In the midst of what’s called the subprime mortgage “contagion,” President Bush seems to have caught a virus of his own: Potomac paternalism syndrome. In his speech just before Labor Day weekend to address concerns about foreclosures and other problems in the credit markets, Bush showed acute signs of this very common Beltway fever that so far he has shown a remarkable resistance to.
This syndrome convinces politicians that the majority of their constituents, despite being somehow smart enough to elect them, are too stupid to run the financial affairs of their own lives. And when politicians catch it, the worst effects of the illness usually are borne by the American people as a result of the new policies enacted.
In his six-and-a-half years in office, Bush has largely remained immune from Potomac paternalism syndrome. Yes, he has disappointed conservatives with his big spending programs, but he has steadfastly supported the freedom of ordinary Americans to spend their own money and manage their finances. From the tax cuts that allowed Americans to spend and save more of their money as they chose, to the health savings accounts enacted that gave workers more portability and choice in their health care, to his proposal of personal retirement accounts to let people invest part of the Social Security taxes they pay, Bush has argued boldly that the decisions of ordinary Americans should not be curtailed by Washington’s perceived wisdom.
But in his housing speech, by contrast, Bush partially abandoned this trust of the people and leaned toward restricting their choices of mortgage products they think would best suit their needs. He seems to have caught the fever by standing too close to politicians already infected with paternalism on the mortgage issue. Namely, this would be the new self-appointed defender of the homeowner, Sen. Chuck Schumer (D-N.Y.)
Schumer is pushing legislation that would mandate a “suitablility” standard for consumer mortgages. This means that it would be the bank’s duty not just to communicate the terms of a loan clearly, but also to virtually ensure that borrowers would never have trouble making payments. In Schumer’s own words, the law would mandate that lenders “will never issue a loan that the borrower cannot afford.” This breathtakingly broad mandate would presumably be enforced by regulatory agencies or by opening the floodgates to a surge of borrowers’ lawsuits for loans they deem “unsuitable.” Barely hiding his condescension for ordinary home buyers, Schumer says these changes are needed to prevent “exploitation of the large numbers of financially unsophisticated borrowers.” (See my earlier HE piece, “Chuck Schumer Thinks You’re Stupid”)And Bush, despite his past political success at positioning the “ownership society” as a preferable alternative to “government knows best” programs, failed to lay out a clear contrast to the paternalism of Schumer and other Democrats. The speech wasn’t all bad. Bush’s was right in his call for the IRS not to impose extra taxes on borrowers who have refinanced loans after their homes have lost value. And he made sensible statements about making sure lenders “provide homeowners with complete and accurate and understandable information about their mortgages.”
But the core of his speech was a needless program getting the government’s Federal Housing Administration involved in mortgage refinancing in a way that could distort the housing market and crowd out efficient private refinancing, as well as lead to new substantial new spending as the program grows. (I will have more on the flaws of this in later articles)
Worse than that, however, was Bush’s flirtation with the paternalistic “suitability” standard pushed by Schumer and liberal groups like the Center for American Progress. Bush said, “Banking regulators are also strengthening lending standards to help ensure that borrowers are not approved for mortgages larger than they can handle.”
“They can handle”?! This doesn’t sound like the same guy who argued for trusting the American people to “handle” their retirement savings or health insurance policies.
Now, banking regulators should punish fraud in peddling mortgage products. And since bank deposits are insured by the federal government, the feds have some say in the loan portfolio as far as a bank’s solvency as a whole. But the government, and especially the federal government, should not be the judge of whether law-abiding American adults can “handle” a mortgage any more than whether they can “handle” the purchase of a firearm.
Bush also erred by buying into the media’s demonizing of a particular type of loan, the adjustable rate mortgage or ARM. Rather than targeting particular lenders who were deceptive, Bush stated, “One of the most troubling developments has been the increase in adjustable rate mortgages that start out with a very low interest rate and then reset to higher rate after a few years.”
Yet, by itself, the availability of this type of mortgage is not a “troubling development,” but an opportunity that many families found to their advantage. The Mortgage Book, an authoritative 1992 publication by Consumer Reports magazine (whose parent Consumers Union, ironically, is a liberal advocacy group that backs laws restricting these types of mortgages), states that “adjustable rate loans do have a few genuine advantages” for borrowers. Among these, the book points out, are lower intial interest rates and an easier ability to sell a home, because a lender would be more likely to let a new party assume an adjustable loan in the face of rising rates.
In Great Britain, ARMs have been available to homeowners for more than two decades, and 95 percent of all home mortgages there now have adjustable rates, according to the New York Times. And there as here, savvy homeowners used ARMs and other new mortgage products for a variety of financial objectives. Money magazine, for instance, recently called home equity loans the “cheapest and most convenient choice” for parents to finance a child’s college education.
