June 24 average daily rates in Orange County for 30-year fixed loans with one-point fee: Conforming up to 6.078%, Jumbo up to 7.446% and Conforming-Jumbo up to 7.208% (Note: conforming-jumbo rates are for loans from $417,000 to $729,750, while conforming is up to $417,000 -- both types are sold to GSEs. Jumbos here are $730,000 or higher and not sold to GSEs.)
Source: Newspaper Chart Services 
The argument against a bailout
September 1st, 2007, 9:46 pm · 11 Comments · posted by Matt Padilla, Register Reporter and Blogger
As the housing slump drags on, some folks, including Bill Gross, the bond guru of Pimco in Newport Beach, have called for a taxpayer-funded bailout of homeowners facing foreclosure. Such compassionate pundits would go beyond President Bush’s modest expansion of the Federal Housing Administration, which will refinance some people who are at least 90 days past due on their mortgages. They would set up a mega fund to buy up delinquent loans and work out new payment plans with borrowers.
Esmael Adibi, director of the A. Gary Anderson Center for Economic Research at Chapman University, is firmly against a bailout. Here’s his take and why, if a recession results from government inaction, that’s not such a bad thing.
Q. What’s wrong with a bailout?
A. “I have no doubt that over the last five years some home buyers bought homes not fully understanding what they were getting into. But at the same time I am confident that a whole bunch of people got loans knowing what they were getting into but they did it anyhow — homes beyond what they could afford. Nonetheless, it is extremely difficult to identify who is who.
When you say bailouts, what politicians are talking about, how are you going to identify those who knew and those who didn’t. Some are saying go cover everyone who is in trouble. I think it’s absolutely the wrong message. It’s saying take extra risk, if you fail, you can expect government to come in and help.
Secondly, the problem is the renters. If honestly you look at the housing market, homeowners are already getting quite a bit of credit from government. First of all mortgage interest is tax deductible, so is property tax. If single you get an exemption from capital gains of $250,000, if you live in the house for two years. And if you are a joint filer, $500,000.
I can see the reason: we want to promote homeownership. But if homeownership is less than 70%, that means 30% of households are renters. Renters don’t receive any equivalent subsidy. The thing about a bailout, it’s saying let’s give a little bit more money to homeowners who knowingly or unknowing got into trouble.”
Adibi also said saving homeowners might aid lenders and investors in securities backed by mortgages.
“There’s no excuse for professionals in this business not knowing what they are getting into. The risk-taking behavior was very prevalent. Some firms made tons of money. … Now we want to save them at the expense of all the renters.”
He added, “If I was a renter, I would scream and shout.”
Q. So, is Gross more interested in Pimco’s bottom line?
A. “No. He’s a very respected person in the financial community. He’s worried that this mess is going to create a huge recession and damage the economy to the extent that it takes a long time to recoup. … His concern is more macro level. I unfortunately do not agree with him at this stage.”
Q. Should the Fed cut the federal funds rate from 5.25 percent?
A. “That was part of the problem with Greenspan — what some called the ‘Greenspan put.’ Every time we got into a financial problem he came in and cut interest rates and supposedly saved the market. In the long run we are paying the price.”
Adibi said he supports cutting rates in response to evidence of an economic slowdown, but not because of financial market gyrations. He said a Fed rate cut might be worthwhile in early 2008. He said Wall Street wants a cut now, in fact more than one.
And he said Greenspan left the federal funds rate at 1 percent too long.
“Then (Fed officials) closed their eyes to what was going on in the mortgage industry.”
Q. How much of a hit is Orange County going to take from the credit crunch?
A. “Orange County is in better shape. We didn’t over build. Unfortunately, there was some fraud. We have to pay a price. My argument is any short-term quick fix will leave a long-term problem.”
Q. Let’s get back to Gross and his concern over recession. Should we take it seriously?
A. “Oh yes. I have even said it.”
He said at this point “some of these big Wall Street firms don’t even know the extent of their losses.”
