Ripples from a bailout

The leading financial news these days has been of the subprime mortgage bailout. While Michelle Malkin has succinct advice that I tend to agree with, I want to go back in time a little bit. There’s obviously reasons why the 6 percent of homeowners behind on their mortgage payments got that way, and it can’t all be profligate spending.

At first blush, this is what I thought about the news on her site:

So the people who have already shown themselves to be poor credit risks will get to take advantage of the taxpayers’ generosity. Do you think that they’ll take advantage of this break sponsored (albeit unwillingly) by people like me who didn’t buy a larger house than I could afford and do something to change their ways, or will they take advantage of the smaller house payments to buy more electronic goodies, ratchet up their credit cards, and the like?

Remember what happened the last time government gave “free” money to victims after Katrina?

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That covered the spending angle. But then I thought about it a little more and realized that there has to be some who had thought ahead to the time when the rate would adjust upward and tried to make it work, but other things got in the way.

One example of this comes from a relatively new local blogger (“Average Girl”) who talked about her situation. She gave an example of an family whose combined monthly income is $3,500 net. After the bills she details (including a $900 a month rent/mortgage payment) they’re only left with $405 a month for a car payment, clothes, emergencies, etc. It’s relatively typical for most families who juggle bills on a monthly basis.

So what has changed for these families that 3 or 4 years ago were confident that they would be able to make their house payments (or re-refinance) when the rates went up?

First of all, the housing prices simply stopped going up. As a personal example, a little over a year ago I made an offer to buy a house in Salisbury. It was listed for $134,900 – one year earlier the owner had bought the place for $90,000. I didn’t offer that whole price because I wasn’t going to be the sucker who allowed a 50% rollover in one year, but somebody else did buy it – for even less than I’d offered a couple months before. The sellers still made a tidy 36.7% profit though in about 17 months of ownership.

In looking for a house, I saw that prices had zoomed up in this area about 50% in 2004-2006. People assumed the good times would roll and the increase in value would either make the house an investment on their way to a better home or give them a backstop to refinance at favorable terms with the appreciated value. (By the way, that house I used as an example is back on the market at the original listing price.)

But that old economic axiom of supply and demand saw a lot of builders try to cash in on the trend too. It kept me busy for the better part of three years doing condo work but those who came in past the peak are now sitting on a whole lot of unsold units. This housing glut drove the prices down and placed a lot of people underneath a mortgage more costly than their home’s reduced value.

I think people could have survived the drop in housing values though until reason number two came into play. In the last two years energy prices have surged dramatically. Here in Maryland, the cost of electricity jumped up by 1/3 or more (depending on supplier) while nationally gasoline costs have gone up by about the same margin. A second sticker shock occurred while trying to fix the first problem, with the price of corn (the component that’s blended with gasoline to make ethanol) nearly doubling. Not only is there a direct cost to the consumer at the gas pump and at the supermarket for all the products made with corn and corn by-products, but farther down the line businesses pass their additional costs to consumers, increasing inflationary pressure.

A third area of concern was the steady increase in interest rates. The Fed had continued to slowly raise the prime rate over a two year period – in July 2004 it was 4.25 percent but by July 2006 it was 8.25 percent. (They finally saw the subprime mortgage problem and began lowering the rate in September. Currently it’s 7.5 percent.) This may not seem like a lot, but with all of the credit card debt being carried by homeowners who wanted to furnish their nice, expensive homes anyone who had a card with interest based on prime plus a percentage saw their interest charges continue to press upward.

These three factors combined to erode the cushion that many families anticipated when they made their deal with the devil to get a larger house than may have been prudent for their budget. Again using a personal example, I was told I could borrow up to four or five times my income but decided to go by the old rule of thumb to not borrow more than 2.5 times my income for a house. Unfortunately, the sentiment that people like me who borrowed in a rational manner are getting screwed over is pretty pervasive, and there’s no way that any credit for doing this will accrue to President Bush – the partisan media will likely ask “what took you so long?”

Honestly, I’m of the opinion that events should have been allowed to run their course. It’s a market correction that occasionally occurs. No one was crying the blues for the oil companies when oil prices cratered in the late 1980’s, instead most of us were reaping the benefits of cheap gasoline. While not allowing a huge number of foreclosed homes to hit the marketplace and depress my home’s value benefits me personally, the ones who are hurt are those who could use a return to sanity in home prices to enter the market (particularly young couples) and the ones who don’t get to learn the valuable lesson about not living beyond their means but could use it.

Yes, there will be some who get financial breathing room from keeping their low “teaser” rate for awhile longer. But don’t think banks won’t find other ways to make back those lost interest charges. And even if they don’t enhance their revenues in that manner, not having to dump a lot of foreclosed housing stock for pennies on the dollar can do nothing but improve their bottom line.

What’s even more sinister to me is that a bipartisan effort to get the government involved in taking any risk out of the mortgage market will lead to yet another huge government bureaucracy, one that will mandate banks lend money to anyone who applies regardless of credit history. (Yes, I know we already have Fannie Mae and Freddie Mac. This bailout impacts them as well.) As we’ve seen with a hundred other examples, once the feds get involved it’s nigh upon impossible to get them out of the heretofore free market.

Crossposted on monoblogue.

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