Applauding Hank: Treasury Secretary Rejects Keynesian Mortgage Bailout

Thursday, Treasury Secretary Henry Paulson stood strong against rising calls for a taxpayer bailout for the struggling housing industry. Paulson rejects the notion that the only way out of the housing mess is for government to engineer a giant bailout using taxpayer money.

In an interview yesterday, Paulson said that a bailout would more likely rescue reckless lenders, investors, and speculators than be of any real assistance to the stated targets of such a plan—struggling homeowners who cannot afford the rising mortgage rates they now face. Paulson and the Bush Administration are in favor of encouraging mortgage lenders to voluntarily ease up on borrowers that are current in their payments but probably will not remain so as their rates adjust upward. At Ockham, we always appreciate fiscal solutions which are grounded in free market principles rather than those based on Keynesian interventionism.

Data released earlier this week demonstrates that the housing market is worsening, as the fourth quarter 2007 S&P/Case-Shiller national home-price index fell 8.9% from a year earlier. This represents the biggest such decline in 20 years. Furthermore, mortgages guaranteed by Fannie Mae and Freddie Mac declined in number by 0.3% last year, the first year over year drop in 16 years according to the Office of Federal Housing Enterprise and Oversight. Paulson himself estimates that last year some 1.5 million Americans were foreclosed on and he expects that number to climb to 2 million in 2008, whereas a normal rate would be about 650,000 homes a year.

Armed with such bleak data in an election year, numerous politicians are anxious to put their name on a bill that will save homeowners. However, is that what is best for either the economy or said homeowners? Barack Obama would like to set aside $10 billion to help homeowners avoid foreclosure and to assist first time home buyers. Hillary Clinton would put a 90-day moratorium on foreclosures and also freeze rates on adjustable rate mortgages for 5 years.

These proposals are not sound economic policy but rather an attempt to pander and glean votes and they will not be able to reverse market forces. Paulson referred to plans such as these and those being considered in the House of Representatives: "I'm seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes. Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street.” In sharp contrast to the bi-partisan support afforded the recently-passed economic stimulus package, debate over a homeowner bailout plan presages a fiercely partisan battle in Washington.

Paulson is correct to trust in the efficiency of the free market to work through this crisis. Housing slumps are not a unique economic circumstance. When prices drop, buyers are incentivized to in enter the marketplace and the situation self-corrects until it reaches equilibrium again. Government intervention, no matter how well-intended, only interferes with market forces and results in complications and distortions which often have unintended consequences—typically worsening and prolonging the correction.

That explains why some of the greatest economic minds in the country—Bernanke and Paulson for instance—believe that any government intervention should involve the original lenders and be targeted to a specific class of intended beneficiaries, the well meaning homeowners current in their debt but at risk going forward. Financial markets do not always go up and, in situations such as these, the best fiscal policy is to “first, do no harm”.

Disclosure: None

Comments

[VennData]

The other day the caps on Fannie and Freddie buying in mortgages from lenders were taken off. The FHLB has already bailed out Countrywide and continues to loans billions.

To say that the government isn't already bailing out the lenders flies in the face of the data.

Paulson's policy on bailouts is identical to his policy on the strong dollar: Bull.

[Britishsteel]

hey this all orchestrated, now that his buddies on wall street are heavily in their short positions its easy to say no bailouts. Talk about a conflict of interest, ex-goldman head now secratary of the treasury? How Noble Mr. Paulson. Bravo Bravo

[dectra]

Once again, bush and his cronies bail out big business and say to the middle class "screw you". Funny how he and his GOP sycophants always find money for foreign wars, but hey, when it's Bob and Jane about to loose their house after suffering job loss, all the right wingers come out and decry bailing out 'speculators'.......NEVER supporting the GOP again.

[dectra]

I find it telling, the quote at the end of your article:

"explains why some of the greatest economic minds in the country—Bernanke and Paulson"

THESE are the greatest economic minds???? No wonder we're in a de facto recession.

[Erich Riesenberg]

One free market response available to homeowners is walking away from the home and the mortgage. This could be a rational response of a homeowner in a situation where the next 4 or 5 years or more of mortgage payments are going to be spent to pay down a mortgage to the home's current value.

[helplessobserver]

Great article and even better comments. Bravo!