“If they really pull the plug on lending, we will have a recession. I would say, let it be. We have to go through that painful process. When we come out of it we are going to have a stronger, healthier economy. In economics, I say recession is actually healthy.”
He compared the economy to the human body, which when pushed too hard gets sick and needs to rest.
Q. Some folks call for an expansion of the Federal Housing Administration program, which insures loans and helps get financing to lower-income homebuyers. What do you say? (Note: I asked him this before Friday, when President Bush announced an expansion of FHA.)
A. “FHA is not going to be much help in markets such as ours. The FHA limit is so low. It’s going to help some areas of the country.”
(Note: Bush proposes expanding the FHA limit from $362,790 to $417,000.)
Q. What about Fannie Mae and Freddie Mac?
A. “In 2002 and 2003, they started getting some risky mortgages. They felt they were behind the curve. Now the problem is some people are pushing them to raise the limit on the size of their portfolios and some are pushing to raise the conforming limit above $417,000. I am not familiar with their portfolios or balance sheets, but I know these two agencies started giving adjustable, Alt-A and even subprime loans. If these two get somehow into trouble, we are going to be in for a huge problem.”
Q. What’s wrong with raising the conforming limit for people with good credit?
A. He said if the housing decline continues even good-credit borrowers will get into trouble down the road. That will hit the profitability and balance sheets of Fannie and Freddie. Raising the conforming limit would expose their balance sheets to more risk, he said.
And he said the picture is especially hazy with Freddie Mac, which was forced to restate $5 billion in earnings after an accounting scandal. “We don’t even know how much trash is on their balance sheet.”
(Note: This week Freddie posted a 45 percent drop in second-quarter net income as it set aside $320 million for loan losses.)
September 2nd, 2007 at 9:08 am
It is good to read a calm, well reasoned argument against a bailout.
Let’s hope reasonable voices prevail, rather than painting some bogeyman “depression” to justify a Bernanke put bailout.
September 2nd, 2007 at 9:11 am
Also, let’s not forget the renter ratio that Mr. Adibi uses is a nationwide one.
There homeowership rate is lower in SoCal and OC.
Not to mention those true homeowners with no mortgage why should their tax dollars support a bailout.
Between the renters and true (no mortgage) homeowners that is a majority.
Why would a politician want to anger a majority of the populace?
That doesn’t seem to enhance the prospect of holding onto political power.
September 2nd, 2007 at 9:45 am
I agree with him 100%
A recession would not be all bad and when you have excess you need a period where pain is felt. Hopefully the pain wont be too bad but I like the fact that someone understands the concerns over renters
September 2nd, 2007 at 9:50 am
Recession is scary and they want to plant fear in you. Housing market is full of scam, greed, and fraud. FHA will buy these exotic loans back from Lenders and Banks with your tax money.
Rich getting richer. Renters end up paying for all the fun. Housing needs a healthy correction. No Bail Out.
September 2nd, 2007 at 10:09 am
My arguement against it is still affordability. The market needs a correction to bring prices down to closer match incomes. I believe something like 30% of the homes are seconcd homes or homes owned by investors. Are they going to bail these people out too?
If prices become more sustainable than more families will be helped since they will be able to buy and enjoy the tax breaks that homeowners already have.
As a single, childless, renter, I am hit harder with taxes than most. I dont want to see what is nearly 30% of my income go to supporting those who I think knowingly purchased something they could not afford, while I waited and saved what I could to hopefully buy something I could.
If the rise in home prices return to the 10% or more a year leap and incomes dont keep up, you get into a situation where many feel the American dream is unatainable. It begins to discourage the desire to get educated and work hard if you feel that you will always be a renter. It almost seems that the government wants to maintain a certain balance of renters to home owners. This keeps a certain tax base going. It discourages saving and encourages spending on frivilous items since home ownership is out of reach.
Let the markets correct themselves and lets get back to reality.
September 2nd, 2007 at 11:43 am
A reasonable and balanced view from someone who doesn’t have to pander for votes and truely understands economics. Thank you Mr. Adibi.
