Subprime Bailout
By Walter E. Williams
Wednesday, January 23, 2008
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A subprime lender is one who makes loans to borrowers who do not qualify for
loans from mainstream lenders. It's a market that has evolved to permit
borrowers with poor credit history and an unstable financial situation the
opportunity to get home mortgages. The catch is they pay a higher and typically
an adjustable rate mortgage (ARM). Encouraged by the housing bubble, easy
credit, along with the expectation that housing prices would continue to
appreciate, many subprime borrowers took out mortgages they could not afford in
the long run, particularly if interest rates rose and housing prices
depreciated.
As with most economic problems, we find the hand of government. The Community
Reinvestment Act of 1977, whose provisions were strengthened during the Clinton
administration, is a federal law that mandates lenders to offer credit
throughout their entire market and discourages them from restricting their
credit services to high-income markets, a practice known as redlining. In other
words, the Community Reinvestment Act encourages banks and thrifts to make
loans to riskier customers.
New homes are being constructed in Carlsbad, California January 18, 2008. U.S.
President George W. Bush called on Congress on Friday to give the U.S. economy
a "shot in the arm" with an election-year package of temporary tax cuts and
other measures worth up to $150 billion. Financial markets are reeling amid
bleak reports of declining retail sales and rising unemployment on top of
soaring oil prices and a credit crunch brought on by a crisis in subprime
mortgages. REUTERS/Mike Blake (UNITED STATES)
Related Media:
VIDEO: 2007: The Subprime Meltdown
VIDEO: Wall Street Bonus Breakdown
According to an article in The Atlanta Journal-Constitution (11/04/07) titled
"Black Atlantans often snared by subprime loans," by Carrie Teegardin, a
national study of credit scores, not just mortgage loan applicants, found that
52 percent of blacks have credit scores that would classify them as subprime
borrowers compared with 16 percent of whites.
Many lenders did make loans to people who had no realistic ability to pay them
back. But that doesn't qualify as fraud, although there might have been a bit
of exuberance in the repackaging of the mortgages into securities and selling
them to investors. Some argue that many borrowers defrauded the banks by
misrepresenting their income, the so-called "no doc" loans or "liar's loans".
President Bush's plan to deal with the subprime crisis is to freeze interest
rates on adjustable rate mortgages. Freezing interest rates would stop people's
mortgage payments from increasing. That is a gross violation of basic contract
rights and would appear to be a Fifth Amendment violation. If a contractual
agreement is willingly entered into and agreed upon by a borrower and lender,
it is binding and if broken by one party or the other, harsh penalties should
ensue. Now here comes government, under the Bush plan, to declare millions of
contracts null and void. The long run effect of the Bush plan is to make
lending institutions even more selective in choosing borrowers. Then there's
the question: If government can invalidate the terms of one kind of contractual
agreement where the borrowers can't pay, what's to say that it won't invalidate
other contractual agreements where the borrowers encounter hardship and what
will that do to financial markets?
The Bush bailout, as well as Federal Reserve Bank cuts in interest rates, is a
wealth transfer from creditworthy people and taxpayers to those who made
ill-advised credit decisions, and that includes banks as well as borrowers.
According to Temple University professor of economics William Dunkelberg, 96
percent of all mortgages are being paid on time. Thirty percent of American
homeowners have no mortgage. Delinquency rates were higher in the 1980s than
they are today. Only 2 to 3 percent of all mortgages are in foreclosure. The
government bailout helps a few people at a huge cost to the rest of the
economy.
Government policy got us into the subprime mess and government's measure to fix
the mess is going to create more mess. As such I'm reminded of Marcus Cook
Connelly's spiritual play, "Green Pastures," where God laments to the Angel
Gabriel, "Every time Ah passes a miracle, Ah has to pass fo' or five mo' to
ketch up wid it," adding, "Even bein' God ain't no bed of roses." That's
something the president and congressmen should think about and leave the
miracle business up to God.
Dr. Williams serves on the faculty of George Mason University as John M. Olin
Distinguished Professor of Economics and is the author of More Liberty Means
Less Government: Our Founders Knew This Well.
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