Posted by Davy Bui on November 30th, 2007 in Gurus, Market Commentary, Politics

Wall Street is giddy with rumors of some sort of deal pending from the Treasury with mortgage lenders regarding the freezing of subprime mortgage resets. There’s a common sentiment among free-market conservatives that when government tries to fix something, they generally make it worse. I’m not a conservative but I’ve got to go agree in this case.

Let’s disregard moral hazard, which has always been a fiction for as long as man has existed. Might has always created right.

Two immediate problems:

1. Can they do it on a meaningful scale? They’d have to bail out enough people that home values stabilize at elevated levels; otherwise, the continuing fire sales in home inventory will drag down real estate values regardless of whether you’re paying your mortgage or not.

2. The Plankton Theory. Bill Gross has written about this in regards to the housing market. If the government artificially supports the massive housing market, it will only prolong the cycle. This is probably the last thing anyone with any amount of sense should wish for. If home prices stay artificially elevated (since government is preventing the subprime mess from clearing) and mortgages become more expensive (as investors and lenders mark up future mortgages to compensate for the previous ones they are now getting screwed on due to the freeze), then you will keep smart first-time homebuyers out of the market. There are hardly any dumb ones left because they are currently the people being kept afloat by the bailout plan. Without the entry of the “plankton” homebuyers, the whole market just stagnates. It’s also possible that the homebuilders’ misery will be prolonged as the cycle drags out.

Not to mention the knock-on effects this will have on consumer spending (how would you feel if you spent the next ten years of your life paying down negative equity?), etc. Just a mess all the way around and it probably won’t work, to boot.