These days, one could be forgiven for thinking there is a direct correlation between the public utterances of government leaders and declines in the value of stocks and investor confidence around the world. This may owe something to an unspoken awareness that the more-or-less Keynesian interventionist approaches being applied by most governments to the global economic crisis are unlikely to work. Indeed, there is considerable evidence to suggest that such policies actually tend to prolong recessions.
Works such as Amity Shlaes’ powerful and eminently readable history of the Great Depression in America, The Forgotten Man (2007), have illustrated that, contrary to popular mythology, the New Deal was for the most part an economic failure. At the same time, few will dispute today that the interventionist policies adopted by the Nixon and Carter Administrations in the 1970s merely exacerbated the problem of stagflation. They also aggravated the effects of the recession (which included the highest unemployment levels since the Great Depression) that followed when the Federal Reserve raised the federal funds rate and the primary credit rate to extremely high levels as Paul Volcker fought successfully to break the back of inflation in the early 1980s.
Still, evidence of policy failure usually has not deterred governments of all stripes, particularly those with populist inclinations, from continuing with or reviving tried-and-failed approaches. Nor does it necessarily lead to politicians and public officials being willing to confront the root causes of problems, especially if the probable solution is unpopular.
This scenario seems likely to repeat itself today when it comes to addressing something that is not only one of the underlying causes of the current recession, but which is now contributing to the current climate of uncertainty: the turbulent American housing and mortgage market.
By now, most people understand that many of the toxic financial assets held by American and European banks were premised to varying degrees on a grossly inflated housing market in America and parts of Europe. Hence, the harsh reality is that until the housing market bottoms out it is going to be very difficult to price the real market value of these financial assets. This in turn creates uncertainty about the real value of many assets held by banks, thereby leaving many banks stranded in their present state of financial limbo, unwilling to lend and unable to attract private investors and capital. As a consequence, economic growth is stalled and will remain so until the housing market regains a state of equilibrium.
It follows that one of the fastest ways to allow the market price of the assets in question to be realized is to permit the housing market to stabilize under its own volition. There is, however, a considerable human price to be paid for this necessary process of adjustment. In some cases, it takes the form of families losing their homes through foreclosures on their mortgages. While the vast majority move quickly into rented accommodations and are in fact very likely to own a house again in the future, the social cost and psychological distress associated with home-loss should not be trivialized. Yet others face the daunting prospect of being stuck with mortgages that are worth considerably more than the property’s actual current value. Naturally enough, there are plenty of people who want to see governments try to alleviate the pain, if not attempt to render the adjustment unnecessary.
Thus no one was surprised when President Obama announced the federal government’s mortgage relief plan this past February 18th. It includes using $75 billion of taxpayers’ money to help approximately four to five million homeowners avoid foreclosure. The same plan also allows the Treasury Department to purchase $200 billion worth of preferred stock in the technically insolvent government-sponsored mortgage giants, Fannie Mae and Freddie Mac, thus allowing the two lenders to re-negotiate mortgages with some of their clients facing difficulties. These measures follow in the wake of other smaller-scale mortgage relief strategies implemented by the Bush Administration—none of which, incidentally, slowed down the foreclosure rate across the United States.
Unfortunately, there is little reason to be optimistic about the probable effects of the Obama Administration’s interventionist approach to mortgage relief. In fact, it is most likely to be counterproductive. For one thing, it will encourage many people to stay locked—potentially for years—into mortgages that, financially speaking, they would be better off exiting. For some people, selling their home at a loss or even foreclosure would actually be a better alternative. Either scenario would enable many mortgage holders to extract themselves from an economically burdensome situation and begin the process of rebuilding their financial lives. Certainly, foreclosure will have some negative impact upon a person’s credit record, but so too will the fact of requesting and receiving government assistance in order to keep one’s otherwise untenable mortgage afloat.
At the macro-level, there is no guarantee that the envisaged intervention will stabilize the housing market. Data provided by the Office of the Comptroller of the Currency suggests that, at present, approximately 55% of those people who renegotiate their mortgages are re-defaulting within six months. This indicates that government-sponsored mortgage relief will merely delay the final reckoning for millions of people. It will also impede foreclosures from shifting properties from those unable to pay their debts to those who can afford to buy. This transfer, along with the normal process of people buying and selling houses at market prices, is crucial for stabilizing the housing market, thus helping to facilitate an accurate market pricing of all those financial products built upon mortgage assets. This is critical if the banking sector’s current difficulties are to be resolved in any lasting way.
Leaving aside the economic difficulties with the Administration’s plan, there are also serious moral problems associated with such government mortgage relief efforts. Primary among these is the problem of moral hazard. Government officials, including the President, have insisted that the mortgage relief plan will not assist those who have behaved irresponsibly.
But this claim is hard to reconcile with the details of the plan, released on March 4th. It makes, for instance, eligibility for what is called “mortgage modification” dependent on how much borrowers owe above their house’s current value (which is presently a rapidly-moving downward target). Eligibility also depends upon borrowers providing, among other things, an “affidavit of financial hardship.” This is a sure recipe for arbitrariness on the part of those deciding who gets relief and who does not. Defining what counts as “financial hardship” is usually a very subjective matter. It depends on factors as variant as one’s income, responsibilities, family-size, stage of life, cost-of-living differences, etc.
Even more problematic, however, is the fact that the plan avoids the issue of why some people are facing financial hardship. There is a considerable difference between, for example, a married couple with a good credit history and who are only experiencing mortgage payment difficulties because the main wage-earner has been made redundant though no fault of his own, and those individuals who freely—and, in many instances, recklessly—played the house-flipping game in order to make rapid financial gains. The willingness to take high risks is rightly associated with the prospect of large gains. But the corollary in justice is that those who take high risks must also be willing to accept the possibility of heavy losses.
As presently configured, the government mortgage relief plan actively undermines this reasonable expectation. Whether we like it or not, it will send the message to many people that they need not face up to the consequences of being financially irresponsible. Quite rightly, those home owners who have behaved prudently and continue to meet their mortgage payments, often at considerable sacrifice, will wonder why a portion of their taxes is being used to shield large numbers of people who have behaved rashly from the effects of their own actions.
The end result is likely to be a community-wide increase in disavowal of personal responsibility for one’s actions in a society that increasingly struggles to accept these concepts as indispensible foundations for a free political order. Over the long term, this is likely to contribute to future economic recklessness on Wall Street and Main Street, not to mention reinforce an already complacent attitude among government officials to the moral hazard problem.
Mortgage relief is a difficult and at times emotional issue. Home ownership is generally a good thing, not least because it creates incentives for a range of personally and socially beneficial behaviors. This does not mean, however, that we should refrain from asking hard, perhaps unpopular questions about policies that, on the surface, appear benign and caring, but which may well do considerable damage to America’s already frayed moral and economic fabric.