Delaying the inevitable

On the one hand, soaring foreclosures unduly punish the housing market, pushing prices lower quickly as banks dump homes at fire sale prices to clear their growing inventory. The broader economy suffers more than it might otherwise because, as never before, economic prosperity in America is based on rising asset prices rather than the production of goods and services.

When asset prices stop rising and then reverse, economic pain is the result.

When combined with a genuine attempt to right a wrong, where unwitting home buyers were "duped" into buying real estate at unfavorable terms in recent years and now see their payments go up as home prices go down, one could argue that recent initiatives to stem the tide of foreclosures by preventing these loans from adjusting upward make some sense.

But on the other hand, "bailing out" homeowners now living in houses that they really can't afford would be one of the greatest moral hazards in U.S. history and, over the long-term, would surely confirm what much of the rest of the world already senses - that the U.S. is a nation in serious decline.

Along with clear signals that the Federal Reserve is open to lower interest rates when they meet next week, yesterday's Treasury Department-led meeting of the minds on the mortgage mess provides more evidence that the plunging confidence of consumers is solidly based on fundamentals.

Not the fundamentals they know, such as rising energy prices and falling home prices, but the fundamental illness of the American economy and the darkening outlook for its long-term future.

In another era, policymakers might say, "Everyone made mistakes, everyone should suffer - lenders, investors, and borrowers alike. In the end, we'll all be better off".

Today, what they're really saying is, "We can't let asset prices fall - rising asset prices are the basis for the contemporary American way of life. We can't take that pain".

The Wall Street Journal reports($) on the attempt to keep unaffordable homes affordable for a little while longer:

The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans, according to people familiar with the negotiations.
...
The plan is being negotiated between regulators including the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp. People familiar with the talks say the individual members have agreed to follow any agreement reached by the coalition, which is called the Hope Now Alliance.

Maybe they should call it the "Hope for Higher Home Prices Alliance" or, a more modest suggestion might be, the "Hope that Home Prices Don't Fall Too Far Alliance".

If the plan is successful, look for it to be next applied to option adjustable rate (negative amortization) loans where buyers unwittingly secured a lower monthly payment by not only deferring all principle payments on the loan but by not even paying the accrued monthly interest.

And then in 2010, holders of Alt-A loans, who unwittingly stated much higher incomes in order to get into a house that might have made them a small fortune if only real estate prices would have kept going up, well, they might see some relief as well.

The rest of the world must be looking at the U.S. government and its spendthrift citizens in disbelief.

They're also probably looking again at the U.S. dollar and wondering about its fate.

According to the WSJ story, Treasury Secretary Hank Paulson commented, "If I ever saw a role for government, it is...to bring the private sector together when innovation has really outrun our ability to deal with it."

Yeah, that's the real problem here.

The reason for all the recent "turbulence" is that we, as a nation, are just too damn innovative (see yesterday's post on "turbulence" which was followed by two more "turbulence" sightings later in the day from Fed Chief Ben Bernanke and Treasurer Anna Escobedo Cabral).

This Bloomberg report indicates that the proposed loan modifications include "letting borrowers with adjustable-rate subprime mortgages, who are living in their homes and unable to afford resets, get extensions on the starter rate for at least five years. They could also be offered 30-year fixed-rate loans. (Office of Thrift Supervision Director John) Reich prefers a three-year freeze."

Yeah, the 30-year fixed loan at current rates will be a real popular option.

Isn't this just delaying the inevitable?