Mortgage Refinance Plan Will Prolong Economic Agony

The Home Affordable Refinance Program, which was designed to help owners whose mortgages are worth more than the value of their homes, may be changed soon. The plan unveiled by President Barack Obama would allow more Freddie Mac and Fannie Mae loans to be refinanced.

Announced in Las Vegas, the current foreclosure capital of the country, Obama said that the plan is critical to allowing consumers to spend money in the economy again. The plan would apply to loans backed by Fannie or Freddie that were sold by May 31, 2009.

The entire program continues a horrendous economic fallacy that will prolong the inevitable correction and incentivize future bad behavior.

First, it attempts to motivate spending in the economy. We would suggest, of course, that with all the uncertainty in the economy, consumers would pocket the extra cash rather than spend it immediately. But even assuming that they would spend the money, this is the exact opposite course of action that the economy needs. The housing bubble collapsed because of mis-allocated capital; investors responded to lower interest rates, reading them as a sign that consumers were saving for long term purchases (like houses) and began to produce capital-intensive goods. The savings, however, was not real and the resources invested were wasted. There is now a capital shortage in the economy, which is fixed only through savings. Spending should be discouraged.

Second, it encourages borrowers to take out loans regardless of their ability to pay them back or the possibility of fluctuating home prices. The logic will always remain, if enough people do something bad, they will be protected from negative consequences. In this case, they'll be given a reprieve from mortgages that they might not be able to pay back. Further, it sets up an incentive for institutions like Fannie and Freddie to give loans that people can't pay back. If one wants to criticize greedy banks, they should begin by removing the moral hazard that allows banks to be greedy without recourse.

The new plan is misguided and will only prolong the economic agony. By forcing consumers to spend, it extends the period of time that we have to suffer without any capital for real investment (which is what drives economic growth and jobs). By setting up bad moral incentives, it makes future crises inevitable; banks will always mis-allocate capital. If the gamble works, they make a profit. If it fails, the institution will be saved by the government.

Mark Tully is the primary contributor to Restorus.org, a conservative news blog that provides commentary on politics, religion, philosophy, and culture.

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