Written July 9, 2008
The United States has interfered with economic natural selection for too long, and we are beginning to pay the price. Rather than accepting the situation as a natural (and overdue) market correction, the Congress is furiously trying to pass a housing bail-out measure that would drag all U.S. taxpayers into the worsening cycle of mortgage-related losses to which only some voluntarily exposed themselves. Our politicians are delighted to have a giveaway in this election year. These politicians, abetted by the media, are only too eager to tar and feather the lenders, who are relatively few in number (of votes). Meanwhile, they pander to the larger numbers of borrowers by attempting to legislate them out of a financial mess which they brought upon themselves to begin with.
The push for a mortgage bail-out overlooks a fundamental reality of human life which is a key driver of natural selection: we only learn from our mistakes when we suffer their consequences. In order to have a healthy financial sector, those firms that originated, packaged, sold and bought loans that were insufficiently collateralized by the underlying assets and/or were made to unqualified borrowers should suffer the financial consequences of their lack of diligence in underwriting. The worst ones will, and should be, driven out of the market. Careers will be ruined, and rightly so.
The same reasoning holds true for the borrowers who entered into those loan agreements to begin with. “The man at the bank said it was okay” is not a valid excuse for not having exercised restraint, judiciousness and discipline in one’s financial affairs. The common argument made on behalf of borrowers who are underwater on aggressive home loans is that they were financial amateurs, and were taken advantage of by savvy loan officers who should have known better. While this was true in some instances, there are plenty of consequences to go around.
Few citizens are expert mechanics, but that generally does not cause us to accept used car salesmen’s word at face value. Careful people seek qualified third-party advice. Those who do not get expert advice get burned, causing them to stay out of the market in the future. If the government paid for repairs on secondhand cars, there would be no incentive for people to seek out the good deals. Home loans are no different, except that they are larger and more important. Predatory loan officers and the institutions that employed them are paying the piper now for their short-term focus on originations and fees, as are the institutions that bought those loans. The borrowers need to be held accountable for their own actions as well, otherwise we perpetuate a situation in which such large numbers of people make irresponsible financial decisions that the whole economy is destabilized.
If the Congress drags Fannie and Freddie further into danger by forcing them to assume or guarantee more risky mortgages and then the lenders fail, the U.S. taxpayers will likely have to assume their obligations. This would take the “selection” out of “natural selection” by making every taxpayer in the country responsible for a portion of the losses incurred only by those who took ill-considered financial risks. Since the borrowers who need rescuing would hardly have shared any upside gleaned from their risky loans, why should everyone share in the downside with them? There is no reason why a taxpayer who pays his mortgage faithfully, or one with no mortgage at all, should bear any of the burden caused by mortgage defaults and their related securities. An undeserved safety net would remove the incentive for borrowers to be careful about what they commit to. Moreover, by limiting or eliminating the consequences of the careless use of credit, we keep risky, careless players in the housing market. The market will never return to stability and strength if we do not allow it to make a genuine correction and drive the worst participants out.
Our housing and financial markets have been an easy place to make money lately, and as a result the markets have become bloated with unskilled players, so that the markets themselves have become inefficient and overburdened with poorly underwritten risk. On the lenders’ and investors’ side of the table arbitrage has been mistaken for value creation, liquidity has masqueraded as adequate capitalization, and diversification and insurance have been substituted in place of conservative underwriting. On the borrower’s side, homebuying has been seen as an investing activity, refinancing has been used as a cash machine, and credit has been mistaken for wealth. We will not see a return to strong and stable financial and housing markets until we accept and embrace the uncomfortable truth that lending, borrowing and investing are risky activities that require careful study, conservative judgment, and a high degree of discipline to be safely undertaken. Left unmolested, the market will dish out enough pain to the parties involved to return us to a healthy respect for risk. A genuine correction will occur, our collective memory will be refreshed, and the risk involved in real estate and its related instruments will be reincorporated into loan prices, underwriting policy, and security ratings. To the degree that we bail out borrowers or lenders who overextended themselves in the housing and debt markets, we prevent such a correction and assure ourselves a repeat of the present economic crisis.
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