The Free Lunch Approach to Finance

by: Graham Summers

Over the last week, the media has been abuzz with numerous bailout plans to help homeowners in danger of losing their homes. The New York Times reports there are at least four plans in the works.

The problem with virtually all of these plans is that they punish the prudent and reward the… Honestly it’s hard to phrase this appropriately. The American dream to a large extent entails homeownership. The problem with Dreams — American or otherwise — is that they’re not based in reality. We’ve now got a situation in which millions of Americans are living in homes they cannot afford. Many of them have simply stopped making mortgage payments and are essentially squatting.

Banks which are already broke and don’t need to spend the extra money filling out foreclosure paperwork have helped facilitate this. The most recent example is JPMorgan, which just announced it will freeze foreclosures on $70 billion worth of mortgages for up to 90 days (three months). Other banks have implemented similar schemes.

But what about the people who saved their money and only bought homes they could afford? Those who exhibited prudence and lived responsibly now look like fools making mortgage payments while their neighbors squat for free.

To me, all of these issues hinge on the fact that we’re talking about homes. If this issue was related to cars — minimum wage employees started buying Ferraris or Porsches — or jewelry — high school teens started buying Tiffany’s diamonds using their allowance — there would be no debate here. The powers that be would simply say, “these people lived excessively and have dug themselves into a ditch. It’s their problem, not ours.”

However, because we’re talking about homes, everyone is uncomfortable saying anything like this. No one wants to be seen as the guy who throws his fellow Americans into the streets. But the reality is that the US left reality and entered fantasyland about five years ago when people who would never have been able to afford a home previously started buying houses.

I realize that the story is more complicated than this. There were predatory lending practices, complicated mortgage structures that hid the real monthly payments from the financially unsophisticated, and more. But the fact remains that for whatever reason, there are now millions of folks living in homes they cannot afford. And the Feds and banks are now doing what they can to keep these people in these homes. Doing this has multiple implications. It provides plenty of incentive for folks who CAN afford their mortgages to simply stop paying, which not only increases the problem but will end up costing Americans more money in the end as we pay off these future nationalized debts over the next couple of generations.

It also opens the door for lax rulings on other debt markets, most notably credit cards. It’s not a huge jump to go from writing off homeowner debt to writing off credit card debt. Indeed, several large banks have grouped together to ask the government to allow portions of consumer credit card debt to be forgiven. The pilot program could affect as many as 50,000 people and could forgive as much as 40% of an individual’s credit card debt depending on his or her financial situation.

What’s next, car loan forgiveness? Student loan forgiveness? It’s getting to the point where there’s no real reason to work hard or make money: Your bills could potentially only be food, clothing and energy. I’m not saying that facetiously. If credit card and mortgage debt are forgiven, the monthly household bills drop big time.

Is this the new American retirement program — Forget about savings and working hard, just stop paying debts and bills, squat in your home, and earn enough to pay for the groceries and heating bill?

Has the formerly impossible “free lunch” begun to exist in America?