“The Mortgage Market Mess” by Christopher Westley
In the United States today, there is approximately $10 trillion in outstanding mortgages, and of these, about one-quarter are subprime and Alt-A loans. (Subprime loans are made to borrowers with little or no credit, while Alt-A loans are made to borrowers with better credit but who are not considered prime.) Individuals who access such loans often pay a below-market interest rate, or an interest-only mortgage payment, for the first few years of the mortgage. But after that, mortgage payments are adjusted to reflect prevailing market rates. If 40 percent of the Alt-A market fails this year (as many estimate), financial markets will be looking at $1 trillion in defaults.
That's a lot of defaults, especially when you consider that the 1980s S&L crisis cost, by comparison, $150 billion (about $240 billion in today's dollars) and is partly blamed for the 1990-91 recession. Does today's mortgage market promise a similar result today, on the eve of the baby boomers' retirement? If so, the sound that defines 2007 may not be that of Beyonce or Bell but of air seeping from the housing bubble. Though unpleasant, it is a sound much to be preferred, since it reflects a housing market returning to fundamental levels, as well as one that will offer buying opportunities to many who currently cannot afford housing. But still, $1 trillion dollars makes for a lot of failed loans that were issued over the last few years. Surely, this is a clear example of market failure. Right?
Well, no, because when hyper-regulated markets fail, you can't blame market forces. In this case, rising real estate prices were forcing many low and middle class households out of the housing market well before the most recent recession. When that happened, home buyers had few options — either relocate to another part of the country and start over, or finance with a subprime or Alt-A loan and wait the bubble out. That's what many did, and it quelled genuine political revolts in bubble-plagued markets in the early 2000s, especially in California and the Northeast.
The situation reminds us that bad things happen when pols manipulate markets to achieve their ends. In this case, there was a recession that resulted from an inflationary boom that they created. What do you do when housing market malinvestments, spurred by Alan Greenspan's cheap-money policies of the 1990s, pushes housing prices out of reach to the middle class?
Option 1: Say mea culpa and cease policies that create bubbles in the first place (and pay a political price at the polls).
Option 2: Give those placed in such positions a short-term solution that allows them a way out, even if you are simply postponing the day of reckoning by a few years.
These two options reflect an important point made in Henry Hazlitt's classic book, Economics in One Lesson. Economic policy options often have either positive short-term effects and negative long-term effects, or negative short-term effects and positive long-term effects. It's obvious which option is favored in today's mass democracy, since politicians are extremely short-term oriented — indeed, their focus is about as long as the next election.
Presidential candidates this year will wax ad nauseam that home ownership is the American Dream and that this dream is now too expensive for average Americans. What they won't talk about is how government policies, and specifically monetary policies, help bring this situation about...Housing was the middle class's best hedge against a growing government intent on expanding its scope and power by inflating the money supply.