We’re all aware that the US is in serious trouble because some unconscionably stupid, or greedy consumers took on mortgages for homes that they could not afford. And they were met all to warmly by predatory mortgage lenders who sold these mortgages, then handed them off to other scoundrels who packaged them up as “mortgage-backed securities”.

There is much discussion about what to do with these mortgages.  Senator McCain’s Presidential campaign included a kind of “buyout” for these mortgages, which struck me as a profoundly un-Republican thing to do.

First, I want to separate the mortgage difficulties faced by a family who’s income has been affected by a recession-related job-loss.  You can’t hold people responsible for a mortgage that they could have managed without difficulty when both parents were working.  I’d actually want to see them assisted before we help the stupid/greedy people.

The “culprits” I want to focus this discussion on are the people who, either through ignorance or greed, bought a house that they could not afford. Let’s call what they have “bad mortgages”.

As Consumers, we all have an implicit personal responsibility to only spend what we can afford. There are protections in place to prevent us from being taken by fraudulent marketing.  This is one of the aspects of “regulation” that is hotly debated by the Left and the Right. Pure free marketeers believe there should be no regulation, but I think that leaves consumers in the position of having to either be, or hire, the services of a financial and legal expert to vet every transaction they undertake. Clearly, that’s not scalable. The Left believes there should be lots and lots of regulation. That will grind commerce to a halt, and add so many layers of bureaucracy that our markets would become massively inefficient wastelands. Neither side is right.  There is a reasonable compromise to be struck.  And the fact that Canadian Bank and Mortgage regulation has largely insulated the Canadian homeowner from these problems speaks to the benefits of reasonable regulation.

President Obama has created a proposal that he describes as follows:

  1. refinancing help for four to five million homeowners who receive their mortgages through Fannie Mae or Freddie Mac
  2. new incentives for lenders to modify the terms of sub-prime loans at risk of default and foreclosure
  3. steps to keep mortgage rates low for millions of middle class families looking to secure new mortgages
  4. additional reforms designed to help families stay in their homes

I’ve been thinking more lately about what the “right thing” to do is with respect to these “bad mortgages”.  It is entirely unfair, in my opinion, to pay off, in any way, the equity shortfall, or mortgage payments of a bad mortgage holder. You can easily imagine a neighbour of his next door, who bought a smaller house, and is fully current with his mortgage, wondering why his tax dollars are paying for the mistake/greed of his neighbour.

It would not be fair.  But in the “big picture” we have an economy which is being held at gunpoint by these bad mortgages.  Some major US financial institutions, like Citibank and Bank of America could become insolvent if the mortgage failure trend continues.  These banks will become the proud owners of massive numbers of homes which are worth much less than their mortgaged value.  The Bank’s money, long gone into the hands of builders and speculators.  The cascading effect of major US bank failures is a terrifying one.  Don’t worry about your savings and checking account, because 99% of us don’t have hundreds of thousands of dollars there.  But think about the small and medium sized businesses.  Think of the credit crunch when a few more major banks fail.  More businesses will fail, and more people will lose their jobs causing yet more mortgage defaults.  It’s not a pretty picture.

So what might be fair? The current proposal is for the government to pay portions of these mortgages, and re-negotiate the lending rates.  But to me, that’s unbalanced. Fred shouldn’t be paying off Stan’s mortgage because Stan is a greedy/stupid guy.  I have a proposal:

When mortgage relief is offered to anyone who has a “bad mortgage”, if they take it, they forfeit any equity to that house when they sell it until the government is paid back.  Think of it as a 100% capital gains tax on bailout home sales.  As with all systems, there are ways to game it to your advantage.  I fear this would be very difficult to implement. But the spirit of this idea is that the government/taxpayer gets it’s money back when/if the home sells at a higher price in the future.  The bailed-out homeowner doesn’t get off scott-free.  Of course, this assumes the house will be worth more in the future, but that’s not likely to happen for a long time.

I’m curious what you think of this idea.  My gut says one underlying problem is that it doesn’t let the “bubble” reset, but it prolongs inflated home values.  One of the arguments used by proponents of a mortgage bailout is that “good mortgage” holders home values will be negatively affected by the default of the “bad mortgage” holders. That’s true, but isn’t the loss in home value related to an inflated supply of homes?  I think the underlying problem is that too many homes were built (at too large a price because of the easy-mortgage money that was available).  That’s not going to be corrected by bailing out these mortgages.  I think the market has to stabilize, which probably means the housing over-build has actually reduced the value of everyone’s home. Supply and demand 101. Grow the economy, and raise the wealth of the middle-class, and perhaps the demand side of the equation will scale up and start raising home values again.

The Obama proposal allows people to continue to live in homes they can’t afford, while honest, hardworking taxpayers continue to live within their means.  Are there no repercussions for being irresponsible and for affecting the health of your country?

I find it ironic that with all the money and attention focused on terrorism that the greatest threat to our “way of life” has come from idiots and scoundrels holding US passports in hot pursuit of “the American Dream”.  I hope these people are ashamed of themselves.

mJm