The Government Hopes the Snakes Can Solve the Lizard Problem

There is a great episode of The Simpsons called "Bart the Mother" where a group of pigeon-eating lizards infests Springfield.   As the townspeople try to do them in, Bart tries to protect his scaly friends and creates a larger problem by allowed the fast-breeding reptiles to run amok.   The town, in it's short-sighted wisdom, decides to solve the lizard problem by unleashing snakes to eat the lizards.   That works for a while, until the town realizes it now has a snake problem.   Never a town to get down, that Springfield, it sets about importing a snake-crushing Gorilla to solve the snake infestation.  The show ends with gorillas in the midst, and the hope of a very cold winter to eradicate what is now a serious primate problem.

The U.S. government is looking a bit like the management of Springfield in the latest housing "rescue" plan.  This plan, floated late today, involves using government might to bring down interest rates to monstrously low levels to stimulate housing demand.  From the Journal:

The Treasury Department is considering a plan to revitalize the U.S. home market that would push down interest rates for loans to purchase a home, according to people familiar with the matter.  The plan, which is in the development stage, would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5%, more than a full point lower than prevailing rates for standard 30-year fixed-rate mortgages.

The message is clear: cheap money helped get us into the mess and cheap money is going to get us out. This idea should be recognized for what it is; the snake to solve the lizard problem.   The solution may do more damage long-term than the current problem.   Pressing artificially low interest rates in the short-term will simply create a generation of homeowners who either can't or will refuse to move because the subsidized interest rates that funded their purchase will vanish, leaving them with no hope of an equal montly payment on a similarly priced home.

The Journal confirms the worst fears by noting that the Treasury is all but admitting it desperately wants to pump back up the housing bubble:

Treasury views this plan as potentially halting the slide in home prices by enabling borrowers to afford bigger loans, thus increasing demand and pushing up home values. The lower interest rates would be available only to borrowers who are buying a home, not those refinancing a mortgage.

Housing is unlike most other asset classes.   Generally it is the absolute price of something that matters most to buyers.  For housing it instead is the monthly nut that makes the difference.    Buyers have historically bought as much home as they can based on the monthly payment.   If a family can afford $2,000 per month on a mortgage, they will tend to buy whatever that $2,000 will get them.   And that $2,000 payment can mean the difference between a $250,000 home and a $400,000 home depending on the interest rate.  It is why home prices boomed in the bubble: low rates made money cheap and buyers could bid up prices because you can get a lot of house at low interest rates.

The lizard in the nest though is that the opposite is also true; as rates rise the monthly payment buys you a lot less house.

The government cannot hold rates down forever.   And when the markets are allowed to work on their own, rates will eventually return to median levels.   As those rates rise, homeowners may literally be stuck in their homes, not able to find a home that can meet their previous monthly payment.   $2,000 goes dramatically less far at 7% then at 4.5%, and home prices will ultimately fall to reflect that.   In "helping" to solve the housing problem, the government may end up actually stranding the new generation of buyers.   Even if they can afford to move, who wants to give up a 4.5% interest rate for a rate that will likely be nearly double that?   Add on another room and stay put, Myrtle, we ain't moving.

Regardless of price predictions there is another pressing issue.  At the core of this it is very simply  impossibly unfair to many American homeowners.   The Journal makes clear that this program would only be available to home buyers and not those who currently own and are looking to refinance.  While refi rates are very favorable right now, they are generally now about 100 basis points (1%) above 4.5% for non-jumbo loans and over 7% for those who buy home over $417,000 (though the "jumbo" home loan amount was raised to $729, 750 until the end of this year).   The government is thus enacting a defacto penalty on those who currently own a home and artifically benefiting buyers.

The government needs to stop being in the business of trying to protect Americans from themselves and let the free market work.  Free markets mean loss as well as gain.   Home prices are down, yes, and may be for some time.  But if the market is not allowed to operate then we will simply continue to postpone the inevitable, sending more losses and bailouts onto future generations.   Someone will eventually have to deal with the gorilla problem once the snakes and lizards are gone.