Pethokoukis: Savior-based economics

Count US News’ James Pethokoukis as one of the unimpressed on Barack Obama’s mortgage-bailout plan.  He refers to the $75 billion as “savior-based” economics, but we used to have another name for it: elitist.  It puts economic management in the hands of a few people in Washington rather than the market, and oddly enough, into the hands of judges:

In the span of just over a week, America has witnessed the debunking of “savior-based” economics. That, you might have heard, is the theory that posits all you need for smart economic policy is to assemble a bunch of indispensable brainiacs in Washington and let them work their magic. (Hollywood has its own version of this theory, which is why we end up with the “great cast, bad movie” phenomenon. See “Ocean’s Twelve” or “Ocean’s Thirteen.” Rather, don’t see them.)

First came Treasury Secretary Timothy Geithner’s tightly-wound presentation of a banking bailout plan that left Wall Street both somewhat confused about its details and somewhat terrified that the fuzzy thing wouldn’t work. Next, came President Obama’s signing of a $787 billion “stimulus” plan where most of the stimulus may actually kick in after the economy starts to recover. (Too little boli, too many Tic-Tacs in that one.) And now comes the third leg of the chair, a $75 billion housing bailout plan (though it could surge to $300 billion or more). It will attempt to help some homeowners refinance, assist others in lowering their monthly payments, and reduce mortgage rates. …

But it is certainly debatable whether we should even be trying a savior-based plan to prevent foreclosures. Do we need Uncle Sam to  “save” homeowners who have sinned against the gods of financial prudence? Here’s how the folks at Weiss Research see things after examining the Obama plan: “Foreclosures are actually resulting in overpriced homes burdened with too much debt being moved into the hands of new buyers, who are paying drastically reduced prices. They can therefore purchase using a traditional mortgage. … Delaying and dragging out the downturn by artificially propping up home prices will arguably work against the market healing.”

James is perhaps a little too polite in this passage, but it was savior-based thinking that got us into this mess in the first place.  Congress took a well-functioning lending market and destroyed it by insisting on forcing loans to people who were at high risk of defaulting.  When government couldn’t get enough distortion through threats of penalties, it instead starting buying paper from subprime lenders through Fannie Mae and Freddie Mac, and converted them into securities sold on Wall Street, which then infected the entire economy with bad debt.  That created unrealistic demand for dubious loans, which created a housing bubble — and its collapse has created all of the mischief we now see.

Why did Congress do this?  Because it wanted to choose winners and losers itself rather than allow the market to do it properly.  They talked about it in glorious tones — home ownership, self-respect, investment in the community — but at its heart was the deep conviction that a select group of elites could run the markets better than the people invested in the market themselves.  That’s elitism, and Obama’s savior-based economics is exactly the same thing.

Consider that homeowners under this program can now force banks to adjust mortgage rates.  How?  They just drag them into court, under this new law, and a judge can tell the bank to reset the interest rate.  (Because of the sale of FM/FM-issued mortgage-backed securities and the splits of loans into thousands of MBSs at a time, banks can’t readjust rates because they simply have no way of finding all of the creditors who have to agree to it. ) What does this do?  It penalizes the people who invested in these bonds by lowering their value — in a very inconsistent manner — and it lets off the hook the homeowners who overextended themselves on the sale of the houses.

The inconsistency is a problem unto itself.  The big meltdown occurred because investors suddenly had no idea how to value their MBSs as foreclosures began to increase.  This plan makes their value even less clear.  If a judge in Omaha can reset the value of a mortgage that may be split over a hundred or a thousand bonds, no one will be able to keep track of the value of any MBS.  Even if the government bought all of them back (the original TARP plan, if you’ll recall), they’d have no means to price them effectively.

Lastly, let’s remember that interest rates aren’t the problem anyway.  The problem is that the principals are too high for the current valuation of the house.  The lender shelled out the principal to allow the homeowner to live in the house, and the interest rate is how the lender recoups his cost of lending.  Instead of subsidizing the principal, which would also lower payments while keeping lenders whole and credit flowing, this plan penalizes the lender and lets the borrower skate on the pain, although not entirely.

This is what happens when elites or saviors think they can outsmart the market.  They turn it into a mess, and this plan is no exception.