Like obnoxious relatives, the mortgage mess won’t go away. Some two million adjustable-rate mortgages (ARMs) will reset over the next two years, and analysts say that within the coming year alone, $362 billion in subprime home mortgages will experience rising interest rates. This will lead to ever more payment defaults and foreclosures, a horrible state of affairs not only for the affected homeowners and lenders, but also for the financial markets in general.
As is their wont, officials from both parties are rushing to offer “solutions.” The Bush administration is urging lenders to maintain the low teaser rates on ARMs, while Hillary Clinton recently advocated a 90-day moratorium on home foreclosures. Although casting themselves as knights rescuing beleaguered citizens from greedy corporations, in truth these politicians will only make matters worse.
In his classic Economics in One Lesson, Henry Hazlitt said that the good economist looks not only at the obvious, immediate beneficiaries of a government policy, but also considers the long run, hidden costs. We should do the same with the latest mortgage proposals. Although particular homeowners may benefit in the short run, such government tinkering will ultimately harm average Americans by distorting the mortgage industry.
To understand the downside of the recent proposals, we need to step back and ask ourselves why ARMs and foreclosure clauses exist in the first place. They are obviously advantageous to the lender, so it’s no surprise that banks favor them. But why do the borrowers agree to these terms? Why doesn’t everybody simply take out a conventional fixed rate loan, and moreover one that is unsecured—so that the bank can’t seize one’s house in the event of default? Is every borrower just plain stupid for failing to insist on loans of this nature?