A Bluebird in a Pile of Manure

It is hard to imagine any part of the Bush/Obama stimulus packages with which I agree. For all of the criticism that Obama and his fellow liberals heaped on George Bush during the campaign, their solutions are remarkably consistent with the bonehead initiatives of the Bush administration — namely, reward those who have caused the problem by making the innocent pay. And the bigger the mistakes the richer the rewards.

The major part of our current economic problems can be boiled down to a pretty simple fact — banks loaned money to people who they knew could not afford to repay it. They did it, in part, out of greed and, in part, in response to Congressional Democrats who were critical of the financial institutions “leaving the poor behind” — you know the people who couldn’t afford to pay the loans that were being made. In doing so the government and the financial institutions created an artificially high demand for housing to which the construction industry responded by overbuilding the housing market.

Whatever the reason, the financial institutions were rewarded handsomely while making the loans. And now that the loans have gone bad — as everyone with half a brain knew they would — the financial institutions are being rewarded again by being relieved of the consequences of their spectacularly poor business judgment. Literally hundreds of billions of dollars are being pumped into these financial institutions because the are “too big, too important” to fail. (It is the same rationale applied to the nation’s automakers after years of poor financial decisions, poor design, inefficient production methods and a proliferation of dealerships — they are just “too big, too important” to fail.)

Meanwhile you can walk down the streets of our nation’s cities — large and small alike — and observe the empty storefronts as small businesses fail left and right. In most instances those business are failing because of a collapsed economy brought on by the sins of the financial institutions and the stupidity of people who bought homes they knew they could not afford and borrowed money they knew they could not repay. They are also failing because the very financial institutions that have been so richly rewarded with “stimulus” money have unnecessarily tightened the credit markets to the point that small businesses no longer have access to “working capital” in the form of inventory financing.

Now Obama and Congress are hell bent on rewarding those very people who could not afford to repay those loans.

I do have some sympathy for some of those people who borrowed money that they could not afford to repay. First they were being solicited by unscrupulous financial institutions. They were told that the money was there for the asking. They were told that they would not have to produce proof of their earnings or their financial status — the “financial institutions” would simply take them at their word. They were told not to worry about repaying it because by the time the “introductory” subprime amounts were exhausted the value of their property would have increased so much that they could sell the home, pay off the mortgage and still have money to do it again. Everywhere they turned for advice — the real estate agents, the mortgage brokers, the property appraisers, and the financial institutions — they heard the same chorus.

However, in the end, common sense should tell them that if a deal seems to good to be true, it probably is. In the end you are responsible for your own decisions. If you looked at your income from the past three years and it was insufficient to pay the mortgage, what would make you think that in the next three years things would improve so dramatically that you could afford to pay it in the future. Yes, many of these people were duped in a modern-day-Music-Man scam but ultimately they are responsible for their own bad decisions.

Having said that and having continued to object to all phases of the bailout and stimulus packages, I do have to say that the latest proposal to aid in the payment of these “upside down” mortgages probably makes more sense than all of the other proposals to date. That proposal has not been “fleshed out” at the time of writing this column and given the penchant of Obama and the Congress to throw money without responsibility at a problem, I’m sure I’m not going to like their versions. However, I submit the following as a responsible way to administer such a program.

As it stands now, mortgage foreclosure rates are extraordinarily high. The financial institutions are taking over properties that are worth less than the balance on the mortgages. In turn, the banks are putting these properties back out on the market, flooding an already surplus market and further suppressing the value and price of the markets. (For those of you educated in Portland public schools — if there is more supply in the market than there is demand, prices go down.)

Look it’s pretty simple. Let’s say a financial institution has loaned $200,000 on a property that is now worth $150,000. The interest rate on the loan is 6.5%, which would have required the owner to pay approximately $1264 per month. However, in order to seduce the owner into purchasing the property and borrowing the money, the financial institution reduced the monthly payment to $800 per month for five years and tacked on the difference between the required amount and the actual payment to the principle of the loan. At the end of the five years, the monthly payments kick up to amortize the increased principle amount over the remaining twenty-five years. Five years of reduced payments will increase the principle amount of the mortgage by more than $15,800 (not including interest on that amount). Now the mortgage payment will have to be around $1450 — a significant increase over the reduced $800 per month and most likely in excess of the owner ability to repay.

If the financial institution forecloses, it will not recover its $200,000. It will not recover the additional $15,800 it lent to cover the difference between the reduced rate and the actual amortization requirement. It will recover a home valued at $150,000 and be lucky to resell it for $125,000.

In the meantime, amortization of the principle amount of the original loan -$200,00 — over the remaining twenty-five years would require a payment of $666.67 per month. Continuation of the payments at $800 per month for a period of time would reflect a return of 1.5% to the financial institution. Even a 1.5% return on $200,000 is better than a current loss of $75,000. If it is necessary for the government to subsidize the payment (and it should not be) any subsidy should not exceed one half the difference between what the original payments ($800 per month) would yield as a return, and current thirty year fixed rates (something less than six percent). The financial institutions should eat the rest and be happy as hell.

But there is a catch here too. The purchasers of homes they couldn’t afford should not be rewarded for their stupidity. If the government provides them some sort of subsidy, then that subsidy needs to be repaid from the proceeds on the eventual sale of the house. The automakers have to repay there loans before their executives can receive raises; the same philosophy should apply here. There is simply no reason that innocent taxpayers should have to bear the burden of the poor choices of the banks or the borrowers.

One final adjustment needs to be made. The current accounting rules that require financial institutions to write down the current value of property securing performing loans needs to be changed so that the financial institutions do not have to display paper losses that may never be actually incurred.

The benefit to all of this is that people will be able to remain in their homes. An already oversupplied housing market will not be further burdened by an inordinate number of foreclosures. The financial institutions will get some return on their loans and will not have to record losses that may never occur. And an economic recession will not be prolonged by more foolish decisions by the government.