Tracing consequences both seen and unseen.
Christine Harbin“Homeowner” Bailouts and their Unintended Consequences
Posted at 10:16 pm on April 3, 2010, by Christine Harbin

In an op-ed published on Thursday, the editorial board at the Wall Street Journal criticizes Washington’s latest attempt to bail out homeowners. They argue that this intervention will be as ineffectual as the those that preceded it, and that homeowners would be better off if the government hadn’t intervened. From the editorial:

Here’s a heretical thought: What if Washington had simply let housing prices fall on their own to find their natural bottom? The pain would have been more severe more quickly for some owners who bought more expensive homes than they could afford. But the pain might also be over by now as housing markets cleared faster, and housing might be contributing to a healthier economic expansion.

The practice of bailing out homeowners has several unintended negative consequences. The following are among the most egregious, in my opinion.

(1) Bailouts discourage employment.

Just like any other type of unemployment benefit, payments to homeowners decrease an individual’s incentive to be employed. This contributes to a higher and longer-lasting unemployment rate.

(2) They penalize individuals who borrowed responsibly, and they encourage people to live outside of their means.

Why put 20% down for a cramped ranch-style when you could buy a McMansion and have the taxpayers pay for it?

(3) Many people bought houses that they couldn’t afford anyway, and they will foreclose on them in the future. For many people, a bailout is just delaying the inevitable.

As described in a relatively recent article in the New York Times:

As a result [of Obama’s Making Home Affordable program], desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies.

(4) They cause housing prices to be artificially high.

Here is a Washington Post article on the subject. The latest proposal, like many of its predecessors, inflates home prices. Additionally, the $8000 homeowner tax credit allowed individuals to buy a more expensive house than they could otherwise afford.

(5) There is a moral hazard problem. If a person knows that they are likely to be bailed out, then they are more likely to assume risk.

I oppose bailing out people who bought houses that they couldn’t afford, and I disagree that the government should encourage homeownership. When a person invests her money, she assumes risk. Higher returns are supposed to be the payoff for accepting larger amounts of risk. Buying a house is just like any other investment outside of Treasury Bonds — there is a possibility that the individual will lose money. In some aspects, real estate is riskier than stocks because houses are not diversified (i.e., in the event of a natural disaster, a person’s entire investment is wiped out). A person should do thorough research before she makes what will be one of the largest financial decisions of her life.

I recommend the article “5 myths about home sweet homeownership” by Joseph Gyourko, chairman of the real estate department at the University of Pennsylvania, in the Washington Post. It repudiates the commonly-held idea that homeownership is a investment that has good returns and no risks. To me, the following is the most eye-opening statistic in the article:

Between 1975 and 2008, the price for houses of comparable quality and size appreciated an average of about 1 percent per year after inflation. You would have earned well over 2 percent per year after inflation had you invested in Treasury bills over the same period.

[Cross-posted at Amateur Philosophy.]


Filed under: Government Spending, Market Efficiency, Uncategorized, Unintended Consequences
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Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson
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