The Conservative Nanny State Strikes Again

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Dean Baker
TPMCafé, June 10, 2010

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The supposed free market fundamentalists are once again running to get a helping hand from Big Government. Apparently, the Republicans are outraged over the fact that many homeowners are now "strategically defaulting" on their mortgages. They have stopped paying a mortgage even though they can still afford the payment because they decided that they would be better off just giving the house back to the bank. There have been some press accounts talking about strategic defaulters who have used their savings to buy a new car or even take a trip to Europe.

This has outraged Republicans in Congress. They have now proposed a bill to have the government punish strategic defaulters by denying them the option to receive a loan insured by the Federal Housing Authority (FHA).

It is important to get some perspective on the issue here. Strategic defaulters are following the terms of their contracts to the letter.

The mortgage contract requires a homeowner to pay a mortgage in order to stay in possession of the house. The penalty for not paying the mortgage is that the bank gets to retake the house.

Banks know (or are supposed to know) when they issue a mortgage that there is some probability that the homeowner will not repay the mortgage. One of the reasons that homeowners may not repay the mortgage, and cause the banks to lose money, is that the home falls in value. Banks should have incorporated this risk into the interest rate they charged on the mortgage.

Since nationwide house prices have fallen 30 percent since the peak of the bubble, and much more in some areas, there are millions of homeowners who would do better by turning over their home to the bank than by continuing to pay their mortgage. Now many homeowners are taking advantage of this option to the detriment of the banks or other holders of the mortgage.

Rather than respecting the sanctity of contract, the Republicans want to punish homeowners who look out for their own best interest and strategically default. Hence they want to prohibit them from later getting a loan that is insured by the FHA. Who knows what other sanction they may look to impose. Maybe they will also prohibit strategically defaulters from getting a loan through the Small Business Administration or allowing their children to getting a government guaranteed student loan.

It is worth noting that strategic default is a standard business practice. There was recently an incident in which Morgan Stanley strategically defaulted on the mortgage of a large property in its possession, deciding it was better just to turn it back to the lenders. There haven't been any calls by the Republicans in Congress for punishing Morgan Stanley - say by banning them it from government contracts.

We also have to look at this issue from the other side. Do we think that bankers are too stupid to understand contracts? Do Citigroup and J.P. Morgan need the government to hold their hand when they issue a mortgage, making sure that these banks fully understand the terms of the contract that they have issued? Maybe the government should require that all mortgage contracts are written in big type and simple language so that highly paid bank executives will understand the terms of the mortgages that they are selling.

Actually, the Republicans are doing the country a valuable service by showing us in the clearest possible terms that they couldn't give flying f*** about the "free market." They are about redistributing income upward. If they can rig the rules of the market to get the income flowing upward, that's great. But, if it takes the big hand of big government to make sure that the money goes to their friends, then they have no qualms about going this route also.

The truly remarkable part of the story is that so many progressives feel obligated to do the Republicans' work by attacking them as "free market fundamentalists." People who want to use the government to change the terms of a contract after the fact to help banks have no interest in the free market. These people are about taking money from everyone else and giving it to the rich: end of story.

Progressives do these Republicans an enormous favor by calling them "free market fundamentalists." It is far better to be acting in the name of a belief in the free market than to be acting in the service of the rich. The Republicans are clearly doing the latter, progressives should stop telling people that their actions have anything to do with a principled commitment to market outcomes.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.