Punishment of the Responsible (AKA Minnesota Truth)

Alexis Glick interviewed Congresswoman Michelle Bachman (R-MN) this morning around 8:15am ET and it was a very rare blast of fresh air with regard to the current housing and mortgage crunch.  She has been one of the first representatives to highlight what I have been calling "the punishment of the responsible."   That is, those in America who nothing to do with the problem (housing bubble) but will certainly be on the hook for the solution (bailing out the housing market).

We have heard for many years to be prudent.   To not borrow more than we can afford.   To maximize tax strategies.  To each month put money into the stock and bond markets and forget about it.   This has often been referred to as the safe and smart road.   

It's turning out that in this housing mess, those who took this road are the ones who are paying the price.    All to help rescue the housing market. 

I have no idea how the Fannie Mae and Freddie Mac problems are ultimately going to play out.   I also do not know when housing will recover or when the subprime crisis will end.   What I do know is that we are all going to pay, in one way or another.   It may come in the form of an official government bailout,  a massive equity infusion, or the government privatizing much of the mortgage industry.   But we will pay.   Taxpayers are going to be on the hook for billions, if not trillions.   Many taxpayers who, I might add, had had nothing to do with helping pump up the 5 year housing bubble.

The methods of paying for this "backstop" are few.   There simply aren't that many ways the government can cover the cost, particularly not in this economy.    We have heard a few things from different sides and sources, but nothing is confirmed.   That said, its prudent to compile some of the ideas and why there is a downside to each.   Given this multitude of ideas floating about, this is by no means a complete list and is overly simplistic.    But its a few of the methods we may have to use to cover the potential trillions in costs Rep. Bachman highlights taxpayers are on the hook for, ranked by my opinion of their likelihood:

1. Fed allows Fannie & Freddie to borrow from the discount window

2. Government buys billions in Fannie, Freddie stock

3. Capital gains tax rate increased

4. Income tax rate increased

5. Mortgage interest deduction scaled back

(Numbers 1 and 2 aren't really the 'payment' per se.    They are more like the government's temporary solution, but you get my point).

The issue is that with any or all of the above, it is the responsible taxpayer and investor who is taking the hit.   Those who had nothing to do with housing's run-up are going to pay to help cover its run-down.    They probably already have in one way or another.   Here's how each of the above may end up playing out.   

1. Fed opens its wallet to the mortgage industry by alllowing nearly unlimited borrowing, basically printing more money and helping spike inflation (You pay more for the things you buy)

2. Government spends more (by issuing even more debt) to help the housing market, increasing deficits and driving value of the U.S. dollar down even further (Your spending power goes down)

3. Capital gains tax rate increased to make up for the billions the government has to spend to rescue the the housing market (Your real return on gains in stocks, bonds, assets and dividend payments go down, giving you less on your 'smart and safe' investment)

4. Income tax rate increased to make up for the billions spent as part of any rescue package (If it goes to 39.5% from 35% as Obama favors, families making $250,000/year will pay an extra $11,250 a year in income tax, or nearly $1,000 a month.   This may sound rich to many in middle America, but tell the family mking $250,000/year in the Northeast or Southwest that they are rich)

5. The beloved mortgage interest deduction is scaled back to provide an extra source of revenue for the billions paid out by the government (Though no one has really talked of this much yet and its viewed as sacrosanct, I suspect that in the desperate rush to figure out new revenue sources the government will find little public opposition to lowering the cap on which you can no longer deduct the interest on your mortage.   Currently its $1 million dollars.    How many Americans would complain if thats cut to $750,000 or so?   I can already hear the moving vans loading up in states like New York, New Jersey, Massachusetts and California, especially if this is combined with #4 above)

6. Home prices on average fall nationwide (enough said)

You see the point.   No matter what the 'solution,' it is going to cost.   And its going to cost everyone, regardless if you were a part of the housing boom and bust.   Consider this: an estimated 30% of Americans own their home outright, with no mortgage.   These people felt no need to refinance to buy a new boat, nor 'trade up' to a larger home to show off that 102" flat panel.   They likely instead did what they were taught: squirrel money away each month into stocks and bonds.   Now those stock investments are likely down with the Dow as the market tumbles.   And the value of that house they own and have paid off is probably going to go down.   No one should be more angry than they.

The Administration continues to remark that the "government" will do what it has to do to protect homeowners.   When will anyone (aside from Rep. Bachman) in Congress or the Executive Branch simply tell us what we already know: many people were sold homes and given loans that could not afford them, and now all of America will have to take the hit.

I'm not going to get into a discussion of how we got here.  Whether you want to blame the homebuyers who bought homes they no doubt knew they would have a hard time affording, the mortgage brokers and lenders who assured said homeowner that "don't worry you can affford it and here's how,"  the appraisers who never seemed to believe that prices could actually come down, the late night infomercial hucksters who could 'teach' you make millions flipping homes with no money down if you only send them $29.95 for the instructional DVD, or the government for turning a blind eye to the bubble because no one ever wants to speak up when things seem to be going well.   The point is we are here, and now we have to deal with the consequences.

Bachman took the no doubt unpopular view that despite all the Congressional searching for blame with banks, mortgage companies, lenders, et al, that much of the blame may actually fall at the feet of the American consumer.   It no suprise we haven't Congresspeople who rely on votes of the citizenry are reluctant to ever tell their constituents that they may have been part of the problem.  Its much easier to blame the monster in the closet.   In this case the monster was the lenders, mortgage brokers and even short sellers.   Too bad Congress doesn't have the same problem telling us that we are going to have to help solve the problem.  

The overall economy never really took the hit from the tech stock bubble bursting.  The damage there was largely limited to those with excess income to invest in stocks.   If anything, the economy boomed because of it as Greenspan & Co cut rates, making credit so cheap that housing became the next tech stock.  We merely traded one bubble for another.   The problem is that the popping of this bubble is much more widespread given housing's importance on the economy.    And I dont see any new bubble we can create to delay the pain from this one like we did in 2001.