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Congressman Frank's Mortgage Bailout Pays A Disastrous "Ransom"

In his interview with The Economist, Congressman Barney Frank undermines the case for his much-criticized mortgage bailout bill.  He admits that such bailouts create serious “moral hazard” problems, and that any recession they are intended to mitigate will probably be over by next year anyway.  But he says his bill is needed to keep home prices from falling faster than he thinks they should, even if we as a society “have to pay a ransom” to do that.  His bill, he claims, pays that ransom in the least objectionable way, since it focuses on bailing out borrowers rather than lenders.  (The American public opposes mortgage bailouts, both for borrowers and for lenders, according to public opinion polls).

But his bill is an insult to thrifty people everywhere.   Frank's bill proposes to bail out people who borrowed so much (and made such small down payments) that their mortgages are actually bigger than the current value of their homes. He would reward those borrowers by writing down their mortgages to their homes' “current market value” (a write-off that by definition would not apply to thriftier, more responsible borrowers who made larger downpayments), even though he admits that for some of them, their plight is the result of “their own irresponsibility.”  Such a bailout will foster future housing bubbles, as subprime borrowers realize that they can gamble at taxpayer expense on housing prices continuing to rise, and expect a bailout if they end up not being able to afford their mortgage.

In his interview, Frank admits that his bill would guarantee $300 billion worth of risky mortgages.  But he claims that it would cost taxpayers only 1 percent or so of that.  The Wall Street Journal takes a different view.  It warns taxpayers to “hold onto your wallet.”  It says that Frank's bill would actually encourage borrowers to default on their loans to be eligible for a bailout.  Under it, bailout beneficiaries would get something (a new, smaller, lower-rate mortgage) for nothing.   And the Journal predicts, based on economic studies, that a lot of irresponsible borrowers would default on their new, smaller loan, too, sticking taxpayers with the tab for even more money.

There is absolutely no reason for Congress to bail out subprime borrowers who took out bigger mortgages than they could afford (especially since some of them exaggerated their incomes to get those mortgages, or borrowed to live beyond their means so that they could buy big houses and fancy cars).

Back in March, Congressman Frank gave an even more dubious rationale for his bailout proposal: to prop up property tax collections by local governments in the United States.  He complained about “a drop in the tax revenue” in “communities where foreclosures cluster.”

That is a very weak rationale for bailing out irresponsible people. During the real estate bubble, local government revenue exploded as property values — and thus property taxes — skyrocketed.  As a result, public employee compensation grew to absurd levels.  In New Jersey, many public employees can retire at age 55 for close to their full salary.  In Washington, D.C. suburbs, even teachers — who are far from being the best paid public employees — now often have generous compensation packages that average over $100,000 annually, including salaries of over $70,000, and pension and other benefits worth around $30,000 annually, far more than most private-sector employees receive.

With a little belt-tightening, local governments could easily make do. But instead, they're doing just the opposite.  For example, a typical Washington, D.C. suburb (Arlington County, Virginia) has adopted a so-called “austerity” budget that increases spending by over 5 percent!  There's nothing austere about increasing spending faster than inflation.

The real estate bubble needs to pop.  Until it does, the U.S. economy will not experience strong and sustained growth.  The government should stop trying to artificially prop up home prices, which just delays the inevitable.  Doing so encourages sellers to keep their homes on the market for months on end at artificially-inflated prices no buyer will pay, in the vain hope that the government will come along and somehow pump home prices back up to that inflated price.  As George Mason University Law Professor David E. Bernstein notes, some would-be sellers simply refuse to sell their homes at their true current market value, stubbornly insisting instead on receiving the value at which their home was assessed at the height of the real estate bubble.

In the meantime, American politicians' support for bailouts that shower money on irresponsible borrowers, their apparent unwillingness to let borrowers suffer the consequences of their financial irresponsibility, and America's lax monetary policy, are leading to a loss of confidence in our economy by international investors.  That's triggering a fall in the dollar, reduced investment in the U.S., and renewed inflationary pressures.