Someone not only gets approved for a mortgage where they once couldn’t, but also finds a fantastic rate! This individual is now on his or her way toward achieving one significant aspect of the American dream . . . home ownership. There are other beneficiaries as well. The seller, for instance, gets rid of a property he or she no longer wants, likely at a profit. The real estate agent benefits from a commission that the sale generates. Mortgage investors who own the mortgage now have a new income stream. Sounds like a great deal for everyone, right?
Now, some number of years later, as the terms of the borrowing agreement clearly spelled out to all parties, the “teaser” rate has begun to rise. As a result, this same individual who gained a part of the home ownership dream suddenly feels the anxiety of the initial adjustable rate decision. He or she also begins to feel the pressure associated with going back to the lending market where fixed rates have begun to rise and resale values have now often dropped below the initial purchase price. As it turns out, however, he or she is not alone in experiencing such anxiety. Investors are also now beginning to become concerned with the ability of borrowers to repay their loans. As a result, it now seems ludicrous to even consider making a loan to someone “on the bubble” from a credit standpoint. Let’s not forget the real estate agents – with prices falling the tentativeness of buyers and sellers alike means finding deals that generate those once plentiful commissions much more difficult. So what’s the issue here?
The reason I raise this question is that in recent weeks the calls for some sort of intervention by the Federal Reserve, or the President to “get involved” seem to continue to get louder, which simply put seems mind boggling to me. I thought that this is the way free market systems were supposed to work – buyers, sellers and investors coming together to agree on terms for a transaction that benefits each of the parties, with each knowing that there is some degree of risk for all parties involved in the process. Each accepts the fact that sometimes they will win, and sometimes they will lose. Moreover, I don’t recall hearing such calls when each of the parties above was reaping the benefits of such transactions. Did I miss something here?
Is the so called “sub-prime housing crisis” really a crisis, or is it just the market doing what it does best ( . . . as I write that I simply cannot help but wonder if someone like George Carlin might see fit to call the “sub-prime housing crisis” a politically correct modern day euphemism . . . and if so, it is even more interesting to think about what he might re-label it!!!)? Sure hindsight tells us that there are individuals from each of these camps that are bearing the pain of poor decisions. Yet how does this in any way suggest that any one individual at the Federal Reserve or in the President’s administration can (and it is not a foregone conclusion that they would do any better as suggested in the paragraph below) or should be responsible for the outcome of such decisions? And even if they can and would choose to “do something,” aren’t they really using someone else’s money (mine and yours)? I just don’t seem to recall finding an 800 number for either of these offices the last time I made a bad decision.
At the end of the day, there is nothing new per se about the economics of this “crisis,” or what we should and should not do about it. In fact, in the Austrian tradition Frederich Hayek (a Nobel prize winner) wrote an excellent piece about fallacy of circumventing the natural workings of the market place way back (for me at least!) in the 40’s. Hayek argued that prices are not merely “rates of exchange between goods”, but rather “a mechanism for communicating information” (Hayek, 1945). He notes that if given a chance, people would clearly become price-makers as opposed to price-takers if their knowledge of their surroundings would allow. Yet in a complex and uncertain modern economic context, individuals rarely, if ever, hold a body of knowledge that would enable them to act on such a desire. And even if they did, Hayek points out that it would be nothing more than “fatal conceit” to think that even the wisest of individuals could “plan” or “design” a system based on such knowledge. In short, Hayek highlighted not only the natural beauty of prices as coordinating mechanisms in an evolving economic marketplace, but also their superiority over that natural cognitive processing power with which any of us as individuals is blessed over the course of a lifetime.
Seems to me that we really have two choices: a) let the original willing parties bear the totality of the benefits AND costs associated with these transactions, or b) ask them to engage in the proverbial playground “do over” by everyone giving back what they previously gained and starting the game over (come on, you know the prospects of this one are highly entertaining to think about!!!). It just doesn’t seem wise to ask the government to intervene given its W-L record on handling such matters, particularly when history suggests that private property rights are likely to do a far better job. What do you think?