Wednesday, April 2, 2008

Risk Of Too Much Federal Government Intervention

Amended to include the chart Figure 13

With the advancement of the Foreclosure Bill through the Senate, the Federal Government is closer to being a socialistic entity. While I agree that the Federal Government should be working to ensure that our constitutional rights are maintained, I disagree when the Federal Government decides to put on its socialistic glasses when looking to solve economic issues like the current spike in foreclosures.

According to CNNMoney, more than 900,000 homeowners are facing foreclosure, or about 2.04% of all mortgages. Yes, it is a historic high but is it worth congressional actions? USAToday reports that the bill contains such measures as:

  • “…letting states issue $10 billion in tax-exempt bonds to refinance subprime loans and permitting home builders and other money-losing businesses to reclaim previously paid taxes.”
  • ”…provide $4 billion to states to buy up and refurbish foreclosed homes...”
  • ”…award $15,000 tax credits to people who buy and move into foreclosed homes.”
These measures will not help the economy at all. After all, this is not the first time that we have been through the mortgage rough patches. According to a 1998 FDIC study, conventional foreclosure rates in 1998 (figure 13, below) exceeded 1% of all mortgage loans and approximately 80% of all loans that were 90-days or more delinquent. A subsequent study on foreclosure rates by the Chicago Federal Reserve reveals that national foreclosure rates exceeded 1% again following the dot-com bubble crash. As of 2Q 2007, the national foreclosure rate was 1.25% with Ohio topping the list at 3.6%.

In previous mortgage crises, the Federal Government did not take drastic measures of handing out thousands of dollars to the public. During 1998-91, the U.S. took direct action of taking over insolvent S&L and banks and working out the mortgage mess. During 1997-98, the growing economy helped to absorb some of the fallouts from foreclosure.

Federal Government Is Rewarding Wrong Behavior
So what is different now? I think the difference now is the Federal Government’s view on the economic slowdown. It appears that the Federal Government is so bent on trying to salvage the economy from a necessary recession that it has taken very drastic actions and now find itself in too deep to back off. First, it began innocuously with lowering of the fed fund rates from 5.25% in 2Q 2007 to 2.25%, currently, then began taking more drastic actions, including offering tax rebates up to $1,200 directly to John Q. Public, increasing the FNMA and FHLMC conforming loan limits up to $729,750 in certain high-cost states, revising the overnight borrowing parameters to allow acceptance of junky collateral. As the economy continued to slow down, the Fed applied even more severe actions of lending directly to the brokerage firms for up to 28 days, providing emergency loans to investment banks directly, and then performing the forced marriage of Bear with JPMorgan.

Now, having come too far and having firmly set people’s expectations for government bail outs when they – the business and public – have made the blockheaded choices and are asked to pay the consequences. This is a Pavlov’s dog gone wild.

Will These Measures Help The Economy?
Now with the masses firmly hooked on bailouts, there is no end in sight. After having pledged to pump $150 billion directly into the economy through federal tax rebate, it now is forced to rescue homeowners to avoid urban blight.

Based on the reactions of the various stimulus plans thus enacted or planned, it appears that the U.S. economy is faring no better than if it was simply left to its own devices. After directly lending tens of billions (and agreeing to lend up to $200 billion, if required), agreeing to rebate $150 billion in federal taxes to the taxpayers, and reducing the fed rate to 2.25%, what do we have?

We have an economy that is still on the verge of stalling; market that is back to its levels a year ago; traders trying to figure out if today’s market recovery is for real (and hoping that it is real); unemployment numbers rising; dollar devalued against major currency; prices of consumer goods rising; and growing unrest from truckers, a vital lifeblood of the U.S. economy.

So, it is conclusive that all that liquidity injection and government intervention really didn’t do a whole lot of good.

Risks Due To The Federal Government Interventions
  • Increased risk of taxpayers having to pay for losses arising from the Federal Reserve Term Securities Lending
  • Increased risk of the Federal Government having to provide more bailouts as the number of foreclosures increases
  • Increased risk of prolonging the current recession
  • Increased risk of stagnant economy with increasing consumer good prices (stagflation)
  • Increased risk of higher unemployment, lower wages, and slowing consumer spending, leading to a depression
In the current election year, the only candidate that seems to understand the fact that the U.S. needs to bite the bullet and take its hits is John McCain. His position of being against the mortgage bailout is a tough but pragmatic decision. After all, the borrowers were not that dumb to think that they could always sell the house for a profit if the mortgage payment resets. Housing is not an investment. For those who have sought profit by flipping or sought to live the “American Dream” but super sized, too bad.

You were given full disclosure of the consequences but you chose to ignore it – it was all there under the “Acknowledgement And Agreement” section of the mortgage application, the part where all borrowers swear to tell the truth and know that it is a federal crime to lie on the application; the good faith estimate; and the Truth In Lending Form (Reg. Z), which tells you when the mortgage payment will reset and the new mortgage payment amount.

There are even instructional videos on the web showing you how things are done. And now these same folks are pointing their fingers at the banks for having lax lending standards. Tough. Two wrongs do not make a right.

The banks are getting their punishment. The mortgage brokers that dealt in these liar mortgages should be punished as well. Will they? Perhaps. However, right now the homeowners who are pleading for help are claiming ignorance and the government is buying it by working feverishly on another bailout scheme. Perhaps it is time to tell the Federal Government that ignorance of the law by the borrowers does not give them the right to now plead for assistance. They folks, either being too dumb, too greedy, or both, had plenty of information going in. As my mom always said: “You will sleep in the bed you’d made.” I don’t think the Federal Government agrees with that.

May You Sleep Soundly

Ed Kim

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