Perspectives on Subprime

I attended an America's Future Foundation (AFF) panel a couple of weeks ago regarding the subprime crisis. It is an organization for conservatives and libertarians, but there were a wide range of opinions. There were arguments over whether homeowners should be helped and what form it should take. Beyond the AFF panelists, almost every politician or pundit has some idea on what to do about subprime, undoubtedly full of unintended consequences that most will not understand until it is too late.

The first question, does the government have a role in fixing the subprime crisis? The panelists certainly did not agree with each other. The argument against government action was primarily philosophical--borrowers and lenders are responsible for their own mistakes. The practical considerations basically came down to the fact that the government would probably make it worse and there would be unintended consequences. For the panelists in favor of some government action, they argued that the dead weight losses from houses falling into disrepair and the like are substantial. The panelists against government action replied another man's loss can be another man's gain. Some investors bought contracts that increased in value if borrowers defaulted. Other investors were able to pick up cheap properties. They question whether government should pick winners and losers.

Since this panel was stacked with conservatives and libertarians, throwing piles of money at the problem was not on the table. I wish it were so for conservatives in Washington. For the panelists that saw a significant role for government, they believed that encouraging renegotiation of lending terms could help. While this idea sounds good to many people, there are some additional consequences. What happens to lending markets and securitization when the government intervenes and sets a precedent? Players in the mortgage markets, long and short, might have an even more difficult time with their models once the government changes the game.

On the Democratic side, voluntary cooperation has already been thrown out the window. Clinton wants to freeze rate increases and force a moratorium on foreclosures. Clearly, people who are defaulting on their mortgages would be pleased with this solution. However, the borrowers agreed to their loans. They could have rented a home or bought a smaller home instead of overextending themselves. While there were cases of unsavory characters in the mortgage industry, most the responsibility lies with the people who borrowed. The borrower has some obligation to know how much they can pay and the risks of a particular type of mortgage.

Regulation might be able ensure that defaults are extremely low in the future, but there is a big problem with this approach. We only have to look to Japan, Italy, or Argentina where it much more difficult to get a mortgage. First-time home buyers much save for a long period of time to even afford a down payment. Home owners find difficulty in getting loans on their homes to start a business. More regulations might make it more predictable and lead to fewer foreclosures, but even that is far from certain. Certainly, it would lead to a reluctance on the part of lenders to take risks on borrowers with short or patchy credit histories. Yet another unintended consequence.