Government interference with the present state of banking affairs could be justified if its aim were to liquidate the unsatisfactory conditions by preventing or at least seriously restricting any further credit expansion. In fact the chief objective of present day government interference is to intensify further credit expansion. This policy is doomed to failure. Sooner or later it must result in a catastrophe. (p 445 of Human Action)Despite claims from some confused commentators, the malinvestment built up during the boom years of housing is still weighing down a significant portion of the economy some five years after the bubble burst. From Reuters:
In a letter sent on Friday to the Republican and Democratic leaders of a U.S. House of Representatives government oversight panel, the Federal Housing Finance Agency explained why it has long opposed principal reductions for borrowers who owe more than their homes are worth.With these toxic mortgages still on the books, it should come as no surprise that financial capital remains tied up in money losing assets such as underwater mortgages. This is just one of the consequences of stabilizing nationalization maneuvers which rather than setting the foundation for a sustainable correction continues to exacerbate the problem. Fannie and Freddie have effectively become zombie institutions forcefully backed by taxpayers when cutting their life line was the truly sensible course to take. Despite close to $200 billion in tax funds used to prop up the housing giants, further writedowns will put more public funds at risk. The vicious cycle continues precisely due to the unwillingness of politicians and regulators to embrace short term pain now in return for long term growth.
It said it had determined that such reductions would be more costly for the two firms than allowing those troubled borrowers to default.
The regulator has been under pressure from Democrats to permit the write-down of principal by the two government-controlled mortgage finance providers as a way to help some of the millions of U.S. homeowners who are “underwater.”
About 22 percent of U.S. homes have negative equity totaling about $750 billion, according to CoreLogic.
Fannie Mae and Freddie Mac were taken over by the government in 2008 as mortgage losses mounted. Millions of soured loans issued during the housing bubble remain on their books and delinquencies on those loans continue to rise.
Fannie Mae and Freddie Mac own or guarantee roughly half of all outstanding mortgages in the United States. Out of the approximate 30 million mortgages guaranteed by the two firms, close to 3 million of those loans were held by underwater borrowers as of last summer, according to analysis provided in the letter.
As grating as it is to hear, the run up of prices in the boom must inevitably be met with a fall in prices. The propping up, or the attempted propping up, of prices via the government prevents the market from clearing and a sound footing from being reached in order for increasing growth to take place. Shoving wads of cash onto the hemorrhaging balance sheets does nothing to solve the core problems associated a central bank engineered boom. It leaves less capital to be invested in actual sustainable lines of production.
Even the Fed recognizes the moral hazard associated with such a policy:
The Federal Reserve, in a white paper to Congress earlier this month, said writedowns “had the potential to decrease the probability of default” and “improve migration between labor markets.”Ironic words coming from the institution which drives perhaps the biggest moral hazard of all as the lender of last resort to both Wall Street and the federal government. As President Obama pushes for further writedowns, such a policy is more about buying votes than an actual understanding of how markets liquidate themselves. If Obama really wanted to clear the housing market, he would have let it occurred years ago when he assumed office.
However, the Fed stopped short of endorsing such an initiative and noted concern that writing down loan balances would create a moral hazard – the concept that rescue efforts breed further behavior that exacerbates the existing problem – and could prompt other borrowers to stop making timely loan payments.
While writedowns will be expensive, they would have been much less expensive for taxpayers had they occurred years ago such as the market dictated. The housing market would have been much healthier by now. Defaults will happen; it’s only a matter of time. The longer the children in the FHFA continue to not take their medicine, the longer sluggish progress continues. And the art of can kicking continues much to the detriment of everyone involved.