Thursday, December 06, 2007

"Hope Now" Means Problems Tomorrow

It appears that the Bush Administration' plans to help struggling home owners fight off foreclosures is destined to happen. Hillary Clinton has offered a similar plan of her own and both Wall Street and policy wonks on both sides of the partisan aisle are embracing the concept. Simply put, it is being proposed that those who got subprime loans and are still current (but struggling with any increase in rates) will see a freeze at their current rate. The increases would be put on hold for as long as five years, according to most estimates. Others, still, are arguing for all the increases to be added to the back of the note through additional years. The reform promoted by the President is being called "Hope Now".

Although this idea is extremely popular and should have an immediate short-term benefit to the economy, I believe the long term effect could be chilling to the economy in general and future home buyers in particular.

When people got an adjustable rate mortgage (ARM) they either (a) knew what they were getting or (b) should have read the contract to know what they were signing up for. They were signing up for a loan that would have future increases. That was the price they had to pay to get their loans because of their credit situation.

Investors back up money mortgages such as these because they thought that although some might foreclose (the risk of doing business), they would at least enjoy a higher rate during that process. Although there is no doubt in my mind that the President's plan is actually beneficial to some lending companies (which usually do well at financing homes, but are terrible at selling Real Estate), it is fundamentally wrong for the government to take such a coercive role.

Besides the fact that this is a violation of contract law (an idea clearly protected in the Constitution), this is also a modern form of Price Controls. When investors consider financing risky loans with the opportunity of failure (like sub-prime loans) they will remember the dollars lost due to government intervention. The loser in this process will be the same person "Hope Now" is meant to benefit -- the risky individual who needed the loan. This is the unintended consequences of bad policy. We won't see it today, but we will see likely see the affects in the future.
Kevin Price is Host of the Houston Business Show (M-F at 11 AM on CNN 650) and Publisher of the Houston Business Review.

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