The New Alchemy: Turning Red Ink into Shackles

By David McAlvany

Everyone knows that criminals can be reformed, addicts can quit their habits, and borrowers with a penchant for living on the banker’s dime can even go clean.  What they might not know is that there is a high degree of recidivism among these social subsets, including borrowers.  In fact, borrowers comprise the group that has generated an important new statistic: the re-default rate.  When once is just not enough, you can now default on your mortgage loan one more time for good measure.

Alan Abelson recently shed some light on this new phenomenon:  Essentially, the government is not solving problems or spending money wisely in its loan modification program.  Even loans that are current at the time of modification are becoming problematic.  Such loans result in default 34-59% of the time within 10 months after modification.  Among loans that become delinquent at any point after a loan modification, the default rate rises to 62-80%

Mark Hanson of Hanson advisors cogently notes that “Loan mods are designed to keep the unpaid principal balances of the lender’s loans intact while re-levering the borrower.” Mortgage modifications, he says, turn “homeowners into underwater, overlevered renters for life, unable to sell, re-buy, refi, shop, or save. They turn homeowners into economic zombies.”  In essence, these loan modifications are worse than all the horrors concocted by mortgage bankers during the bubble!

 [Ed. Note: If you ever doubted that government has the reverse Midas touch, this should alleviate any doubt.  This shows how government can take something that’s unpleasant, but not necessarily bad, and make it immeasurably worse!

What if the loans in default were allowed to go into foreclosure – which the majority will do anyway – and we instead modified the loans of homeowners who are not even close to default?  Homeowners with weak hands would be freed from the house-shaped albatrosses around their necks and could start renting at lower cost.  Those with strong hands would have an extra $250-$1250 a month to use in ways that caused them to have strong hands in the first place – perhaps to save or invest.  I would plead with them not to do this, but perhaps they would invest this “found money” in treasuries.  That way, they could help lower our exposure to foreign creditors and offset the government’s present predilection for spending more than we collect in tax revenue.]

Financing Failure

On top of this insanity, the government has now given Freddie Mac and Fannie Mae the green light to refinance homes at up to 125% of their value.  This policy is simply incredible.  The government, through these two quasi-governmental organizations, is re-creating the circumstances that have caused hundreds of thousands of Americans to walk away from their homes, mailing their house keys in to their mortgage companies.

University of Texas Economics Professor Stan Leibowitz has said that “the single most important factor [in the rise in foreclosure numbers] is whether the homeowner has negative equity in a house – that is, the balance of the mortgage is greater than the value of the house.”  In other words, homeowners are not as brain-dead as government bureaucrats.  If by having their loan foreclosed they come out ahead, they mail in their keys.  If foreclosure will hurt them, they buckle down and make their payments.  It’s not rocket science.  It’s not even rocking-horse science, but it seems to be beyond the ken of bureaucrats and elected officials.

The bottom line is that the government is eagerly providing troubled mortgage loan holders an incentive to walk away from their loans with taxpayer cash in their pockets (Freddie and Fannie have received over $200 billion in taxpayer-provided bailout funds).  Once again, the government is plundering productive Americans to benefit parasitic Americans.  The end result can never be good.  Perhaps the following quotation from Adrian Rogers can help us understand the problem:

"What one person receives without working for, another person must work for without receiving. The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it."

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