Turn on any business related show and you are likely to hear some pundit or so called expert bemoan the potential for mass foreclosures and proclaim that the government must do everything in its power to avoid such a scenario. To pundits and experts like this, mass foreclosures is the worst case scenario to be avoided at all costs. Is this really so?
First, mass foreclosures is the end result of a different problem, mass unqualified borrowers getting loans they can't afford. To avoid foreclosures at all costs is like a lifetime smoker avoiding a heart transplant at all costs. With or without these foreclosures, the underlying problem will remain, large quantities of unqualified borrowers. Some, most namely John McCain, have proposed a reincarnation of the FDR era Homeowner's Loan Corporation. Under such a plan, the government would take over loans from troubled borrowers and provide them with terms they could afford. In fact, FDR's name and policies have often been mentioned in dealing with this crisis. That is unfortunate because in fact, FDR's original policies were, in my opinion, totally ineffective in dealing with the original depression. Eight years after taking office the unemployment rate continued to be just over 10%. We were still in the middle of a depression after two terms of FDR big government policies. Had we not entered WWII, it's unclear when our country would have gotten out of the depression.
Now, some would like the federal government to reinvent the New Deal and the reincarnation of the Homeowner's Loan Corporation is just one of the ways. There are two ways to look at the situation. One way is to see these borrowers as patently an unqualified who desperately need to be removed from the housing market immediately. Another way to look at it is to see these borrowers as generally qualified who had the misfortune of getting into a loan they can't afford. If you believe in the latter, you also likely believe in something like the HOLC, loan modifications, foreclosure moratoriums, and other measures to provide these borrowers with loans they can't get. Those that believe as such must come to grips with this question though. If these borrowers are really in fact qualified why are they in a loan they can't afford? If you believe the latter and expect government to do something about it, then you are taking a massive multi hundred Dollar gamble with tax payer money. If you are wrong, then it will be the government stuck with these bad loans. There is no bailout of a bailout. The government will have to go in and foreclose on these folks.
I am of the opinion that a mass foreclosure will act as a sort of cleansing of the real estate market. There is no doubt that mass foreclosures will devastate real estate prices, but that devastation will be temporary, and once its over, then we will all know we have hit bottom. Then, all of these irresponsible borrowers will be removed and the real estate market will have only those qualified to be in it.
I believe that for the most part these borrowers are simply irresponsible. They got into loans they couldn't afford, and saving them from themselves with new loans that would in effect reward their irresponsibility. This will only encourage these folks to just spend lavishly again. Only, once they get themselves into trouble the next time they will be holding onto government loans.
Think of this with this metaphor. If you have a big bandage covering a huge bruise, you can take it off one of two ways. You can either rip it off quickly and have it hurt immensely for a short period of time, or you can take it off slowly and have it hurt a little for a very long time. I would rather pull the bandage off really quickly. I would rather take whatever pain we have in store and get it done with. The real problem is that saving borrowers may work temporarily. If it is done at the right time, it might even appear to be working just in time for the 2010 election. All those that implement such a plan would likely be rewarded in those elections. Yet, the day of reckoning would come eventually. When that day comes though, it will be a disaster that will make what is happening now seem very mild.
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