December 10, 2007
The trouble with the Paulson plan
“This is a private sector effort, involving no government money,” Hank Paulson, US Treasury secretary, said last week, announcing the deal he had just brokered among representatives of mortgage-security investors and mortgage-service companies to freeze interest-rate resets on some loans. He emphasised that the compact was voluntary. “The industry standards announced today do not change the nature of responsibilities in the servicing industry – servicers will continue to modify loans when it is in the best interests of investors.” In short, he said, it is a “market-based approach”. Give the man some credit for using that term without laughing. Is there a housing-finance market on the planet that is more pervasively manipulated and distorted by government than that of the US – even before this latest intervention? Start with virtually unlimited tax relief on mortgage debt. Throw in the two giant “providers of liquidity”, Fannie Mae and Freddie Mac, key enablers of the mortgage securitisation surge, operating in the background under implicit government guarantee, with transactions accounting for 40 per cent of US mortgages on their books. Do not forget the Federal Housing Administration, the government mortgage insurer (6m loans and counting), which the administration has just asked to take on a much expanded role. And now this. Totting up the explicit and implicit cost of these programmes, the mind reels. The tax deduction alone is nearly $80bn a year. It is a little late for a market-based approach. You can read the rest of this new column for the FT here.
It is not the government that is primarily responsible for distorting the market for subprime mortgages. It is the lenders who took advantage of poor, elderly and minority borrowers, up to 2 million of whom in the US are now at risk of losing their homes and life savings. If the predatory lenders who concealed the true costs of the loans from these unsophisticated borrowers, and steered some with good credit ratings into the subprime market hoping to earn higher interest rates, or even to benefit from almost guaranteed foreclosure in a housing market that looked as if it would keep on rising for ever, did not “distort” or “manipulate” the market, then all of the 17th century Dutch tulip and South Sea bubble transactions were also standard textbook examples of how free markets should work. So was the off balance sheet accounting involved in the Enron scandal, to mention only one recent example.
Even laissez-faire fanatics such as Milton Friedman and von Hayek never, as far as I have ever heard, advocated “free” markets with no rules at all. Indeed, without courts, a body of contract law and enforceable banking and securities regulations, mortgage or other financial markets of any sort would be inconceivable. But we never hear about the evils of “regulation” and “distortion” as long as the profits of the predatory lenders and investors in risky CDO’s and the like are protected. It is only when those who are least able to protect themselves ask for some basic fairness as well that we are treated to hypocritical lectures about the mortal dangers of “over-regulation” and “market distortion”.
The best way to preserve free markets is to make the people who were cheated by predatory and fraudulent subprime lenders whole by freezing interest rates and eliminating prepayment penalties for everyone who was victimized, and by locking up the lenders responsible for unleashing this tsunami of fraudulent and bad faith lending.
Posted by: algasema | December 10th, 2007 at 9:12 pm | Report this commentOf all the articles that has appeared in the FT (and God knows there is a surfeit of them!)yours is the boldest. I wonder why the adage “call a spade a spade” has suddenly seemed so difficult for many other columnists to follow, as they go about churning reams of literature.
As someone who was personally affected, let me share with you how the Indian Government handled a similar problem anongst the tribe called “Non Banking Finance Companies” (NBFC) who were in the business of funding retail assets from Fixed deposits taken from the lay public. Similar to the mortgage lenders in the US , these private NBFCs were irresponsible in lending and, as a consequence, defaulted on their fixed deposit repayments. Rather than come to their help, on one December day in 2000, the Reserve Bank Of India stipulated stiff lending and borrowing limits and norms that spelled doom for the players. Six months down the road just 10 of the 4500+ Companies survived. Others ( including mine where I was a CEO) closed shop. Thousands of depositors lost their savings as they were unsecured deposits and had no recourse to court action or even initiate liquidation proceedings.
It is now a cleaner environment, though I lost my job.
If this what a poor country like mine could do , what happened to capitalist USA? Obviously the problem is huge and there is fear of a countrywide impact.
Your bold expose in this article and the article in the National Journal, sadly fails to suggest an alternative solution to what is obviously a catastrophe in the making. I am keen to know what you have done in Mr PAulsons position. have
Posted by: Sridhar Chari | December 16th, 2007 at 4:13 pm | Report this comment