People also have used these loans to free up cash to start small businesses. Tamara Monosoff, inventor of household products and author of the popular “Mom Inventors Handbook,” often recommends that aspiring inventors tap into home equity to get their products off the ground. “This is one of your best sources of additional funds,” Monosoff writes in Entrepreneur.com. “These loans generally charge much lower interest rates than a traditional business or personal loan.”
So contrary to media reports that Bush and other politicians seem to be relying on, many people did not get ARMs or other mortgage innovations because they were confused or were under the illusion that the real estate market would always go up. They were savvily using their home as their business partner. The use of a mortgage loan to start a business or learn a new skill is actually a way to reduce risks to a family’s wealth from a souring housing market. But if “reforms” of the mortgage market from Schumer or even from Bush ban certain types of loans, it will limit families’ ability to pursue the financial strategies they believe best fit their needs.
Basic but overlooked facts about today’s mortgage market provide even less justification for Schumer’s proposal or a GOP-backed “Schumer lite.” Although some aspects of the credit crunch puzzle even the smartest financial minds, there are a few clear facts. The rapid pace of issuing new types of both consumer and business loans has generated a repricing of debt that is slowing credit in all sectors. Housing prices are also falling, and home sales are slowing, although the pattern is still not uniform and some areas of the country are bucking the trend. But there is by no rational measure a “housing meltdown” or even a “subprime meltdown.” Washington Post economics columnist Robert J. Samuelson even argues that “although subprime U.S. mortgages — home loans to weak borrowers — are the center of attention, they’re not the real problem” in the credit crunch.
And the “record number of foreclosures” the media report are meaningless statistics without reference to the “record number” of homeowners in the last few years. Thanks in part to the innovations in lending now under attack, the U.S. homeownership rate has climbed to nearly 70 percent. The overall foreclosure rate for the latest quarter, while increasing over the past year, is still well within historical norms at .58 percent of all mortgages, according to the latest National Delinquency Survey. This survey, conducted by the Mortgage Bankers Association for more than 50 years, is the same one the media cherry-picks for their breathless reports on “record” foreclosures. And, interestingly, for all the hubbub about subprime loans given to borrowers with varying degrees of troubled credit histories, the foreclosure rate for these types of mortgages was just 3.2 percent in the latest survey.
These statistics do not, of course, minimize the hardship of specific families struggling with mortgage debt. However, they do show that the grandiose solutions proposed may not even be addressing the core problem of the credit crisis. In fact, penalizing lenders for making “unsuitable” loans will in all likelihood further discourage credit and make housing woes that much worse.
Last month, with Congress out of session, the private sector has already completed some significant repricing of credit instruments. Bank of America bought a good chunk of the mortgage portfolio of troubled bank Countrywide Financial. Although it had to lower its asking price, Home Depot successfully sold off its construction supply unit to a consortium of banks and private equity firms. Credit is picking up its pace, albeit more slowly than many would like, and should continue to do so if Congress or federal agencies don’t throw a big regulatory stumbling block in its way.
An important history lesson to remember during the current market nervousness that government intervention was at the root of nearly every long-term financial panic. As Amity Shlaes notes in her brilliant new book, “The Forgotten Man,” the stock market crash of 1929 was not the major cause of the Depression. “The deepest problem was the intervention; the lack of faith in the marketplace,” Shlaes writes. One of the worst years for unemployment and output, she notes, was 1937, when four years of Franklin D. Roosevelt's New Deal policies – and Herbert Hoover's more limited but substantial intervening before that — had sapped energy out of the private sector through
During this slowdown, the most productive thing policymakers can do is to look for existing government intervention that may distort mortgage and other credit markets. The Community Reinvestment Act, long backed by Schumer and others now complaining that banks gave too many loans to low-income home buyers, actually mandates that banks lend to a certain amount to homebuyers or businesses with higher credit risks. Regulations are also to blame for much of the length and complexity of home mortgage forms. As Alex Pollock, American Enterprise Institute fellow and former CEO of the Federal Home Loan Bank of Chicago, notes, “Most of us have had the experience of being overwhelmed and befuddled by the huge stack of documents, … which result from legal and compliance requirements — ironically including regulatory attempts to ensure disclosure.”
The good news is that Potomac paternalism syndrome does have a cure. Politicians simply need to get to know the new “forgotten” men and women who have used credit wisely and should not have their choices limited in the name of protecting them. In the wake of current financial concerns, let’s not “melt down” the creative energies and entrepreneurial instincts of the American people that keep the economy going.