Friday, September 26, 2008

When The IRS Is Your Landlord

Imagine a world in the not-too-distant future when the U.S. Government has bought up all of this "bad paper", the Mortgage Backed Securities that no one in the private sector is currently willing to buy.

How long will it take before people start defaulting on the loans which are the value of those securities? They already are, to some degree, which is the straw breaking the camel's back. And what will the government response be?

First, we will have a class of people enter the public eye, the "ARM deadbeats". These are people who took out adjustable rate mortgages on overpriced property, and then couldn't afford the payment when to no one's surprise, rates adjusted upwards (as they always do with Adjustable Rate Mortgage, which you only choose because the rate is lower than a fixed rate mortgage would have).

So one of three things will happen. This group of people will either be ignored, subsidized, or demonized by the demagogues in Washington and the media.

Probably there will be a push by liberals for the government to convert their ARMs to fixed rate mortgages, the kind sane people get. But of course the liberals will want to subsidize the rate.

Some will try to demonize the ARM deadbeats as being fatcats who ought to bear the brunt of the mortgage crisis fallout.

As the defaults continue the government will quickly pass rules saying that no one in default, or perhaps just late, on their government-held mortgage can get a tax refund. Next will come the wage garnishments and criminal penalties for failing to do one's patriotic duty to pay the debt owed to the Fatherland. Okay, so maybe that's a bit over the top.

Perhaps worse, these ARMed fools may not be noticed at all, with all of the focus on executive pay on Wall Street. The vast majority of people will not receive the lesson they should: if you can't afford the fixed rate, you can't afford the ARM, either. Buy less house, or rent. People don't lose their life savings paying rent for a while.

We already have bankruptcy laws, which are supposed to provide an orderly transition for a company in a liquidity crisis. Among other steps, we give bankruptcy judges the power to shield the core of the company from the collections efforts of its creditors while a plan is mapped out either to a return to normal operations or to dissolution.

Why won't that work with the MBS crisis? Sure, you may have a whole industry in bankruptcy, but that's what happens when a whole industry makes a stupid move.

There are two other effects of the MBS bailout, whether it's a straight bailout or some loan-making scheme, which someone needs to look at.

First, we can be sure that by bailing out the financial industry, the bad loans will continue. The $700B bailout plan in particular would have as its major outcome the continuance of bad lending practices. Like supplying the addict to keep away the symptoms of withdrawal, subsidizing failure is bad policy.

Second, any governmental purchase of private paper will suck up business from the private sector. It will have the effect of slowing down the economy.

Well, as I said the other day, maybe our dysfunctional two-party system will cause us to back into doing the right thing, which is nothing.

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1 comment:

Anonymous said...

An interesting point, Loren, can be drawn from the sinking ship analogy.

What do you do when your ship starts to sink?

(a) Bail.
(b) Plug the hole.
(c) Repair the ship.

in that order. I would be nice to have a plan that guarantees (c) after (b) after (a).

But it isn't going to happen. ~Jimmy

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