[talktowen]

The Bush, Ben B. and Paul H. are not to be trusted. They say a strong Dollar is in the best interest of US. In the meanwhile, Ben lowered interest rate by 225bp to save banks from collapsing. Inflation based on PPI is almost 8% yoy. Yet, Ben told us inflation is under control while food, energy, healthcare and real estate price went up the roof in th e past few years. The Fed was established to maintain a stable currency, their job is to fight inflation, yet they create inflation with its loose monetary policy and low interest rate.

If Ben B. and Paul H. want a bailout, it's intention is to bailout wall St. and banks. For an average middle class living in New York, I can't even afford to buy a house nor a condo in NYC. Average price for a 2bedrm condo in Manhattan is $1.1million. In better locations in Queen or Brooklyn, a 2bedroom condo cost over $600K. Yet, these fools wants to a bailout the irresponsible lenders and borrowers. How can first time home-buyers can afford these houses. Let it come down and let some of these banks fail. Business and some home owners need to be responsible for their actions. Sadly Based on history (the S&L crisis and LTCM), the government will bailout the banks. My bets are weaker dollar, strong commodities and gold prices for years to come. Can't afford a condo for the next few years with my average NY salary even with an MBA. Just keep working....

[WAKEUP]

Everyone who is seriously upside-down on their mortgage should simply walk, NOW. The much-ballyhooed consequences of doing so are ridiculously exaggerated, and getting out from under a deadly mortgage is well worth it. This has the additional benefit, market-wise, of putting the consequences for the reckless lending that started this mess back where said consequences belong, on the reckless financial institutions who made the loans. Let the weaker institutions fail. The result will be a fundamentally stronger financial structure. By the end of 2011, single-family home prices are going to fall to about 40% to 50% of what they were, in 2007, and interest rates will be at about 6%. Buying a house will be what it used to be, a fairly expensive, but manageable undertaking. Yes, I know it sounds too simple to be the right course of action, but that's because we've been listening too long to the graph-drawing, index-reading, "gurus," who have never done an honest day's work, in their frat-boy lives, and who, by the way, are in the pay of the banks.

[Tim T]

First the author states: "At Ockham, we always appreciate fiscal solutions which are grounded in free market principles rather than those based on Keynesian interventionism."

Then he states that Bernanke is one of "the greatest economic minds in the country..."

I'm sorry, but I find it extremely difficult to provide the author with the smallest shred of credibility.

[keanemd]

The amazing bailout of the banks will not reach main street and that is ok for some people? Unbelievable.

[Wyliedog]

For most of the "Commentors" - Ignorance is bliss. They obviously don't know how far reaching the "Mortgage Meltdown" is. Man I wish I could walk out on all my finiancial responsiblilities, I would consider it a "Rational Response" and it would definitely be "Worth It".

Do any of you realize that, because John & Jane Doe decided to "walk out" on their financial responsibility, high school grad Jimmy with promising aspirations and a middle class family income will not be able to go to college because there will be no money to lend him for a student loan? It's already happening in Michigan.

You cry at a bailout because you think that means you, the tax payer, will have to pay for this mess? Make no mistake about it - you WILL end upaying for it, one way or another! Obama and Clinton scare me also.

Don't get me wrong, I think ALL the perpetrators should be held accountable. The borrowers (who didn't bother looking a gift horse in the mouth) who knew they couldn't afford that much house. The borrowees (who were too busy making their cut by signing people up) who knew the borrowers couldn't afford that much house. The players on Wallstreet, who bought the loan packages, made their cut and resold them as fast as they could because they knew how risky they were.

I don't think any one person has the answer - it's far too complicated, they can't even figure out who owns which loan. I have a feeling there will be a restructuring of the whole mortgage industry and the way the loan packages are put together and sold off.

As for the article it's hard to believe ANYTHING that Bush, Bernanke and Paulson say.

[whidbey]

The Secretary of the Treasury is correct, no bail out is to the advantage of anyone except the risk takers who should lose as a lesson in free market operations. If you want to shoot a few bankers or GS, and loan brokers, that is fine, but pain for a few is better than pain for the many.

[gordon]

You say "Bernanke is one of "the greatest economic minds in the country..." .That was the end of your credibility. Bernanke just told us there is no hyperinflation coming, inflation is "well anchored", it doesn't matter if foreign countries price oil in other currencies, and inflation will be coming down... and not many months ago the subprime was "contained". He's taling out of some textbook or is paid-off by Paulson. Bernanke should resign.

[rooster]

why do the democrats think that they should bail people out who got in over their head. Most of the people in our society make their house payment every month why should we spend tax payers money on the few that got in over their head. Our tax is too high to start with over half of everything we make goes to some sort of tax.