In A Subprime World cont.
In addition, the nation's subprime mortgage crisis prompted many Florida cities, counties and agencies to withdraw billions of dollars out of a state-run investment fund. Prior to October 2007, investments in subprime mortgages had a market value of $27 billion for Florida investors. Now, those same investments have a value of $6 billion. One need not be a Wharton or SBI finance professor to know what these plummeting values mean for key Florida stakeholders.
The announcement by the Bush White House last week to help at-risk homeowners facing expected interest rate adjustments in 2008-2009 was greeted with both caution and a sense of relief by the general public. While the quick federal response won't exactly erase the memory of the sluggish federal response to Hurricane Katrina, the Treasury's plan to impose a rate freeze for eligible mortgage buyers provides some degree of hope for edgy holders of these loans.
It's important to understand however what the Treasury plan will and will not do. First, to qualify for the rate freeze, you must have taken out a subprime adjustable-rate mortgage between Jan. 1, 2005, and July 31, 2007. Second, eligible buyers must be facing their first interest-rate adjustment between Jan. 1, 2008, and July 31, 2010, and the payment increase must be at least 10 percent. Third, eligible buyers must have a FICO credit score less than 660 and less than 10 percent higher than it was when you took out the loan.
These guidelines imply that the rescue plan will benefit about two-thirds of the subprime borrowers facing adjustable interest-rate increases scheduled to take place in 2008. The Treasury plan seems to be swift in its implementation, fair in targeting low-income at-risk homeowners and sensitive in seeking rate relief by freezing the adjustable rate over the five-year period.
Who then, in their right mind, would object to such a plan?
Not surprisingly, most economists look at the Treasury's subprime rescue plan as a textbook example of how political goals and economic goals are seldom in sync. For starters, the plan is a reincarnation of the medieval sanctions against usury practices. Any price freeze prevents relative prices to perform their basic allocative role and arbitrarily shifts income away from one group to another. A rate freeze is nothing more than a euphemism for the old-fashioned, ineffective and inefficient price controls employed during the 1960s and 1970s. In the case of the subprime mortgage market, the freeze effectively transfers income from the sellers of the mortgage-backed bonds to buyers of subprime mortgages. The plan also seeks to subsidize risk at the expense of repealing market-price decisions. Risk is ubiquitous in our everyday lives.
Since we can't eliminate risk we must manage risk. When borrowers enter voluntary contracts to purchase subprime loans the seller has every right to make an interest rate upward adjustment in order to cover for the anticipated cost of capital.
Critics of subprime loans have attempted to villainize such lenders by describing their practices in unsavory terms like "predatory lenders" who target gullible borrowers. Demonizing their market-based services is patently stupid since in their absence many low-income families would not be among the ranks of homeowners. It's interesting to note, due to the obsession with expected rate increases, that supporters of a freeze seldom protest when rates are falling.
The rapid response by the White House to the subprime crisis puts the focus on symptoms (expected rising interest rates) and not the root causes of the problem.
Structural economic changes which foster job losses are the fundamental cause for foreclosure. Buyers of subprime paper can't be expected to be treated the same as buyers of mortgages in the primary market due to their impeachable credit histories. There is no legal "right" to good credit. Any federal rescue plan that ignores financial counseling for vulnerable clients is irresponsible and counterproductive. For better or for worse, choices do have consequences.
Bill Dickens is a Tallahassee economist. Contact him at dickensb@comcast.net.