The federal government's housing bailout may be setting us up for a harder fall the next time around. It could have some unintended consequences that could actually amplify the next downturn in the economy.
I don't use the word “bailout” casually. It's more accurate than others currently offered by Congress and the Administration. I think that when you provide support beyond any obligation that removes the penalties associated with bad behavior, you're talking about a bailout.
Nearly 1-million homebuyers could qualify for the mortgage assistance being offered, creating a situation that is not in the best interests of the country as a whole.
Even if no monies are transferred from the public coffers to the assistance program, it's still not a good idea. The people involved bear some responsibility for the situation they are in, yet will likely suffer only minimal consequences.
Let's look at the economic reasons for not supporting — directly or indirectly — the homebuyers, primary lenders, secondary market and regulators.
The profile of the typical homebuyer probably looks something like this: under age 35; accumulated wealth is less than 10% of annual income; future income stream is limited due to lack of opportunity for advancement; family size has recently, or is about to, expand. People who fit this profile should be allowed to invest in a home, but lenders need to recognize that they are at-risk investors.
Most people in this age group have not experienced a significant recession as an adult. Consequently, they haven't been motivated to put some assets aside for a rainy day. If it never rains, you think you'll never need an umbrella.
At the same time, some of these households had economic support from parents that provided a false sense of equity investment. Rather than rely on their own savings, some were able to purchase homes because parents gave them the down payment. Economists have developed several theories of consumption, one of which is known as the “expectations hypothesis.” Simply put, it posits that future behavior is based upon past behavior, experience, and expectations for the future.
Applying this theory to the group of homebuyers mentioned above, we see that the trap was easily set. Not only did they not have the experience of living through a recession to test their ability to handle a decline in income, but they also saw a fairly steady increase in the value of their homes.
In addition, inflation has been relatively modest, which means they didn't experience sharp increases in rent, insurance or other essential goods and services.
Since our theory says it is logical for the consumer to expect the future to be pretty similar to the recent past, investing in a home seems like a safe bet.
How does the system normally place checks and balances on this process? The primary lenders, secondary markets and regulators should all have a hand in providing the necessary procedures for the new homeowner to clearly identify the financial risks associated with owning a home, as well as the level of risk that their individual circumstances dictated. But they did not.
The primary lenders, the secondary markets and the regulators, as well as the homebuyers, should have to pay the piper. Instead, we're establishing a precedent in which irresponsible behavior is rewarded — or at least, bailed out.
From each, according to their abilities; and to each, according to their needs.