By David Keene - 09/22/08 06:34 PM EDT
As the president and Congress rush to spend untold billions to “stabilize” the economy and save us from their past mistakes while looking for others to blame, one can only be sure of one thing, and that is that the real losers will be America’s taxpayers.
I’m no economist and don’t pretend to understand the intricacies of how we got into this mess, but common sense tells me that bailing out folks who make stupid economic decisions is generally a very bad idea. Markets work by rewarding smart decisions and punishing stupid ones. Risk-takers make a profit for acting as they do when successful precisely because the risks they take are, well, risky. The knowledge and even fear that one can lose as well as win on any investment imposes discipline on the economic decisions we make.
When people discover ways to profit without risk, discipline goes out the window. This is what happened to homebuyers, investors and bankers in recent years, all of whom managed to convince themselves that home prices would move forever upward. They harbored the belief that in the end the government would somehow save them from their own folly if things turned bad.
In the old days, those who wanted to buy a home had to make a substantial down payment and pass muster from relatively conservative bank loan officers who knew that their banks would be left holding the bag in the event of a default. It was a tight but safe system, in spite of the grumbling from potential borrowers that banks were only interested in loaning money to people who could prove they didn’t need it.
This all changed as politicians decided to do what they could to expand U.S. homeownership.
There were good reasons for this beyond simply buying votes. Giving people the opportunity to own their own homes gives them a greater stake in things and statistically leads to greater civic involvement and stronger families. In 2003, President Bush called for expanded homeownership “in the national interest.”
The problem, however, was that a lot of the people politicians wanted to help simply couldn’t qualify for mortgages. The politicians, Republican and Democrat alike, sought ways around this stubborn economic reality and, as politicians always do, found some.
Ultimately, Fannie Mae and Freddie Mac were encouraged to guarantee and even to purchase loans that no private sector banker would even consider without an outside guarantee. What’s more, since these guarantees were being made by institutions set up by the government itself, everyone involved proceeded assuming that regardless of how foolish what was being done might seem, all would be well because the taxpayer would always be there to bail them out.
At the same time, the banks and their guarantors devised a scheme that would allow them to “securitize” their loans, package the good with the bad and sell the resulting paper to pension funds and investors all over the world who would have no real idea whether any particular loan was good or bad. This risk dispersal relieved lenders of the burden of having to pay much attention to whether borrowers could ever repay their loans the minute the ink was dry on the loan documents their borrowers were signing.
The lenders had achieved what David Smick, in his insightful and just-published book The World is Curved, calls “riskless risk.” Banks and mortgage companies made loans and collected fees with abandon, knowing they’d make money regardless of whether the loans proved good or not.
This, along with adjustable rate mortgages, made it much easier to buy a home and many families became homeowners thinking only about appreciation and not about the cost of their mortgage.
When the bottom fell out and home prices began falling, investors walked away from property that had fallen in value and millions of newly minted homeowners discovered that they owed more on their homes than they were worth. Higher interest rates on adjustable and negative amortization mortgages kicked in that couldn’t be paid anyway. As more and more loans went bad, institutional investors here and around the world who had bought the securitized debt assembled in this country began to get nervous, and the U.S. government decided to step in to save the day.
All of this could cost America’s taxpayers as much as a trillion dollars. Families who pay their bills and pay their taxes will be left holding the bag as government once again comes to the aid of the greedy and stupid at the expense of the prudent and hardworking.
The Financial Times summed the situation up pretty well early this week: “[B]eing an American taxpayer just got a lot more expensive in the short term and a lot riskier down the line.”
Keene, chairman of the American Conservative Union, can be reached at Keeneacu@aol.com.