Details are still a little sketchy but I’m assuming that the new subprime bailout plan will closely resemble California’s plan.
Previously, I listed some unintendend consequences. Quickly, those were insufficient scale to work and keeping the “plankton” out of the housing market. Those are still valid, IMO. After getting the details about Gov. Schwarzenegger’s plan in California, this plan is absolutely horrifying.
The most insidious aspect of the CA plan is that it is a lie, much like Bush’s supposed tax cuts for the middle class back in his first term. In that case, the tax “cuts” were actually tax rebates, akin to payroll advances. It was zero-sum and not a cut at all — taxpayers just got an interest-free advance and had to pay it back at tax-time.
Well, this “teaser freezer” is very similar — it actually turns your ARM into a de-facto negative-amortization loan. Nothing is forgiven and no amount is written off from the borrower’s perspective. From the investor’s perspective, they may take a loss or writedown if the security holding these loans is devalued but that might be acceptable if it means staving off defaults and total loss altogether.
The intent is not to help homeowners at all. Rather, these borrowers are being treated like the human batteries in the first Matrix movie — being kept in a virtual mortgage cell where their income can be sucked out from them, basically for life. It could be decades before these people get to a zero-equity situation, much less positive equity.
Unfortunately, most of the people this directly affects will probably not view it this way. I suspect the emotional aspect to being a homeowner will overcome any economic sense (which Americans generally have very little to begin with). If so, these people are doomed to a lifetime of financial insecurity and the stress that comes with it. The kicker is many of them will be grateful for it. This is the reason I left politics — as much as I wanted to help people, you can’t help those who won’t help themselves.
For the rest of us, there’s a very real possibility that this plan will only set us up for the next big leg down in the housing market and eventually, the economy. It’s very simple: houses are (still) too expensive. Unless gov’t officials have an ingenious plan to massively boost middle class income in real terms without knock-on effects on inflation, the only solution is waiting for housing prices to drop.
Lowering interest rates will not work because as Congresswoman Sanchez pointed out to Ben Bernanke, even good-credit borrowers can not get credit at the listed best rates. We are already seeing this at the corporate level. Only the government can borrow at low interest rates. Citigroup (C) had to pay 11% and mortgage off 5% of the company at a 40% discount to its value at the beginning of 2007. So if the Fed continues lowering rates, lenders will not pass the whole of those cuts to borrowers but rather widen the spread to help pay for the current mess.
Therefore, the housing market must be allowed to decline. Much like the banking credit crisis, anything that prevents the “discovery” process is likely to prolong the misery.
