The Liberty Papers

Liz Mair reports that Congress is now considering a new round of bankruptcy reform in response to the crisis that has developed in the subprime mortgage business. As with most of the government regulation that’s been suggested in this area, it takes exactly the wrong approach to the problem.

Earlier this month, Republican Senator Arlen Specter of Pennsylvania introduced the Home Owners’ Mortgage and Equity Savings (HOMES) Act, which seemingly takes a balanced approach to dealing with the crisis. However, the Specter legislation has already provoked criticism on both sides of the debate. It may ultimately be too interventionist for the taste of banks and yet too timid to win the approval of Democratic Senator Dick Durbin of Illinois, who is pushing for a much more radical overhaul of the bankruptcy code.

The most controversial elements of the HOMES Act are its provisions allowing bankruptcy judges to delay, prohibit, or roll back increases in mortgage interest rates, to waive early repayment penalties (so as to enable desirable refinancing), and to write down principal on a mortgage where the lender agrees. The law would apply strictly to borrowers who took out mortgages before September 26, 2007—and only if they sought relief within the next seven years.

Even that limitation though would bring within the laws reach millions of homeowners who entered into these high-risk loans because it was all they could qualify for and now find themselves in financial trouble not so much because their circumstances have changed, but because the loan has reached a point where, by its terms, the payment must go up. This is the loan that these people signed up for, and yet Specter would have Bankruptcy Court judges the authority to rewrite the terms of the loan; although, strangely, his proposal requires the lender’s consent, which it would seem would almost never be given.

Even Specter’s proposal isn’t enough for some in Congress. Mair reports that Senator Dick Durbin would propose a law that allows Bankruptcy Judges to rewrite the terms of the mortgage loans as well as other changes to the law that would fundamentally alter the nature of the relationship between debtors and creditors.

As I’ve noted before, even Specter’s timid proposal misses the point. Politicians see what’s happening in the real estate industry and assume that it’s their duty to fix it. In reality, what’s happening is the market reasserting reality after a prolonged period of what was called in another context “irrational exuberance.” The days of real estate values increasing by double digit percentages, or more, on an annual basis are gone because they weren’t realistic and weren’t going to be sustained over time. What’s happening now is simply the market’s way of readjusting

Given that, there’s really only one thing the government should do, nothing:

Rather than delaying the inevitable, the government needs to let this “crisis” play itself out. Yes, it will be painful. People will lose their homes and the housing market will remain depressed for another year, if not longer. But, quite honestly, this is the price to be paid for nearly a decade of an irrationally-rising real estate market and people who bought houses that, notwithstanding the great no-interest loan they could qualify for, they really could not afford.

The likelihood of that happening ? Pretty much zero.

Previous Posts:

How Not To Fix The Subprime Mortgage Crisis
How Not To Fix The Subprime Mortgage Crisis, Part II