September 2nd, 2007 at 1:22 pm
[…] Padilla’s Blog over at the OC Register, Mortgage Insider, had a good interview with Esmael Adibi, director of the A. Gary Anderson Center for Economic Research at Chapman […]
September 3rd, 2007 at 4:22 pm
I would like Mr. Adibi to more fully address the “Fannie/Freddie” issue. Surely it would more equitable if those twins were as kind to California (and New York) as they are to the low cost areas of the country. If their protective umbrella were extended to credit worthy borrowers in high cost areas, why wouldn’t that LOWER their risk? Getting paid back on big loans has to beat the socks off eating a bunch of failed “conforming” loans from the rust belt. How about it people? Why should the heartland be entitled to what is in effect a free (to them) government mortgage interest benefit, while the more heavily taxed states (us) have to pay extra, just because the loans here are bigger?
September 4th, 2007 at 12:57 pm
Some voice of sanity.
All these guys proposing a bailout want to do it with someone else’s money. They are terribly misguided. Last weekend, the San Jose Mercury News had some non-sensical editorial which is so representative of this. Here’s the link, and my response/comments to it:
http://www.mercurynews.com/opinion/ci_6785658?nclick_check=1
–
I have my head shaking in disbelief about the lack of financial literacy at the Mercury News Editorial board, and a lack of appreciation for the fundamental unfairness that debt fueled high housing prices represent for savers, and responsible buyers.
The elephant in the house is the high housing prices. Any analysis that doesn’t recognize the fact that housing prices have been inflated to the stratosphere and need to come back to earth will be terribly flawed and this editorial is a prime example of that.
The mortgage situation is not a mess NOW, it has been a terrible mess for the last 7 years. It is only now beginning to come back to have some semblance of normalcy and reflect the fact that a home cannot be bought with free money, but needs to be financed responsibly with the buyer assuming a significant risk.
Homes across the country are terribly overpriced, perhaps to the tune of 20-50%, especially so in the bay area. No amount of hand-wringing and pseudo-analysis will alter the fact that home prices NEED to come down for a sustainable future where young families have a chance at owning a home without becoming debt slaves to exotic, monstrous mortgages.
Inflated home prices represent an unjustified transfer of wealth from the buyers to home-owners, nothing else. None of this wealth was earned, so the sellers are not “entitled” to this wealth, which is usually the underlying assumption by a lot of people, including the current Mercury News Editorial Board (which for sure is perhaps 100% home-owners).
Mercury News Editorial board: Can you please recognize high home prices as the problem #1? Not “falling property values”?
In any of your analysis, can you try to keep in mind that the goal should be reasonable home prices, not propping up inflated home prices at taxpayer and savers’ expense?
We didn’t see any significant editorial board discontent over the years with mortgage players’ malfeasance causing unfair home price inflation (”appreciation” to the cheerleaders). Now that market forces are bringing some semblance of discipline, people are begging for bailouts and trying to raid the taxpayer and savers and trying to shortcut a much needed correction.
–
September 4th, 2007 at 9:36 pm
The problem of the Greenspam PUT was that through the years it has allowed to much excess.
I relate this to fighting forest fires like we have the last 40-50 years. We now have to many trees in the forests of the West and every fire we get is huge intense and hard to recover from. Its natural for fire to burn the forest occasionally to thin the trees and keep them healthy. Look what happened in Yellowstone a few years back that huge fire was like an economic Depression caused by foolish intervention. Best to let nature takes its course and weed out the weak.
September 4th, 2007 at 11:08 pm
any government “bail out” would be counter- capitolistic - the market
must correct itself otherwise we are no different than a socialist
banana republic- a “bail-out” essentially says hey its OK to do
do anything you wish and if its fails the government will bail you out-
they would in essence be trying to manipulate the housing market
that my friends would have counter productive longer term consequences on our entire economic foundation– there is no
easy way out of this pain is merely weakness leaving the body-
NEXT UP ALT-A AND HER PAIN
http://www.fool.com/investing/dividends-income/2007/09/04/the-worst-is-yet-to-come.aspx