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Reestablishing the Reality of Risk

During my roundup of the debate post, I took an exception to comments made by Biden in the VP debate and to McCain's new housing plan. Each talked about taking home loans that were on the verge of foreclosure and allowing renegotiation of the terms to lower the interest rate and the principle. I wanted expand on my thoughts in this post.

My issue with Biden and McCain's plans is due to lowering the principle. I have no problem with bankruptcy judges having authority to lower the interest rate on a loan. That makes sense, especially with the predatory lending and the bad loans people took on. Additionally, if banks continue to pay the price for foreclosures the economic crisis will continue for far longer. On the other hand, the thought of people being able to lower the principle owed on their loans is ridiculous. The argument seems to be that since home values have decreased so much, it is only fair to allow people to pay what their home is worth now instead of the agreed upon purchase price. This is frightening to me.

I'm not sure if this has ever been allowed before. I did a search but could not come up with any historical cases. However, I will admit, my research skills may not be up to the task. I could see this happening in the days of the hometown bank when the mortgage stayed with the initial lender. In that case, the borrower would work directly with the loan owner. The resulting agreement would have been beneficial to both parties. Today on the other hand, due in part to deregulation, we don’t know who the loan holder is in most cases. To solve this problem, under either the McCain or Biden proposal the government will step in and renegotiate the terms of the loans. Without the lenders input these negotiations will be one sided, and will benefit the borrowers who didn't educate themselves before making a the purchase. Due to their bad decision, instead of being punished, they will receive a benefit. In the case of someone who purchased a home for $300,000 two years ago, whose house is now worth $250,000, they get the benefit of a $50,000 payment on their principle--for free. Now once the market turns around and that home regains value, they are making an extra $50,000 on the home.

This is unfair to the millions of borrowers who purchased a home they could afford. They will see their neighbors who were on the verge of foreclosure keep their homes. This is a good thing of course, but when they go to sell their home, they will be put in a situation where those around them can afford to chop $50,000 off their selling price without losing money. Responsible borrowers will be punished for their neighbors irresponsibility.

This country is treading down a very dangerous path if we keep bailing out those that make these kinds of mistakes. For a capitalist economy to function we need risk to come with a cost if something goes wrong. And today it's even more important that home buying is included in that. It is unfortunate that Americans spent the last 25 years telling their children that a home is basically at 100% safe investment. It seems most of my generation was taught that you are always better off buying then renting. Unfortunately, that isn’t always true and purchasing a home is a risk. It may have been a safer risk then purchasing stocks for random IPO's but it was still a risk. There is no such thing as a 100% risk free investment. Putting your money in US treasury bonds or into a savings account is close but even that carries a small risk. Unfortunately, as our tax dollars continue to go toward saving those who lose money when taking a risk, we are sending a message to everyone to continue taking on absurd risks without concern. It appears the worse that can happen is falling into taxpayer-funded safety net. Or, even better, in the case of the housing plan that McCain and Biden proposed, a government mandated profit.

I understand that we need work hard at trying to keep people in their homes. With that though we need to impose a level of responsibility on the borrower. They negotiated the purchase price and they signed a contract agreeing to that price. If we can lower their interest rates to something very close to the current market and allow them to keep their homes go for it. If they can't keep their home without lowering the principle, then unfortunately they shouldn't have been in that house to start with. The citizens of this country need to step up and start taking responsibility for the direction we are heading. Let it start with paying back our debts.