Tuesday, December 30, 2008

Rationing Credit

Yes, the government has managed to force mortgage rates ever lower in their bid for 4.5% home loans. They'll get it there even if they have to destroy the entire financial system in the process.

To me, this is beyond farcical. Yes, we know that if the government puts its massive force behind something, it can will just about anything into existence. But there are always unintended consequences... these in a moment...

The big worry to me is that despite the government's best efforts, we have yet to see the follow through in actual mortgage origination. The same goes for corporate bonds... Yields have fallen sharply in the last 2 months, from over 9.5% to about 8% for Baa credits. But issuance has yet to follow suit.

The truth is that when the government sets a price for something artificially low, we shouldn't be surprised to see less of it. Unless the government itself is willing to lend the money in the mortgage market, there will never be enough capital to fund these loans.

We're headed towards a world where the "official" mortgage rate is 4.5%, but it will be close to impossible to get them. The richest people with the best credit scores will manage to refinance loans, but I am predicting now that the average person won't see the slightest benefit from this process. If anything, it might have the unintended consequence of inducing lots of Americans to seek refinancings, only to find a rude surprise when the appraisal comes. Just like we learned with the original TARP, sometimes ignorance is bliss.

Even if "appraisal shock" doesn't emerge as a major theme, what good is refinancing mortgages? It will only help the richest people who don't need help -- just like we see in the case of things like farm subsidies and public school, that's normally the way government works in this country.

How does letting the richest people refinance their mortgages prevent foreclosures for marginal borrowers? (Answer: it doesn't.) Who does benefit? (Answer: the banks, which are positively salivating at the prospect of earning fees from the whole process. In the early 1990s, Alan Greenspan deliberately caused a steep yield curve to help banks "rebuild their balance sheets." Some commentators elevated him to an Atlas-like stature for this policy, which put the country's monetary policy at the service of its lenders. This time cutting rates isn't doing much good, so the powers that be will find a way to help the banks make money somewhere -- anywhere. Never forget who the Ben Bernanke actually works for: the banks.)

We're headed to a situation where official mortgage rates are 4.5%, but no one can get them. It will be like buying gasoline by lottery in the 1970s, or going shopping in the Soviet Union, when the shelves were full of cheap merchandise that only existed on paper.

Whenever the government tries to overrule the basic laws of supply and demand, black markets develop. This is why I fear something much more sinister could emerge from these artificially low interest rates. I think it will be so hard to actually get the money that we'll see the rise of personal connections and politics play a role in getting a home loan. Given the President Elect's established ties to groups like ACORN, I fear the day when they gain control of the mortgage lending system.

It's disturbingly likely given the way things are playing out. First, we'll see some mortgage lending done at 4.5%, but only the richest peple will benefit. Then the media and Congress will express outrage (and somewhat rightly) that so many people are being "excluded"... After all, if the government's doing it, it should be for everyone. There will then be some kind of political pressure to extend loans to "minorities" etc. The next thing you know, groups like ACORN will be all over the mortgage market. Of course, it won't play out exactly like that... But the basic dynamics are there.

It's almost 2009. We are not learning capitalism, or seeing mistakes made for the first time. History teems with examples of politicians who tried to make the free market (ie, free people) do what was against their free will. Sometimes, such experiences end in violence. Often, they end in more poverty. But, they always end up as failures.

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