The Mirage of the Mortgage Fix


Joy, joy, the Fed has cut rates again.

Picture the Joker from the movie Batman throwing money from his float on the parade and you can see where this is going. Or imagine the alchemist of medieval lore, attempting to conjure up wealth from chemical mixtures.

The sea of inflationary credit is the core problem behind the falling dollar, the subprime crisis, the housing meltdown, not to mention the rise in the national debt and a thousand other problems.

And how do they deal with it? More credit and more calls for controls. No one in Washington seems to understand the reason for the crisis, much less how to fix it. The markets go for this stuff for a while until it looks like Washington is in panic mode. Even Wall Street is starting to sense that something is very wrong.

A good indication is President Bush’s freeze on subprime mortgage rates. It is a classic case that provides serious lessons for all of us. It shows the political penchant for intervening in the market, the market response, and the further interventions that are called forth when the first round doesn’t bring the utopia they imagine.

Here is the great mortal threat that intervention poses to the economy: not the first round, not even the second round, but the relentless dynamic of political rescues that drive us further into the pit of state planning. Under Bush’s solution, rate freezes kick in next year and subsidize only part of those affected. His plan is under fire, not for being an intervention but for not bailing out every living soul.

Why do subprime mortgages exist in the first place? They are a market response to a regime of easy money that was brought about through the Federal Reserve in cooperation with government-backed mortgage underwritings, which have undergone an explosive expansion in recent years.

Since the period after World War II, the American dream has been identified with owning one’s own home. And when the government makes a dream come true, it is going to do it good and hard. So there were no limits. The housing market has boomed and ballooned beyond belief. No amount of money has been too much.

Houses require loans, so the mechanism of choice here is the interest rate. A high rate both discourages borrowing and tends to separate good lenders from bad ones. This is what the politicians, who love nothing more than giving people something for nothing, do not like. So from the perspective of the state, the interest rate can’t be low enough.

The political establishment loves this method of subsidizing the public as much as it loves the welfare state or any other transfer program. In fact, it loves it even more. The transfers associated with easy money are harder to detect than taxes and spending, but they are no less a redistribution. They redistribute money from dollar holders to dollar spenders.

The 30-year mortgage has been on a 15-year downtrend at the very time when savings rate has been falling. People were screaming when rates peaked in 1984 at 14.6%. They bottomed out in the salad days of 2005 at 5.77%.

Then there was the subprime market that has accounted for 20% of these loans. These are for people who, in a real market, would never get a mortgage because their credit score is too low. These loans come with adjustable rates, which sank millions of borrowers once rates began to rise.

The incredible fact is that these loans are an expected result of 15 years of government propaganda about mortgage loan “discrimination.” Some genius noticed that the loan markets tend to favor people with good credit histories and some savings built up over time. And then some other genius noticed the demographic fact that these credit histories, in general, parallel racial demographics. Hot button! And so the pressure was on to lend as if the prospect for repayment didn’t matter.

The loans in this category were only viable if we presume that housing equity would rise forever. Then it works like magic. It’s like an economic perpetual motion machine. You borrow and borrow and the loan pays itself off. Crazy? Yes, it is, but such is the craziness of any inflationary environment. It leads people who should know better to believe that the impossible is happening.

It was not just the subprime market but the entire housing market that has been wildly distorted through intervention. The money lent has had no economic justification, and the low interest rates are unsustainable. And by the way, it is myth that the market has bottomed out. The data still show that housing prices are rising nationally, albeit at a much slower rate than in the past. What the market needs to be thoroughly re-balanced is a massive downward correction, one that is permitted to take place without any intervention.

But will the political establishment settle for it? No way. The relative minor problems that have cropped up with subprime have elicited some of the most ridiculous regulation in memory. Both parties agree that rates should be frozen low, so that existing borrowers don’t have to pay market rates. This strategy only forces banks to hold low-quality loans and passes the risk up the chain of borrowers, penalizing people with good credit and rewarding people with bad credit — which is essentially the opposite of what credit markets are supposed to do.

But it gets worse. Interest rates are dropping, not rising, both long term and short term. This is precisely the opposite of what is best at this stage in the market. The drunk is taking another snort just as he was sobering up a bit.

Where is the end of all of this? We can’t know the specifics, but long-term disaster looms. One can’t create prosperity out of a printing press. Michael Heilperin, one of the prophets of the current money mania, once described the attempt as the pathology of money. It is a pathology because it amounts to an amazing denial of reality.

Here is the plan in Bernanke’s own words: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

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