Another Whacky Scheme

A Whacky Scheme
To Pump Housing

For edition of December 05, 2008

And now the government is hoping to raise the price of real estate by artificially pushing down mortgage rates. Does anyone actually think this is the best way to use what remains of America’s dwindling capital? Not that such a hair-brained scheme could possibly succeed. NASA might just as well try to launch a trash can into orbit by stuffing it with cherry bombs. One reason the plan must fail is that no amount of mortgage stimulus could possibly counteract the huge asset deflation that has already occurred worldwide. Our colleague Bill Buckler of The Privateer recently put the number at $52 trillion dollars, including $38 trillion in stock-market losses. That’s nearly 80% of global GDP, but we think it greatly underestimates the actual amount of deflation, since many assets have yet to be marked to market. New York City, for instance. Real estate there is virtually certain to collapse because the top tier of income earners have become unemployable. Can the U.S. Treasury keep thousands of condos that once sold for $5 million to $25 million from falling by 50% or more? We think not.

The Government’s intention is to use the “clout” of Fannie and Freddie, such as it is, to “encourage” banks to lend at rates as low as 4.5 percent �' more than a full point below current market rates. Question: What would you do with the extra money if you could refinance your home right now at 4.5 percent? Pay down debt, right? You might even answer Paulson’s prayers by blowing it on a Chevy Tahoe. Whatever the answer, unless the saved money is invested in productive capital, it has no chance of increasing the nation’s wealth. And yet, that is the Big Lie the Government is now attempting to sell us �' that by misdirecting yet more investment dollars toward the housing sector, we’ll somehow be better off in the end.

Here is another reason why the plan cannot succeed: Real estate fatal problem lies at the margin. Perhaps 25% of American homeowners are underwater on their mortgages, and they are the ones who are going to drag the rest of the market down. This is what triggered the subprime crisis. In fact, most subprime mortgage were not in trouble, but the relative handful that were, undermined the entire market. So what does that imply for the Government’s whacky scheme to suppress mortgage rates? Well, if the money is going to help those who are in the worst shape, it would have to go to homeowners who are underwater �' i.e., those who could not qualify for refinancing. Policymakers apparently are hoping that helping homeowners who are in good shape will pull up the home values of those who are underwater. This is a very risky bet, for the reasons cited above. It would probably be cheaper in the end for the Treasury (i.e., taxpayers) to mail out checks to every homeowner for 20% of the amount of their mortgages. (If you’d like to have Rick’s commentary delivered free to your e-mail box each day, click here.)