A New Plan to Socialize Losses

A New Plan to Socialize LossesPresident Obama’s a man with a plan.  A couple weeks ago he unveiled his plan to save the middle class by calling CEOs.  This week he told people in Arizona he plans to save the housing market by providing government guarantees to securitized mortgage packages.  No kidding…

“The core of Obama’s proposal involves winding down mortgage finance giants Fannie Mae and Freddie Mac, which own or guarantee more than half of all U.S. home loans and are critical to keeping capital flowing to lenders and borrowers,” reported Reuters.

“The administration wants to replace Fannie Mae and Freddie Mac with a system in which the private market buys home loans from lenders and repackages them as securities for investors.”

So far so good, right?  It sounds like the President wants to get government intervention and government price distortions out of the housing market altogether.  But unfortunately he’s not content to leave it at that.  For there’s always room to enter moral hazard into the plan…

“The government would still play a role in housing markets by insuring or guaranteeing those securities – at a cost to investors.”

What’s a Moral Hazard?

A moral hazard is the idea that a person or party shielded from risk will behave differently than if they were fully exposed to the risk.  A person who has automobile theft insurance, for instance, may be less careful about securing their car because the financial consequence of a stolen car would be endured by the insurance company.

Financial bail-outs, of both lenders and borrowers, by governments, central bankers, or other institutions, produce a moral hazard; they encourage risky lending and risky speculation in the future because borrowers and lenders believe they will not have to carry the full burden of losses.

Do you remember the Savings and Loan crisis of the 1980’s?

The U.S. Government picked up the tab –   about $125 billion – when over 1,000 savings and loan institutions failed.  What you may not know is the seeds were propagated by FDR during the Great Depression when he established the Federal Deposit Insurance Company (FDIC) and the Federal Saving and Loan Insurance Company (FSLIC).

From then on, borrowers and bank lenders no longer had concern for losses – for they would be covered by the government.  The Savings and Loan crisis confirmed this and further propagated the moral hazard culminating in the subprime lending meltdown.  President Obama’s new plan could be the origin of a future housing and mortgage market bubble and bust.

A New Plan to Socialize Losses

By guaranteeing mortgage securities the government will encourage risky lending by banks and speculation by investors.  The banks will be less prudent about who they loan money to because the loans will be securitized and sold to investors.  Similarly, investors will speculate on these securities because they will be guaranteed by the government.

Once again, the government will promote a “heads, I win…tails, you lose” environment where banks and investors reap big profits taking on big risks and where the losses are socialized by tax payers.  It may take a decade – or more – for things to get out of hand.  But they eventually will.

Before then, however, there will be a new bull market in housing.  This, of course, is precisely what the government and the Federal Reserve want.  They want rising housing prices to bailout all the underwater loans, stimulate a new building boom, and float up the economy.

In fact, our friend Paul Rosenberg, over at Free-Man’s Perspective, remarked earlier this week that, through QE, the Federal Reserve is buying upward of 130,000 houses per month.  This amounts to 1.43 million houses since the Fed initiated its mortgage buying program in September 2012.

Aside from the Treasury market, the housing market must be the most manipulated and government bolstered market there is.  Without all the funny money going into the housing market, houses would actually be affordable for many more Americans.  Instead, Obama’s plan promotes higher housing prices, greater speculation, and the enticement of more and more people to borrow money they can’t pay back to buy houses they can’t afford.

No doubt, we’ll be looking for offshoot investments to profit when the next price run up takes off in earnest.  We’ll be certain to keep you apprised of what we come up with.

Sincerely,

MN Gordon
for Economic Prism

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