George Mason University economist Tyler Cowen says, "We've all heard about the defaults on subprime mortgage loans. But so far, the real story is how little the broader American economy has suffered. Today, banks usually sell their loans to third parties. You might have originally borrowed money from Wells Fargo, but now a bank overseas cashes your mortgage checks.
"If a large group of people can't pay their mortgages, they may lose their homes. But the banks don't suffer as they used to -- local American lenders have already converted those loans into cash and sold off their risk. In fact, German regional banks suffered some of the most significant losses from bad American mortgages. Other European and Asian banks and hedge funds took their lumps as well. American banks essentially bought insurance by exporting their risk overseas."
Let's not minimize the trouble faced by thinly collateralized borrowers and their lenders, given the soft housing market. But the financial difficulties affecting both sides of transactions voluntarily entered into do not warrant a taxpayer bailout.
U.S. homeowners' equity today equals almost $11 trillion. Price declines for this year and next year may amount to $6 billion, or a 0.05 percent decline -- a worry, but hardly Judgment Day.
Christopher Cagan, of First American Real Estate Solutions, estimates that "the impact of rate sensitivity and subsequent defaults will be well below one-half percent of total mortgage debt outstanding" and spread out over several years.
Donald Trump, who knows a bit about crisis management, having dealt with his own financial "meltdown," suggested a simple, direct approach: Cut a deal with your lender. Similarly, Treasury Secretary Henry Paulson has already urged banks and borrowers to get together and renegotiate the terms of their loans.
So what would a bailout say to those who avoided the subprime lending fervor? The Wall Street Journal reports that unlike Citigroup and Merrill Lynch, Goldman Sachs "maintain(ed) relatively small holdings of collateralized debt obligations, or CDOs, the complex mortgage-related securities whose rapid devaluation prompted the massive writ-downs at other firms." Should government reward the shortsighted losers and, by extension, punish firms such as Goldman Sachs and Lehman Brothers that had the foresight to protect themselves?
People in the insurance business use a term called "moral hazard." This means actions, however well-intended, that shield people from the consequences of their behavior lead to even more irresponsible behavior. Secretary Paulson recently said, "I have no interest in bailing out lenders or property speculators."
OK, then butt out!