Mortgage Crisis

We are in a market correction, but at what cost? The effects of the mortgage crisis are not felt only by lenders and their strapped borrowers. It has a ripple effect through the economy that drives down the home values of those who have acted responsibly and generally weakens the economy. Further, a lot of jobs are created by home building.

A smart economic policy going forward will discourage the kind of recklessness and deception that poses a problem for all Americans. An important component of a future policy will be disclosure requirements that ensure borrowers understand the decisions they are making. I am apprehensive about completely prohibiting ARMs and other such loans because I think we should have a virtually unlimited right to contract, but tighter controls on who is eligible for these products may be advisable (perhaps by qualifying based on debt-to-income ratio, credit score, and/or loan-to-value ratio).

Also, a large part of the problem was packaging these loans together and selling them with no information as to the likely default rate. When the weakness in the market began, investors did not know which assets were risky and became wary of the entire industry. More information with which to assess their investments would have slowed the crisis.

That being said, I think the government's response after the fact should be limited. We should not bail out lenders who have made and will continue to make money on these loans. We should not bail out homeowners that knowingly or foolishly got in over their heads, especially those who short-sightedly opted for adjustable rate mortgages.

We must also remember that while subprime borrowers have a significantly higher default rate, the vast majority are still making their payments on time. Subprime lending has allowed countless Americans to realize the dream of home ownership.

Clinton's idea to freeze foreclosures and readjustment of interest rates on ARMs may sound good to subprime borrowers in the short-term, but preventing lenders from enforcing their contracts will only discourage future lending to borrowers looking for a first home or a second chance.

The right to contract is a pillar of our economy. The government should do nothing that impairs that right.

However, some borrowers were victims of fraud. The illegality of fraud is long-standing and also very important to our economic well-being. If fraud is proven, the borrower is enitled to recover damages from the lender.

Lenders do not want foreclosure, and neither do the borrowers or their neighbors. There may be a role for government, in conjunction with voluntary participation by lenders and borrowers, to help ease the pain of this market correction for lenders, borrowers, and the economy as a whole.

If the government wishes to back some loans with government funds to allow borrowers facing foreclosure an opportunity to get back on their feet, and lenders wish to take advantage of this opportunity to keep borrowers making regular monthly payments, I think that would be good policy.

Some borrowers find themselves in a house worth less than their loan with payments that they can't afford. Another option may be for the government to back personal loans to these borrowers for the difference between the loan and the sale price, so that they can find cheaper housing and make good on their debts to mortgage lenders.

I do not favor a bailout of lenders or borrowers who made knowing decisions, however reckless and painful for them. I do not favor impairing the precious right to contract. I do favor punishing fraud and finding creative solutions to help borrowers meet their contractual obligations and, if possible, keep their homes.