home owners... and you claimed bailing out home owners only helps the greedy people who bought homes. Buying a home is not greed for all people. I agree that the idiots that bought 12 houses with sub-prime mortgages should get laughed at. I bought my house on top of the bubble, with a fixed rate. I was and am able to pay my mortgage.

Again, i hate bail outs. I hate everything they represent. But let me tell you how bailing out home owners, i believe, would save the economy...

Joe Blow owns a house. He like many other responsible people (or greedy as you call it) bought a house after his new promotion at Target. Joe Blow has a wife, and two kids. He was able to afford his mortgage for the first two years. He may have had to stretch, but no worries. It was a sacrifice he was ready to make. Joe got a mortgage from National City. In May of 2008, Joe was laid off due to the economy. Joe can no longer afford his mortgage. In turn National City is losing out on its payment. Imagine this multiplied by hundreds of thousands.

If the government, instead of giving the bank money no questions asked, gave Joe help, he would have to in turn pay off his defaulted mortgage. Paying the bank with the money he got from the government. Imagine that. The banks are saved. =)


Shadox said...

Rusty - take your Joe Bloe example and change one thing: instead of being unable to afford his mortgage Joe loses the house he rents because he can't afford it... why would you want to help home owners, just because they are home onwers? Why are they in any way preferable to renters? In your specific example, the problem is the lay-off not the home ownership and it seems to me that helping the newly unemployed get jobs is a better strategy than seeking out only the unemployed who own a home and singling them out for assistance.

Also, another problem I have with your example is that you describe a person who could only afford his home assuming EVERYTHING goes exactly according to him plan. He assumes he doesn't lose his job, he assumes he will have no major health problems etc. As soon as he loses his job, he loses his house... Another guy on the other hand carefully planned my investments. He understood that even if he could meet the mortgage payments the risk that something goes wrong (job loss and such) would cause him to lose his house, and chose to continue renting. Who do you want to reward? The bad planner at the expense of the prudent spender. That seems to me as strange logic.

With respect to your statement that I have a so-called vendetta against home owners, you are entitled to your opinions. I simply don't like wealth re-distribution, and I particularly don't like wealth re-distribution where it's primary goal is to shift money from smart planners to greedy or bad planners.

Thanks for visiting my blog for the first time. Hope to see you back.

Rusty said...

I agree with being against spreading the wealth, but if we HAVE to give money to someone... Why are the rich getting richer? That is my chief complaint I guess. And I personally think that homes are one of, if not the, biggest back bone of our economy. I have two vacant houses on my street due to forclosures. (my street has five houses on each side and is a dead end.) That is just in the first year of hard times.... If you don't think vacant houses have an effect on a local market wiki "white flight." Then visit down town Jacksonville. It is still recovering from this after 50 years. Some businesses may move, but a lot wont reopen. Then apply this to schools, law enforcement, other gov't infrastructure like tax collectors, utility company pay offices etc.

Note: when i used white flight i was just using an example that if people leave a neighborhood the businesses leave as well. Jobs leave and so on. Obviously i hold no regard to race when using white flight as an example.


Shadox said...

Rusty - no one can claim that foreclosures and declining home prices are not a problem. They clearly are a problem. However, my objections are twofold: doling out cash on the basis of who owns a home and who doesn't seems to me to be counter-productive. In fact, I will go as far as saying that as a group, homeowners are wealthier than non-homeowners. Why then should the latter subsidize the former.

Second, home prices are collapsing because we just lived through a real-estate bubble. Home prices should not be propped up, just like government should not try to prop up stock prices when those collapse, or any other asset price when it collapses for that matter. Foreclosures and falling prices are the market's natural way of recovering balance and matching supply and demand. Sure there is a lot of pain involved. There is a tremendous amount of pain involved. However, the way to recovery lies not in re-inflating the real estate bubble or in giving people checks so they could pay for houses they couldn't afford to begin with. The right way to handle this is to try to limit the damage by: (i) ensuring that damage to the larger economy is as small as possible; (ii) taking action to reduce job losses and unemployment and to assist those who lose their jobs; (iii) to support local government's efforts to limit damage to communities, by ensuring that the reduced tax base is still able to support critical services.

These are tough times. No doubt about it. But and effort to make the pain go away by waving a magic wand is almost guaranteed to back-fire, in addition to being extremely unjust and immoral from a distributive point of view.

All that being said, I understand your concern and frustration.

Anonymous said...

I totally agree to this point exactly!