How antitrust worsens mortgage woes

Hans, excellent points about the folly of a government-organized bailout. Indeed the Dow had gone back to 14,000 the week before Paulson opened his mouth and proposed the bailout last week. Today, the Dow rose by more than 100 points when big mortgage bank Countrywide Financial Corp. announced, without any direct prompting by any government agency, that it would refinance or modify $16 billion in mortgages. Part of the rise in the Dow was probably due to the fact that investors knew Countrywide was making a decision that would help its bottom line, rather than responding to the “moral hazard” of a promised government bailout.

The market has lots of incentives to smoothe out volatility. The problem is the government often gets in the way. Before I get into government stumbling blocks to private solutions for market woes, let’s look at what the private sector has been doing largely without government help.

With both individual mortgages and the debt securities they’re packaged into, private sector firms have plenty of incentive on their own to reprice and renogtiate. As I’ve noted before, a foreclosure is rarely in a bank’s best financial interest. In fact, lenders can lose 30 to 60 percent of the outstanding loan balance because of legal fees and property expenses associated with foreclosure, according to a 2003 Federal Reserve study.

Although Countrywide said some of these mortgages would be refinanced into loans backed by the Federal Housing Administration, the company didn’t have to wait until Congress raised the loan limit for the agency, yet another reason for Congress not to take this foolish action.

Firms have also another reason for buying other firms’ mortgage-backed securities, as Bank of America did with Countrywide in August. They’re taking a risk, but may be getting a pennies-on-the-dollar bargain. The credit crunch stems mostly from the flaws in the valuation models for mortgage-oriented securities. The foreclosure rate is still less than one percent, according to the Mortgage Banker’s Association National Delinquency Survey. 99 percent of borrowers may repay their loans. The problem is that market participants don’t know which “box of chocolates” has the bad loans. So firms able to take the risk could very likely get a premium. That’s what happened in the quasi-private bailout of Long Term Capital Management ten years ago.

But notice I said the plural “firms.” It may be the case that all these loans are just too big for one company, and it would make sense for financial firms to pool their assets for a deal, spreading the risk by splitting both the profits and losses among themselves. But that could very well trigger antitrust concerns. “You’re cornerning the market on mortgages and consumer loans,” the antitrust proponents would charge. That, in addition to the fact that many are rent-seekers who want a government safety net for their risks, may be why some firms are waiting for a government-organized bailout. They want some kind of “green light” so they won’t be busted later on for some cooked-up antitrust violation.

So this gives new urgency to repealing or overhauling antitrust law. But until that happens, we shouldn’t have a government bailout either. One bad government intervention doesn’t justify another.