Mortgage Bailout Will Hurt Homeowners in Long Run

The answer to the first question looks something like what the president and his top money and housing men offered Thursday. The government's new "teaser freezer" plan would extend for five years the artificially low introductory rates on mortgages made to some buyers with spotty credit between January 2005 and this past July, a period that contained the real-estate market's bubbliest months. A typical such mortgage carries a teaser rate of 7% to 9% for the first two years, and an ordinary rate of 9% to 11% thereafter. Without government intervention, monthly mortgage payments on these loans will increase as much as 30% over the next two and a half years, forcing vulnerable borrowers to fall behind on their payments and lose their houses. The president's plan will keep some of these people in their homes, no question.

But it will also make them poorer. That's because if two percentage points on a mortgage rate decides whether someone can afford to keep their house or not, then they can't afford to keep their house. They're paying too much. By continuing to pay too much, they'll divert their would-be savings to an asset that's likely twice as expensive as it should be right now, and even if it's not, tends to produce poor returns over long time periods.

In April I argued that house prices have swelled since World War II to the point where renting, for most people, now makes far more financial sense than buying. The ratio of house prices to rents has more than doubled during that period, as has the ratio of house prices to incomes. That's because the government has worked in earnest during that time to make houses more affordable by subsidizing down payments. In doing so, it has increased demand, and with it, prices. Ironically, affordability efforts have made houses more expensive than ever before. And we're still pushing them. The Federal Housing Administration still talks about owning a house as a key part of the American Dream, while the less-math-inclined members of my profession still talk about renting as "throwing money down the drain."

I throw money down the drain. I live in a modest apartment in a working-class neighborhood of New York City, despite having enough money to afford a splashy apartment or a house. I do that because I want to keep my monthly housing expense below 10% of my gross income. And I do that because I want to have plenty of money left over each month to buy shares of businesses. The ownership structure of the box I live in has nothing to do with my American Dream, but growing rich does. As I explained back in April, stocks tend to return 7% a year after inflation over long time periods, while houses tend to return zero. So at today's prices, I'm keen on renting the latter while owning the former.

Once upon a time in America, before the FHA, we didn't need the government to intervene in the decision about whether we should buy, or continue to own, houses. Amazingly, most Americans who bought houses at that time didn't need mortgages to do so. That's because prices were much more reasonable. Buyers who did borrow typically put 40% down and borrowed for five years. Those terms are unaffordable for most today, because while things like clothing, cars and food have grown more affordable since World War II, houses have become a bad deal.

But prices are on their way down, and I see that trend continuing for a decade. That's not to say that house prices will fall for a decade straight. In fact, they rarely fall from one year to the next. But I think they'll stay flat for most of the next decade, thereby giving rents and incomes a chance to catch up to historic ratios.

If I'm right, the government isn't doing any favors for recent house buyers who are struggling to afford their payments by guaranteeing that those payments will keep coming at their current pace for five years. It's merely forcing those same homeowners to divert too large a percentage of their income to a no-growth asset, while leaving little or nothing to invest in a fast-growth asset. The government isn't doing that because it's mean. It's doing that because it honestly believes it knows better than its citizens how they should allocate their money. What's particularly sad about that is that the government has overspent its own checking account by $1.6 trillion since 2002, thereby increasing the national debt by as much. On Thursday, struggling homeowners got misguided financial advice from a source that can't even pay its own bills.