Imagine that you live in an area that gets its water from a community well. We used to have a lot of them around here. Imagine also that the community also has one neighbor who chronically overexplores the effects of fermented beverages. We’ve had some of them, too.
One night, said neighbor, stumbling around, somehow manages to fall into the community well. In his current state, he cannot do much for himself and needs others to help him get out. It won’t be easy.
Morality and ethics demand that you haul him out, but some neighbors might be forgiven for their initial reaction: he got himself in there; let him rescue himself — or not. Still, if you leave him there, the well will be ruined, and you will have to endure weeks without water in addition to the expense and uncertainty of digging another well. Self-interest would suggest that the community get him out as soon as possible.
America seems divided on what should be done about the subprime mortgage mess. The initial reaction of many people was to let the market deal with it, and strong elements of that feeling remain today. Others feel compassion for those who have lost, or are at risk of losing, their homes, a compassion fueled in no small part by the belief that many of the homeowners were victims of predatory or deceptive lending practices.
While the terms are often used interchangeably, there is a difference between the two types of lending. Predatory lending is generally defined as a loan situation in which the lender profits from the loan’s likely default. Deceptive lending involves practices that conceal the real costs and risks of borrowing.
The losses booked so far by financial institutions are testimony that predatory lending was not a major factor in the subprime mess. Greed, stupidity and deception were in abundance, but actual predation was rare.
While we can agree that deception was the prime factor, we can still argue over whether deceptive lending, self-deceptive borrowing or deceptive marketing of the mortgages that resulted was more at fault.
Fortunately, our self-interest suggests that it doesn’t really matter much right now. The argument over fault bears a close resemblance to debating whether your well-dwelling neighbor is down there because of too much beer or too much whiskey. If we do not act soon, our well, the American economy, will suffer serious damage.
It is far more important to make a decision on what to do, but, unfortunately, that is what neither the regulators nor Congress seems to be capable of. The subprime mortgage problem was visible at least three years ago, and we did nothing. We have endured successive credit crunches this year, and we still did essentially nothing other than adding liquidity to the financial system in the hope that the problem would go away.
Now, we have a plan. More accurately, we have another plan. The previous plan, which involved a bank-underwritten rescue fund, seems to be pretty much melting away.
Ironically, by the time this latest plan is put into effect, we may have already seen the worst of the subprime crisis. Lawrence Yun, the chief economist for the National Association of Realtors, is encouraged by the increase in its Index of Pending Sales. It wasn’t a particularly large increase, certainly not enough to offset the overall declines of the past year, but it meant two successive months of improvement.
Yun believes the worst effects of the August credit crunch have worked their way through the housing market, and he expects the sales of existing homes to continue to improve throughout the coming year.
The Bush administration’s latest plan is, remarkably, a voluntary one based on self-interest. The mortgage lenders, a “leave-him-in-the-well” crowd if there ever was one, were persuaded to freeze mortgage rates — for homeowners who can continue to make their existing mortgage payments but who would default if held to the rising payments called for in their mortgage contracts.
The plan, announced by President Bush, has taken some heat from both sides. There are those who believe it interferes too much with free markets and those who believe it doesn’t interfere enough. From an economic standpoint, the administration’s latest plan has the merit of implementing the lenders’ self-interest — which at least gives it a chance of succeeding in its modest goal of heading off a disastrous glut of foreclosed homes on the housing market.
Given the possibility that the subprime storm may have peaked, it makes sense to cushion its effects so our economy can move forward without dragging a dead weight behind it. And it sure beats standing around the well arguing about what to do.
James McCusker is a Bothell economist, educator and consultant. He also writes Business 101 monthly for the Snohomish County Business Journal.
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