Hillary Clinton's Fundamental Misunderstanding of the Mortgage Crisis

Hillary Clinton delivered a major address regarding the economic and more specifically real estate situation today. She said somethings I liked. She wants to appoint a heavyweight economic panel headed up by Alan Greenspan and Robert Rubin. Clinton is a politician not an economist and thus it would do her good to address this deepening crisis with folks that are experts, though one would think her regular cabinet could do the job. That said, she continues to have a fundamental misunderstanding of the mortgage crisis...

Clinton said she supports proposed legislation to establish a federally backed auction system for hundreds of thousands of mortgages in default. Under the Democratic-drafted plan, lenders “could sell mortgages in bulk to banks and other buyers,” Clinton said, and they in turn would “restructure them to make them affordable for families, because they know the government will guarantee them once they’re reworked.”

The Federal Housing Administration “should also stand ready to be a temporary buyer to purchase, restructure, and resell underwater mortgages,” she said.

Clinton said a recently enacted $168 billion stimulus package “did next to nothing to help homeowners and communities struggling with foreclosure.”Clinton also pointed to recent events on Wall Street that she said show there is greater need to focus on homeowners, singling out the Treasury Department’s decision to back the buyout of the Bear Stearns investment bank by J.P. Morgan.

“If the Fed can extend $30 billion to help Bear Stearns address their financial crisis,” Clinton said, “the federal government should provide at least that much emergency help to families and communities to address theirs.”

There are several things that are fundamentally incorrect here. What the Fed did is not entirely unusual. The Fed is the banks' bank. For the Fed to extend credit to procure a transaction that would save a struggling bank is something we should expect the Fed to do. More importantly, Clinton continues to advance the faulty and politically correct narrative that struggling borrowers must be saved in order to save the economy. In my opinion, the exact opposite is true.

Fundamentally, this crisis is as a result of a market that included millions of borrowers that had no business getting loans. The real estate market went out of whack because it included borrowers that should never have gotten loans to begin with. In order to move forward, they must be extracated from the market as soon as possible.

If these folks are offered new terms, several things happen. First, unfit borrowers are allowed to stay in the market. The terms of their loans may in fact be better, but their fitness to receive them remains troubling. Second, and just as troubling, the worst borrowers will be rewarded while borrowers that were responsible will receive no consideration. Loans will be restructured artificially specifically for those that CAN'T pay their mortgage on time now. If you are able to pay on time, you receive no special consideration. This is of course the opposite of what is supposed to happen. Politicians continue to believe that irresponsible behavior can be rewarded with no unintended consequences. That is simply not the case.

Now, there is an important and fundamental difference that must be addressed. First, it is quite crude and frankly inaccurate to call what the Fed did vis a vis Bear Stearns a bailout. In fact, that was not at all what happened. Bear Stearns stock was trading at 150 dollars per share this time last year, and now it is being bought out a a fraction of that. That is hardly a bailout. What the Fed did was provide capitalized backing to JP Morgan, in order for Morgan to buy out Bear Stearns. Markets work in part by having winners for every loser. Stearns over extended itself and nearly went under. As a result, JP Morgan stepped in and bailed it out at a handsome deal for itself. The Fed helped Morgan procure this victory for itself. I keep going back to this quote from a recent Wall Street Journal article...

Where are the speculators, vultures and hedge funds? Where are the big money players willing to buy the exotic but still substantial mortgage-backed securities for which markets have ceased? The Fed's liquidity rush seems only to have convinced them the time is ripe for staying on the sidelines.

In the case of Bear Stearns, it was JP Morgan that acted as the vulture stepping in and buying Stearns at a couple dollars per share when it was just a year ago valued at 150/share. In order for the real estate market to move forward, vultures need to step in and buy up distressed properties at new low values. That isn't going to happen if borrowers are artificially kept in properties at loans they only qualify for because of their poor mortgage performance.

What I say is NOT politically correct and is likely no way to get votes. Unfortunately, the politically correct narrative of protecting borrowers at all costs in my opinion only perpetuates a deepening crisis. While Hillary Clinton means well, she is proposing a solution that is ultimately counter productive and would only deepen the crisis.