What Not to Do about Subprime Failures
Sept 18, 2007

IRVINE, CA--As high default rates on subprime loans continue, various state and federal officials are eager to "do something" to counter the failures--especially to give aid to the homeowners who bought mortgages they couldn't afford.

"This is exactly the wrong approach," said Alex Epstein, an analyst at the Ayn Rand Institute. "The current subprime problems are the result of borrower and lender irrationality, and of government intervention in the market to 'help homeowners.' Government housing assistance programs, like Fannie Mae and Freddie Mac, encourage people to buy homes even when they cannot truly afford them. And the government's longtime manipulation of interest rates to keep them artificially low led many to expect that their adjustable rate mortgages would stay low forever--only to see their fortunes at the mercy of government rate hikes or rate cuts.

"This does not absolve lenders or borrowers of responsibility for taking on risky loans, and it certainly does not justify any sort of bailout. The individual who buys an expensive home counting on interest rates to stay low forever is responsible for the consequences of his risky decision. For the government to 'do something'--anything--to alleviate a mortgage failure necessarily rewards those who took on large housing risk at the expense of those who didn't. And it invites future irrationality by telling people that they do not need to think about their financial decisions, because the government will always be there to save the day.

"The only moral and rational response by the government, besides prosecuting genuine cases of fraud, is to stop encouraging people to make bad decisions--but then leave them to face the consequences when they do."

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Alex Epstein was a writer and a fellow on staff at ARI between 2004 and 2011.