On the Conservative Mortgage Crisis Meme

The standard conservative response to the mortgage crisis is about the same as Herbert Hoover's initial response to the Great Depression: do nothing. As George F. Will more or less said on "This Week" last Sunday and wrote in his regular column, the government should not reward people who bet on the upward housing price spiral and lost. In short, they took a risk and they should face the consequences. We're only encouraging more defaults if we do anything to help the dolts who got themselves into trouble.

If only it were so simple.

The housing price rise was stimulated by strong demand for new housing. While a number of factors undoubtedly drove housing prices upward, easier access to credit was surely one of the more important ones. More people had easy access to money so more people had money to spend on buying houses and prices rose.

Credit was made much cheaper--artificially stimulating demand and jacking up housing prices--through several factors, including:

(1) Loans requiring no down payment. People who "buy" homes with these loans start with no equity in their home. If prices decline, it becomes hard to refinance since they already owe more money than the value of their home. Moreover, portions of these loans usually have extra-high rates because of the extra risk.

(2) Lending too much. When I bought a home, I was amazed at how much money lenders were willing give me. Indeed, brokers offered around twice as much debt as I could reasonably expect to service without radical life changes. Since many loans are sold within days of closing, brokers generate income by lending money but feel no long-term responsibility for the ability of the borrowers to service the loan.

(3) Interest-only mortgages. The hot lending instrument of the decades, interest-only loans are tempting because the payments are lower. However, the buyer doesn't acquire an asset as with more traditional mortgages.

(4) Adjustable-rate mortgages (ARMs). Once upon a time, Americans used to almost always buy homes with fixed-rate mortgages. While not as new as interest-only loans, higher prices led a lot more borrowers to turn toward these mortgages because the lower interest rates are more affordable--in the short term. The payments can become much more expensive if interest rates rise, even as modestly as they have recently by historic standards.

(5) The combo platter. Of course, many of the above options were often wrapped into a single loan. As housing prices soared, more Americans sought more complex loans which have turned out to be unaffordable just to get into the game.

I am not sure how government should respond to this crisis in terms of either how to help people in danger of losing their homes or to prevent it in the future. The one measure which strikes me as immediately sensible is eliminating the mortgage-home-interest tax break for new interest-only loans taken out to buy properties of greater value than currently owned by the homeowner since the point of the tax credit is to help people acquire a home.

As we do figure out how to handle this problem, it is important to remember that most people borrowed money to have a place to live--not as a means of cashing in on the country's housing price boom. And the boom made the American dream of owning your home that much riskier. While this doesn't mean that the federal government, or the Federal Reserve, should rush to bail out borrowers or lenders with bad loans, it does mean that the question deserves a far closer look than implied by conservative pundits.