Posts tagged with: loans

Blog author: ckaupke
Thursday, July 12, 2012
By

Yesterday I blogged about the unintended consequences of the federal government’s mandate that Stafford student loan interest rates would not double as scheduled on July 1. Organizations such as the Jubilee USA Network praised the government’s action as an act of Christian charity towards students who were oppressed and taken advantage of by unscrupulous lenders. The phrase “predatory lenders” has been coined to describe entities that intentionally deceive borrowers into accepting loans they won’t be able to repay without going bankrupt. This is the accepted narrative, and is certainly what the Jubilee USA Network would like us to believe is true. However, this may not be the whole story.

In a working paper called “Complex Mortgages,” a group of four economists studied the differences between traditional mortgage borrowers – who paid down their balance over time – and complex mortgage borrowers, and found considerable evidence that suggested that many complex mortgage borrowers may have gone into mortgages fully intending to default. Thus the paper coined the term “predatory borrowers.”

The paper found that people who defaulted on complex mortgages were more likely than traditional mortgage borrowers to be highly educated and more highly paid, and to have higher credit scores, and they often defaulted even though they were not suffering financially. Complex mortgages are also more frequent in “non-recourse” states, where borrowers are legally protected from being pursued by lenders.

In summary, many mortgage defaults were not the fault of unscrupulous lenders, but rather, of unscrupulous borrowers. The accepted explanation for the housing bubble may only explain a part of the problem. If so, it is a sign of the moral laxity of our times that so many people seem to have no qualms about entering into agreements they fully intend not to keep.

Click here to read more.

In last night’s State of the Union address, President Obama commented that “even though banks on Wall Street are lending again, they’re mostly lending to bigger companies. Financing remains difficult for small-business owners across the country, even though they’re making a profit.”

He then offered some of our tax dollars to help: “So tonight, I’m proposing that we take $30 billion of the money Wall Street banks have repaid and use it to help community banks give small businesses the credit they need to stay afloat.”

The irony is that our government helped create this problem in the first place, both Republicans and Democrats. By repeatedly bailing out big corporations, Washington signaled the markets that it will protect “too-big-to-fail” companies if they should falter. So is it any surprise that big companies are attracting the lion’s share of the available credit?

What else has the government done to help? Well, it’s gobbling up an obscene portion of the world’s available credit by borrowing unheard of amounts of money. And by holding interest rates artificially low, it’s preventing the price function from coordinating the supply and demand of credit.

With help like this from the federal government, it’s a wonder there’s any credit left over for small businesses.

In college I wrote a paper for a Latin American Politics class titled, Barnum & Bailey Circus bailouts. The paper took the position that another financial bailout of Mexico would be a huge mistake and would not be money well spent. The paper was probably a little flippant because I interwove within the framework of the paper some characters with top hats, traveling bands of political circuses, and other outlandish theatrical symbolism. I was trying to make light of what I thought was a circus-like proposal, as well as rely on smoke and mirrors to downplay my lack of reading for the course.

There is nothing funny, however, about mortgage bailout proposals. Hillsdale professor Gary Wolfram has an excellent article in Human Events, titled “Econ 101: The Problem with Bailouts.” Wolfram shows how markets correct themselves, and even discusses the upsides to a now more affordable market:

As Sherlock Holmes told Dr. Watson in “Scandal in Bohemia,” one problem is that we see but do not observe. For every homeowner who loses his home and moves into a smaller home or a rental, there is another homeowner who moves into that home and out of a smaller home or rental.

It would be interesting if the media began doing stories on how much more affordable it is for people to move from rented apartments into owner-occupied homes. The house that used to cost $280,000 and was out of the reach of the young family is now $220,000 and becomes affordable.

If the federal government, including the Federal Reserve, bails out the mortgage industry in some fashion, the market will quickly learn that taxpayers will bear some of the risk of the investments of homeowners, lenders, hedge funds and other market participants. This will result in their taking more risk than is economically justified, encouraging the very activity that led to the situation of declining housing prices and foreclosures in the first place.

But if politicians keep rattling off vague proposals of bailout proposals in the belief it will raise their polls, they may have to think again. In an Associated Press article, J.W. Elphinstone, cites a newly popular online petition, Tax Payers Against a Wall Street and Mortgage Bailout. Furthermore, Peter Viles in the Los Angeles Times, references a Fox News Poll that shows 70% of the public against a taxpayer bailout.

Many of those people have been priced out of the market and understandably they don’t want to support people who cannot afford their homes, many of whom made really bad financial choices. The people against this bailout simply want back in the market, and they understand now the market is correcting itself.

In awarding the Peace Prize to Muhammad Yunus and the Grameen Bank, the Nobel Committee has focused the world’s attention on the power of “bottom up” economic development. Jennifer Roback Morse reminds us that “the micro-credit movement has helped many of the poor become less poor, and to lift themselves, their families, and their neighbors out of abject poverty.”

Dr. Morse reflects on Yunus’ background as an economics professor, educated at Vanderbilt, teaching in Bangladesh and seeing the abject poverty that afflicted communities near his post. Muhammad Yunus began to reach out and practice his own principles, and started giving loans — not handouts — to people in these communities who he believed had the potential to work themselves out of poverty, given the chance. In conjunction with the Grameen Bank, Yunus has now financed millions of small projects, many of them requiring loans of only $50, and helped many poverty stricken, yet driven, people emerge from their poverty by the work of their own hands.

Read the full commentary here.