The Injustice of "Doing Something" about Subprime
By Alex Epstein (Riverside Business Press, November 26, 2007; Beaumont Enterprise, January 10, 2008)
As we witness large numbers of defaults on subprime loans--loans extended to those with no credit or bad credit--many are calling for the government to do something to stop the suffering. At the same time, many recognize that a bailout of struggling homeowners would be wrong. Thus, we see a growing list of proposed solutions that purport to save the day without a bailout: "borrower assistance" programs to refinance defaulting mortgages, crackdowns on "predatory lending" practices, or laws restricting mortgages the government deems too risky.
In fact, regardless of how these proposals are described, all embody the essence of a bailout: they absolve individuals of responsibility for their bad decisions--and force those who did nothing wrong to pay the price.
While we may empathize with those suffering the pain of foreclosure or bankruptcy, we must recognize that any struggling borrower or lender who signed a clear, non-fraudulent contract, is responsible for making sure it is paid off. In cases where fraud was committed, the victims can and should take legal action under existing laws--but there is no evidence that such cases are epidemic. Most of the defaults are due to the simple fact that many lenders and borrowers made risky loans. Some were betting on a never-ending real-estate boom. Some, observing the Fed's longtime manipulation of interest rates to keep them artificially low, expected that their adjustable rate mortgages would stay low forever. Others did not carefully assess the contracts they signed--while certain lenders gave money without carefully analyzing the borrower's finances. Still others were encouraged to buy homes, even when it didn't make financial sense, by a government that believes home ownership is essential to the American Dream.
Given this range of factors, many people and institutions besides struggling borrowers and lenders--most notably, the federal government--bear responsibility for the mess. But the ultimate responsibility lies with the borrowers and lenders themselves. Any problems they have are their responsibility to remedy--just as any gains borrowers and lenders have made on risky subprime mortgages are theirs to keep. In the case of a mortgage borrower, taking responsibility might mean trying to find a lender who will pay off and renegotiate the old mortgage into a more manageable one. If such attempts fail, however, a person must accept the unfortunate consequences--for example, the borrower who loses his house and must live more modestly, or the lender who must take a large loss from a loan default. The only alternative is to make others pay for the consequences of his actions--which is exactly what all government attempts to "do something" necessarily do.
The government is not a savvy lender or mortgage expert able to contribute innovative financing strategies or new knowledge to the mortgage market. Its sole power, which all forms of "doing something" utilize, is the power to forcibly compel some people to give up their money or freedom for the sake of others.
Any government "borrower assistance" (read: borrower bailout) programs, such as a Massachusetts proposal to give struggling homeowners new loans they could not get on the free market--at a cost to taxpayers of at least $250,000 per homeowner--compels those who did not make or take out risky loans to bail out those who did. The same is true of measures to target "predatory lending"--an undefined term that gives the government license to extract huge fines from any innocent lender it retroactively deems should have given better counsel to borrowers. The government is also punishing the innocent when it attempts to "protect" future borrowers. For example, proposed prohibitions on future mortgages that the government deems overly risky punish individuals who manage risk well, many of whom will not be able to afford new homes without these vehicles.
The proper response of the government to subprime problems is simple; commit to no new interventions in the housing market, and cease all existing intervention designed to influence home ownership--from programs like Freddie Mac and Fannie Mae to artificially low interest rates. Such a move would send a message befitting a free people: a message of responsibility. Individuals would be responsible for the loans they make and for choosing the housing option that is best for them. The government would protect everyone's rights by enforcing laws against theft and fraud, and by protecting the individual's right to make his own decisions and keep his own money--even when others make bad use of theirs.
Alex Epstein was a writer and a fellow on staff
at ARI between 2004 and 2011.