Adam Smith’s key insight was that both
parties to an exchange can benefit
and that, so long as cooperation is
strictly voluntary, no exchange
can take place unless both parties do
George Passantino of the REASON FOUNDATION wrote an
article today in the FlashReport about the proposed
freeze in interest rates which will protect borrowers
who made bad decisions and will punish investors who
invested in mortgage-backed securities because they
believed in the sanctity of contracts.
It is easy to call yourself a supporter of economic freedom
and the rule of law amidst a rapidly rising economy. Now
with dark clouds of the recent rise in mortgage
foreclosures—and more expected on the horizon—political
expediency has eroded the support for free markets in
some of its perceived champions.
Even self-proclaimed devotees of the late Milton Friedman,
President George W. Bush and California Governor
Arnold Schwarzenegger, sound more like critics than
In the wake of a perceived mortgage crisis both have
attempted to use the coercive power of government to
solve the problem. Both plans center on agreements
with the largest mortgage servicing companies to
“voluntarily” freeze interest rates on adjustable rate
mortgages for a set period of time.
Upon Friedman’s death, President Bush remarked that
“Milton Friedman has shown us that when government
attempts to substitute its own judgments for the judgments
of free people, the results are usually disastrous. In
contrast to the free market’s invisible hand, which
improves the lives of people, the government’s invisible
foot tramples on people’s hopes and destroys their dreams.”
Perhaps the President should re-read his talking points and
share a set with the Governor.
There are several flaws in the approach to “voluntarily”
freeze rates. First, it is disingenuous to call the plan
completely voluntary. When a government seeks a
“voluntary” commitment in one hand, you can be sure
that the hammer of regulation is hidden behind the
back in the other hand.
Moreover, such a freeze is tantamount to a moral bailout.
While it may not necessarily be a financial bailout of the
S&L magnitude, it bails out lenders and borrowers from
bad decisions and forces someone else to shoulder the
cost. Behind each mortgage is a pool of investors that
make life decisions, such as retirement planning,
based on an expected return of those investments.
Forcing these investors to eat a loss by government
fiat is fundamentally unfair. Moreover, this tramples
the rule of law and the sanctity of a contract. And, of
course, as the regulatory feeding frenzy grows,
you will no doubt see a host of new efforts to clamp
down on lending practices and in doing so eliminate
the access to capital that so many families depend upon.
Equally troubling, the proposals seem to try to encourage
responsible borrowing by only applying to people that are
current on their notes but who can’t afford the rate
adjustment. It doesn’t take a Nobel Prize Economist
to figure out that thousands of families that actually can
afford the rate adjustment, and who made those decisions
willingly, will nonetheless seek relief by claiming that they
will not be able to afford it. And what constitutes not being
able to afford it? Does a family that goes out and finances
tens of thousands of dollars worth of home entertainment
equipment and luxury automobiles and whose monthly
debt obligations have increased dramatically qualify for relief?
Perhaps most troubling of all is that this move to freeze
rates and ratchet down the industry with new, tougher
regulation completely misses one fundamental reason
that so many Californians have turned to adjustable rate
mortgages and other exotic loans. The price of
housing in California is simply too high.
Is it any surprise that five of the ten areas with the
highest foreclosure rates nationally are in California,
or that in some markets there are more foreclosures
than new homes for sale?
If Schwarzenegger and Bush want to stay true to their
philosophical allegiances to Friedman, they could start
by tackling the root causes of the affordability crisis
that has driven so many families to secure loans
that are a poor fit for their unique conditions.
According to statistics from the California Building
Industry Association, California homes were on par
with national prices as late as the 1970s. As
development became more difficult in California,
prices relative to the nation began to shoot upward.
Now, California home ownership rates are 10%
lower than the nation.
If California really wants to ensure that people have
a home to live in, we need to make housing more
affordable. New regulations on mortgages or short
term freezes will not do that.
The price of regulation—both in hard dollar fees
and in the costs of time—can easily add $50,000
to the cost of each home. That can account for
$300 or more in each monthly payment. In many
jurisdictions, the cost of regulation is much higher
At the same time the costs of regulation are increasing,
anti-growth activists have become experts at utilizing
the California Environmental Quality Act (CEQA)
and other well-intended laws to stop development
or force substantial delays which also results in
significant costs. The longer a home takes to build,
the more it costs in interest and construction expenses.
On top of that, finding land that is suitable for devel-
opment is increasingly difficult, and when land is found,
political pressures typically mount against “affordable
housing.” While such conditions exist in varying
degrees around the nation, there is a uniform need
to address them.
While it may seem politically appealing for government
to directly help people keep their homes, as Friedman
said of government intervention, the results are usually
disastrous. Both Schwarzenegger and Bush would do
well to focus, instead, on underlying cost drivers of
the housing market that are truly governmental in origin.
People, faced with home prices they simply cannot
afford, have far too often found refuge in loans that
probably don’t fit their personal economic conditions.
While no amount of intervention can eliminate the
obligation that anyone has to fully understand
and honor the terms of the contract they sign, it
would nonetheless be helpful for government to
eliminate or reduce some of the cost drivers that
they developed and which have helped fuel this perfect
George Passantino is a Partner in Passantino Andersen
Communications, LLC and a Senior Fellow at the Reason Foundation.