In his State of the Union address, President Obama let us know that he will be “sending this Congress a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low interest rates.”
What he failed to tell us is that such a push would do nothing to turn around either the housing market or the broader economy. In fact, by continuing his trend of confusing redistribution of wealth with its creation, the effort will likely hurt both the economy and the housing market.
Let’s start with the impact on the economy at large. The logic is that when you lower mortgage rates for thousands of families, reducing their monthly payments, you thereby increase disposable income and spending. That spending then increases demand and helps turn around the economy.
In other words, it’s a no-cost stimulus.
The error in this logic is that it looks only at one side of the balance sheet. A mortgage is one person’s liability, but it is also another’s asset. Lowering rates may cut monthly payments, but it also drives down payments on mortgages and mortgage-backed securities. Since you will have made mortgage investors poorer, they will, by the same logic, reduce their spending, lowering demand.
At best, the impact on spending will be zero. But then, that’s what you get when you redistribute income.
The President wants you to believe that even if he is taking from citizen A and giving to citizen B, the latter is more deserving. But for government-owned or guaranteed mortgages, about half of those outstanding, the taxpayer is the one taking the hit. Because homeowners are wealthier than taxpayers in general, the President’s proposed redistribution is regressive.
For the remainder, the investor is often a pension or mutual fund. Why retirees should pay to benefit younger homeowners is far from clear.
The President implies his plan is free because it will be paid for by a tax on the largest banks. But again, nothing is free; for every economic action, there’s an equal and opposite reaction. The tax would reduce bank equity, thereby reducing new lending. In effect, it would punish potential borrowers by reducing the availability of credit while also increasing its costs, simply to benefit existing borrowers.
Not to mention: The rewriting of existing contracts will reduce the willingness of lenders to provide new mortgages, exactly at a time when we desperately need private capital flowing into the mortgage market.
A mass refinancing is also sold as a cure for the weak housing market. Those looking to refinance, however, are not in the market to either buy or sell a home. In fact, by lowering their mortgage rates, you will reduce their offering price next time they look to trade up, because if the buyer faces higher rates in the future, prices will be depressed to compensate for giving up their current low-rate mortgage.
In other words, this could reduce future home prices.
The fundamental problem facing our housing market is a glut of homes, coupled with weak demand. The President’s plan does not change these facts. In fact, by reducing the supply of new capital for mortgages, we run the risk of reducing the demand for housing, leading to further price declines.
It is time for Washington to understand: Underwater borrowers are not victims. They borrowed money at a particular rate and are paying back at that rate. They knew going in that to refinance, they’d need equity. If said borrowers wanted to take advantage of interest rate declines, they could have gotten an adjustable-rate mortgage. Instead, those borrowers chose the certainty of a fixed rate.
They have what they selected. That’s something that cannot be said for the taxpayers who continue to pay for Washington’s meddling in the mortgage market.
Finally, the President also promises a new financial fraud unit to investigate lenders. Appointing New York State Attorney General Eric Schneiderman to head it may be enough to earn his support for a settlement with the banks, but it will do little to help the housing market. In fact, by increasing litigation risk for lenders, the move is likely to further reduce the supply of mortgage credit.
Continued efforts to delay foreclosures only prolong the inevitable adjustment of the housing market. If lenders have committed crimes, then they should be prosecuted in open court, not subject to back-room shakedowns.
If we wish to turn around our housing market and broader economy, we must stop taking from Peter to pay Paul and disguising it as public policy.
This article appeared in The New York Daily News on January 26, 2012.