We can hardly bring our self to talk about America’s socialist subprime bailout. So we won’t spend much time on it!
Don’t confuse the Hope Now Alliance of lenders, investors, and banks for a bunch of modern day capitalist altruists. A close examination of the plan offered by George Bush and Hank Paulson shows that it’s an excellent example of battlefield triage.
In triage, there are three kinds of victims. The first is the guy who’s going to die anyway. He gets no medical care because it won’t save his life. The second is the guy who will survive anyway. His injuries may be disfiguring and gory. But he doesn’t need any immediate care anyway. He’s going to live.
The third guy is the guy who gets triage. He’s the guy who will survive only if he gets immediate medical care. This is the guy the mortgage bailout plan is aimed at. Why?
The folks already in default are never going to pay back their loans. The bankers know this. And the schmucks who are responsible enough to keep paying their loans, they are too conscientious to default. They’ll keep paying on their mortgages, and this money will go to bondholders and prevent the banks from having to take larger losses.
But what the bankers and bondholders were really after is a way to reduce losses and ensure continued payments from distressed borrowers. Freezing the resets on ARMS for five years does this. It means investors and lenders recoup a larger portion of the loan/income that looked in doubt prior to the bailout.
You might also think of it as a modern version of indentured servitude. If you wanted to make it to the New World from Europe, sometimes the only way to do it was to sell your labour to a land holder for a five to seven year period, after which you’d be free of your bonds (contractual, of course), and could start building your own capital.
Today, debtors accept more fetters. Instead of walking away from a bad financial decision – taking a loss and moving on – they will lock themselves in to a longer commitment. And a commitment to what? To paying bondholders and bankers. Seems like a bad choice.
It only works if the borrower builds equity and US home prices continue to rise. But even a bailout of this narrow niche of borrowers can’t reverse the trend in home prices. Homes are simply too expensive as a measure of income (in the US, the UK and Australia.) No bailout will change that.
We’d add one last note as we go into the weekend. A fall in home prices would certainly make them more affordable. But what’s more likely is that backdoor subsidies that prevent a massive wave foreclosures will keep home prices high in nominal terms, putting a kind of floor under them.
But in real terms, inflation will eat away at the value of housing as an investment. As the money supply grows and prices race ahead, a $250k home will have the same price, but fall steadily in value.
Markets and Money