Monday, September 08, 2008

Socializing the mortgage industry

Normally I don't weigh in on the issues that cause large daily moves in the stock market, because they usually end up being irrelevant in the long run. But today is not a normal day. The anticipated Federal takeover of the U.S. mortgage industry, by way of Fannie Mae and Freddie Mac, has finally arrived. Stock markets in Asia and Europe are up between 3% and 5%, and the futures market anticipates similar gains in the U.S. (I'm writing this before the market open.)

My simplified version of the current mortgage/credit crisis goes like this: Banks and other lenders are no longer willing to give high-risk loans to home buyers because too many borrowers have been defaulting. In order to stay profitable, banks have had to raise interest rates on those mortgages that are still being paid. However, higher interest rates cause a new round of defaults, because people who could just barely afford their monthly payments now no longer can. Higher rates also discourage new buyers, which causes existing home prices to fall, which can create even more defaults when the amount owed on a mortgage exceeds the value of the house.

Fannie Mae and Freddie Mac are at the center of this crisis because they hold a significant fraction of all of the mortgages in the U.S. The mortgage payments made to these two companies are distributed to investors around the world who own Fannie Mae and Freddie Mac bonds. Needless to say, bond holders can't be paid if mortgage payments aren't being made. If discouraged investors stopped buying Fannie Mae and Freddie Mac bonds, then Fannie Mae and Freddie Mac wouldn't be able to buy new mortgages from lending banks, and that would make banks even more reluctant to give out loans in the first place.

The takeover means that you and I, Mr. and Mrs. taxpayer, will be making up the difference between defaulting mortgage payers and Fannie Mae and Freddie Mac bond holders until the crisis passes. I don't know whether or not this will fix the current problem, but I'm worried about the long-term effect. Programs like this, in which taxpayers are tapped to make things more affordable, usually end up just growing larger with time. Social Security, for example, makes up the difference for retirees, and Medicare and Medicaid make up the difference for health care costs. In total, Social Security, Medicare, Medicaid, Welfare and Unemployment have grown from 8% of the Federal budget in 1950 to 58% in 2007.

Today the taxpayer will make it easier for new home buyers to get low-interest home loans. If you think that home buyers five years from now will allow the taxpayer-subsidized lending program to come to an end, think again.

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