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"Moral Hazard" bailout?



December 06, 2007 – Comments (3)

In a post on Economics Briefing quotes Mark Kiesel at Pacific Investment Management:

 "This reeks of moral hazard.  This is pure politics as we enter an election year, and it is not going to help the problem.  It's going to prolong the bubble.  A government bailout which alters contractual interest payments to bondholders will fuel moral hazard problems and raise mortgage rates for future borrowers and home buyers."

First, can I underperform this company? 

Robert Wallach seems to agree and gives short-sighted reasons with poor conclusions compared to the alternatives.

Housing prices are coming down regardless of what is done, the question is how fast will they come down.  

Mortgages have been granted without pricing the risk into them and now the consequences of such negligence is unfolding.  A rate freeze or doing nothing will not change the fact that today the world is moving towards more responsible lending practices.  Investors and bankers have seen enough disasters here to be exercising more caution and they are doing that regardless of what the fed does with respect to the existing problem.  To suggest that will happen because of a rate freeze is non-sense.

This is how the world works, Sally know Bill made a ton on flipping houses and Sally decides to try it.  She also knows John did it without putting money down.  Sally tells Hilda, who also decides to try it.  John wants a home for his family but doesn't have a down payment.  He know Joe got a place a few years back and Joe is doing ok, or at least he appears to be doing ok.  Eric know Paul who is making a fortune of these hedge funds.  He asks Paul and gets into the action.

Today, Brenda sees that Eric lost the money he was going to retire on through somekind of mortgage lending.  She was thinking about copying Eric and Paul but decides she is good where she is.  Tina wants a place, but she sees that John's home is being forclosed on, and Joe's home has declined back to what he paid for it, but he is very concerned about how to pay the extra interest.  Tina decides renting is better for now, she just doesn't need those kinds of problems, and so on.  Scott tried to find out about those no down payment mortgages but every place he checked doesn't offer them anymore.

People are seeing people being touched by this stuff and they are responding with different behaviour regardless of what the feds do. 

Housing prices inflated far beyond the rate of inflation and those involved in construction and housing related business benefited from greater financial rewards than many in other occupations.  Now there is going to be a claw back in those industries.  Wage increases aren't going to be able to piggyback on the asset price inflation anymore and likely there will be downward pressure on wages in that sector as so many find themselves out of work.

Reduced costs, caution from buyers, investors and bankers are all going to be here.  Those that must sell will be the weaker hand and prices will decline.  The demand for housing is already down.  Speculation out there now is by those buying foreclosures, not those expecting to ride an equity increase.

Mass foreclosure will cause much, much fast price declines and the rate freeze will slow the foreclosure rate.

Right about now I doubt very much that investors want to have little to with all but the most credit worthy.  They've figured out that other wise they can lose their capital.

3 Comments – Post Your Own

#1) On December 06, 2007 at 8:02 PM, dwot (28.99) wrote:

I was just thinking about an acquaintance in Edmonton Canada that was all excited about buy a second property, the housing market was booming and he figured he'd make a killing.  This was sometime earlier in the year, maybe June. 

I was just reading Edmonton's housing prices are down 5-10%.  We had a very frank discussion about it and I gave many reasons why I wouldn't do it.  His arguments about how strong the economy was made me think he might have a year before a down turn.  I guess I was wrong.

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#2) On December 06, 2007 at 10:34 PM, dwot (28.99) wrote:

And here's another poorly thought out analysis...

The plan will "sharply reduce the availability of new buyers."

My goodness I don't get this one...

One thing I am for sure agreeing on is that prices will be lower, but I think regardless of what is done, prices are going to head for the same price correction.  If you have mass foreclosure, which will happen when people were granted mortgages they could barely afford, the faster the price correction and the more investors lose.

When I start thinking it through, I ask how does the money transfer.  Home owners that stay in their homes and continue to pay their mortgage will be far worse off, if they are worse off, their mortgage holders have to be better off.  Home owners that walk can reduce expenses and have a chance to become home owners that can afford their homes.  If they walk, that money they would have spent goes to investors.

Schiff argues that kicking them out sooner will result in less losses as people who are going to be foreclosed on let things go and don't pay taxes, condo fees, or look after the property.  At any time during a foreclosure that can happen.  It takes roughly the same amount of time to go through foreclosure regardless of when it is started.  Homeowners making payments will be likely to look after their homes as they would not make payments if they thought they would lose their home.

There will still be losses from people who continue to pay and eventually give up.  I just don't believe the prices will be lower later than if you have the rate of increase of foreclosure that will come without the plan.

The comment about subprime borrowers borrowing more, this I really don't get.  The problem is because these people were loaned money in the first place, loaning them more will not be a solution. 

Borrowers will alter circumstances to qualify for aid?  Borrowers that see no way out will walk.  

Borrowers who have extracted huge win falls from their homes are likely to walk regardless of what happens.  With my way of thinking these frozen rates aren't for the equity scammers, but families like the debt slaves mentioned in a previous post.  They are living beyond their means, but they didn't extract equity from their home to pay for their lifestyle.  The money they got from mortgages went to the person who sold.

There is a constant theme here about the need for home equity to pay for lifestyle, like car loans.  Is his left brain listening to his right brain? 

This is a disasterous analysis and one that is easy to slaughter.  Prudent lending standards do not allow people to use their homes as ATM machines so why the argument for this at the same time as arguing tighter standards or the "bailout" will prevent people from covering other debts with home equity?

What I find really interesting is the statements about home prices resetting to practical prices or "prudent," at the same time he's supporting investment in gold.

If you have price contraction I don't see how gold goes up.  If you have hyper-inflation, gold protects your wealth.  It seems to me that if you have price contraction gold goes down.

Since money expansion comes far more from credit than from government printing, I see contraction. 

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#3) On December 06, 2007 at 11:12 PM, hall9999 (90.34) wrote:

  I read that safehaven article.  Car loans, etc. are "the camel's nose under the tent".  Heh, I've not heard that expression before.

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