The bursting of the housing bubble has created huge losses in wealth. Many are now upside down on their home and feel trapped without any good solutions.
A popular line in one of my kid's favorite movies, National Treasure, is "Someone has to go to jail".
When asset bubbles are burst, "Someone has to pay". It's even more of a cold, hard reality because there is no one who can simply sign a pardon and get rid of all the losses. The losses are real and aren't going away by executive order.
The big question is, who pays?
In the free market usually the parties who freely entered into a contract with each other assume all of the risks along with all of the rewards. People take out mortgages to buy homes, many with the hopes that they will be able to eventually sell for a higher price and make a nice profit. What a great deal. Instead of throwing their money away in rent payments, they become owners and make mortgage payments instead. If they get 100% financing, it looks like a complete no-brainer decision. Just by living in a home, one can become wealthy. Many people did. Many people envied the home owners who made hundreds of thousands of dollars just by being an owner instead of a renter.
But with opportunities for rewards, come the risks of being an owner. Sure, many people ignored the risks of home prices actually going down. Most thought that that was an impossible scenario.
Now many people owe $300,000 on a home that they might be able to sell for only $200,000. They're in a real bind if they have to sell right now. I feel for them. It really stinks to be in that situation.
People are looking for solutions to get people out of this unfortunate situation. Unfortunately, someone has to pay.
Some people seem to think that the government or banks should bail the homeowner out.
- Either by giving them the $100,000 to cover them for their negative equity so that they can now sell at the market price of $200,000, or
- they want the banks to reduce their mortgages down to $200,000.
- A third alternative would be to give the potential home buyer an extra $100,000 so that they can pay the seller the full amount, $300,000, in order to pay off the mortgage. This would keep homes prices at bubble prices and we can just make believe that nothing ever happened.
Any one of these sounds wonderful at first glance. But step back and figure out where the money is coming from. If the government gives out money, they have to get it from somewhere. Government doesn't create any wealth or real money.
- It can only take it from one group and give it to another. So it can collect taxes from the many and give it to the fewer homeowners in trouble.
- It can borrow money which places the burden of repayment, with interest, on to the next generation.
- It can just print more fiat money which then eventually devalues all of the current dollars in circulation. This is basically just another form a taxation but it's more invisible and harder for people to pinpoint the blame.
One way or another, someone has to pay.
Forcing the bankers to forgive the $100,000 usually sounds good to many people. But follow that through and see who really takes the hit. All of those mortgages were packaged into securities that were bought by investors. Many of the investors were people like you and me who were just trying to make a little interest off the money that they worked so hard to save. Many have retirement accounts that have funds that invested in these "safe" bonds. So if you require the banks to reduce the mortgage amounts, then all of these securities get reduced accordingly and anyone with any exposure to these securities takes the losses.
The next thing you would need then is to have the government step in to guarantee all of these mortgage securities. With what money? See the paragragh above about how government gets their money.
I'm sorry to say that there just isn't any clean and easy solution to this mess.
I have confidence that when government steps aside, the true free market process is the most efficient mechanism to get things where they need to be.
Government has it's role, but not as the entity that decides the winners or the losers or the one who tries to spread the losses around. Their role is to prosecute fraud and to provide transparency in the markets so that people can make the best informed decisions.
Doing nothing sounds so lame and unresponsive. But many times doing something just for the sake of trying to look helpful, actually worsens the situation and prolongs the agony.
The sooner the losses are taken, the sooner we can get back to some sanity.