Thursday, April 17, 2008

Time to Foreclose on Hillary's Housing Plan

Since this post is somewhat politically-related, I need to stress the following upfront:

  • I have always been registered as an independent.
  • I find both parties equally nauseating, ignorant, and polluted (but not in a scary Unabomber kind of way).
  • I don't believe any of the three remaining Presidential candidates have a clue when it comes to economic policy.
  • I tend to mumble a bit and spasm when I watch the debates.

With that out of the way I wanted to touch on Hillary's comment about the housing situation during last night's debate. She said,

I want to see us actually tackle the housing crisis, something I've been talking about for over a year. If I had been president a year ago, I believe we would have begun to avoid some of the worst of the mortgage and credit crisis, because we would have started much earlier than we have -- in fact, I don't think we've really done very much at all yet -- in dealing with a way of freezing home foreclosures, of freezing interest rates, getting money into communities to be able to withstand the problems that are caused by foreclosures.

To say that you would have prevented the largest housing and credit bubble we've ever seen from collapsing is the height of arrogance. She doesn't say that she would have prevented the bubble itself from happening. This thing was already uber-inflated a year ago when she claims to have started talking about it. So, though she wouldn't/couldn't have prevented the bubble she believes she could have prevented its deflation. I suppose she believes she could have prevented the tech bubble from bursting and Dutch tulips from collapsing.

Trying to prevent a bubble from popping is a terrible idea. Bubbles are not healthy for the economy in the long-term as they lead to gross mis-allocations of capital. In the case of housing, far more money was thrown at housing and mortgages than warranted by economic fundamentals. A bubble is not a state of equilibrium - that's what makes it a bubble. The quicker the bubble is popped, the quicker we return to sound economics. Trying to prop up a bubble only introduces further moral hazard and prolongs the ultimate damage.

Looking at her specific proposals, she first mentions freezing foreclosures. Keeping people in houses they can't afford serves no one. Many of these people were never qualified to be homeowners in the first place. Furthermore, the ability to foreclose is one of the reasons lenders are willing to make loans in the first place. Freezing foreclosures certainly isn't going to make more money available for mortgages. Think about what you would do if you were lending your money and all of a sudden the rules are changed so that the government, at its whim, can prevent foreclosures. Would you be as willing to lend? If you were still willing to lend, wouldn't you want to charge a higher interest rate? Wouldn't you severely tighten your lending standards so that you were only lending to those with the best credit and finances? Wouldn't you require a larger down payment? Hillary (and all politicians) love to talk about making homeownership affordable for more people, but this policy would do exactly the opposite.

How about freezing interest rates? Same thing. Imagine you're a lender and all of a sudden the government can come in and freeze the rates you charge people. You've logically been charging riskier people higher interest rates, but now the government steps in and doesn't allow those rates to adjust up (think ARMs). You might be less willing to make ARM loans. Either way, you've just had a big new risk introduced. Might you want to increase the interest rates you charge to compensate for this new risk?

Next, she mentions "getting money into communities". That's fairly vague, but it certainly entails spending tax-payer money to support a bubble. The government needs to get out of the way and let housing prices fall to market clearing levels. Housing prices in many communities never should have climbed as high as they did - virtually everyone agrees with this. So why must the politicians try so hard to keep them from falling? (that's a rhetorical question)