Wednesday, March 5, 2008



Yesterday, Fed Chairman Ben Bernanke called for lenders to aid “homeowners” by reducing the principal amount of troubled home loans, arguing that doing so makes more sense than other forms of loan modification because, as Dr. Bernanke put it, “a stressed borrower has less ability…and less financial incentive to try to remain in the home.” Bernanke also said that a “potentially important step” in getting lenders to go along with principal reduction is to increase the principal amount of loans the FHA can guarantee. Thus Obsequious Ben once again tries to straddle the fence between the aggressively interventionist Democrats and the surreptitiously interventionist Republicans in a brave attempt to please everyone.

Principal reduction does have some intuitive appeal, especially in this new age of ethics in which borrowers feel no compunction about welshing on their debts when it makes financial sense to do so. Hey, it’s just another deal, so why keep paying on a mortgage loan when the value of the asset you are trying to save is less than the amount of the loan you must service to save it? If the lender made a bad deal, it’s his problem, not the borrower’s, according to the new mores, which comply completely with the new American motto: It’s not my fault. And, after all, it’s more important to be facinorously clever than scrupulously honest. But I digress.

From the perspective of the lender, principal reduction is merely recognition of reality. A mortgage loan is rarely worth more than the underlying collateral, especially in the brave new ethical world outlined in the last paragraph. If the books are kept honestly (Try not to laugh too loud at that conditional clause; we must maintain some semblance of decorum while conducting such searingly insightful examination of the issues.), principal reduction should have little or no accounting impact, and even if the books are of the same basic genre as the Harry Potter novels, principal reduction has little or no economic impact.

So what’s the problem with Obsequious Ben’s plan? Besides its tacit endorsement of scrofulous conduct on the part of borrowers, the big problem is, of course, the expansion of the FHA’s guaranteeing powers. Once again, it is being proposed that taxpayers, most of whom have been reasonably responsible, be put on the hook for those who acted irresponsibly on both the lending and the borrowing side.

Lenders made lousy loans to homeowners who had no business buying as much home as they bought and/or borrowed against their homes to finance lifestyles they couldn’t afford but simply HAD to have. The lenders sold those loans to clueless financial wizards who didn’t understand what they were buying but kept telling us not to worry about it; after all, they were financial wizards, that’s what they do for a living. So who is made to pay? The taxpayers. This makes sense only to the following constituencies:

--otherwise staunch supporters of the “free market” who suddenly need a handout due to their own financial foolishness.
--politicians, many of whom are self-professed acolytes of the “free market,” looking to win votes and campaign contributions from former free marketeers who see an urgent need for government action due to “special circumstances,” hoping no one will notice that those “special circumstances” arose because those valiant defenders of the free market bollixed up something.
--central bank chairmen who see their primary function as keeping Wall Street charlatans and Washington parasites happy.

Meanwhile, moral hazard, in more ways than one, eats away at the already frail underpinnings of our financial and economic systems.

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