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A self-professed “classically liberal” friend of mine continues to make the claim that. “It is difficult to deny the relief to the mortgage borrowers once the pirates have helped themselves to the Treasury.” In other words, since the Fed and Treasury are taking actions to bail-out the major financial institutions (a terrible idea, I agree), then it is only right that the government bail out individuals and families that are in danger of losing their homes. One way to bail out homeowners is to rewrite mortgage contracts (reducing interest rates, or writing off some of the loans as losses)

To that I say hogwash.

To abrogate these contracts is outright theft. Two wrongs do not make it right. If homeowners get a hand here, then the “pirates raiding the Treasury” will never strike them as untoward – it would continue to appear to be just the natural order of things. The Fed, the Treasury, the elected officials will never have an incentive to get their house in order if the citizenry is not outraged.

In the words of Amity Shlaes, “What About the Forgotten Men?” — those of us who have behaved prudently (and I remind you it is the large majority of us). It is ok to stiff all of us but to bail out the imprudent? Rewriting contracts to keep people in their homes makes house prices higher than they otherwise would. It would make it harder to obtain credit in the future because lenders fear that their property rights are not secure in a bad market. Where does that leave prudent individuals and families that are saving in order to afford a home, or that smartly purchased homes they could afford, rather than nicer ones that they didn’t? This all sounds awfully utilitarian to me – particularly when the “externality” arguments start coming out from behind the bushes. (Note: the externality argument is simple – a (negative) externality is something which, when produced, is produced for all members of existing group. The costs are borne by all members of the group and are not compensated because it is difficult for those on the receiving end to be compensated for their losses. In the case of foreclosures, so the argument goes, is that a home foreclosure reduces the values of all homes in the neighborhood, and stigmatizes a neighborhood. But, since the full costs of not paying a mortgage do not fall on the delinquent homeowner, we get too many homeowners not paying their mortgage. So, government action, it is asserted, is warranted to stem this bad behavior – to prevent the fall in house prices for everyone else – how clever.)

I’ll use myself as an example, again. My house probably cost me $50,000 more than it should have, absent the housing frenzy. House prices all over Western, MA went crazy. Our option was to find a place we could afford, so we bought a house that was falling to the ground – but comfortably within our means with a traditional 30-year fixed rate mortgage. Alas, we need to sell it because of my job situation – and we are going to take a bath (certainly will lose much of my down payment). And even though I am completely credit worthy, I am looking at the prospect of not being able to get a mortgage in our new location because of lenders’ unwillingness to make me a loan without a full 20 percent down, or something near it.  So we don’t even get into a house. And perhaps the neighborhood we would have moved into has that new house remain empty. That’s the same externality you would be referring to from a foreclosure.  But, if I would have been a glutton, and bought the big house down the street from me – and financed it with an adjustable rate that I couldn’t afford – you are saying that I should be helped in that case? And what about all of those families that decided to rent because house prices were originally too high for them? Many are low income. Where is the justice in that.

Some still assert that all of the foreclosures are due to predatory lending. That’s a term I dislike a great deal. I challenge readers to:

  1. Define what predatory lending is
  2. Show me the data
  3. Convince me that credit will be available after the reforms

And once we go down this path with relieving mortgage borrowers … what next? Car buyers? Credit card debtors? Isn’t action by anyone in any market likely to spill-over to others within that market? Heck, if I go out and buy a new set of golf clubs, that might incrementally put upward pressure on golf club prices for everyone else. Should all golfers therefore be subsidized in lieu of my actions? Should my purchase of golf clubs be taxed more severely? This is all nuts.

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