Fiscal Discipline at All Levels of Society Is Answer to Mortgage Crisis

Published October 8, 2008

As I write this, I have already lost more than $7,000 in my retirement accounts and $5,000 in my children’s education accounts due to the financial meltdown. It appears the bailout will cost me approximately $6,500 in additional taxes, and there appears to be no end in sight. This is rapidly becoming an extremely costly exercise, and although I am only adequately educated in the area of finance–and that education came from the school of hard knocks–I am annoyed and beginning to get very nervous. My guess is that I represent middle-America today.

We have turned ourselves into a nation of debtors, with no fiscal discipline and no grasp of self-reliance in savings. Like drug addicts, our natural reaction is to ask Uncle Sam for a fix or a handout as we suffer the pangs of withdrawal from our habit of borrowing. The loans through Fannie Mae and Freddie Mac to low-income borrowers seemed the charitable thing to do during a time of plenty, but without the fiscal discipline to pull back the reins when the signs became readily apparent a few years ago, it was yet another lending program run amuck.

Like any addict who truly wants to kick the habit, we are going to have to learn that the only way out of this mess is to make some very difficult choices and take the hard path back to self reliance.

Our crisis today is not that we will suffer losses financially; it is that we will sacrifice free enterprise in a perverse attempt to hang onto our borrowing habit. Government regulations, subsidies, and tax policies led to bad mortgages, which led to bad investments, which led to the creation of bad financial instruments, which led to a housing bubble, which finally led to a systemic market failure. Any response to this crisis is going to require a multi-pronged approach that we can use individually and as a nation to pick ourselves back up.

First, we must develop a succinct and accurate definition of the crisis. We have to understand the links between the bad mortgages, government programs, and international markets before we can prescribe a fix. Certainly, the market has to clear itself of its problems, and we cannot and should not interfere with that natural process lest we cause further complications and a delay in the recovery. Each day we identify a new part of the financial quagmire that has yet to be fully revealed.

Changes in the regulations three days before the bailout enabled Wells Fargo to bid on Wachovia without using government funds. The bailout included funds for Citibank to purchase Wachovia. Hence, the government is interfering with major transactions or deals in a rush to act, costing the taxpayers more money. The politicians did not show courage in action; instead, they demonstrated cowardice by reacting too soon, to preserve their own jobs and perhaps their own investments. They demonstrated a lack of trust in a system they have vowed to protect.

Second, there must be transparency in any and all actions. The lender, purchaser, or borrower should know everything about the transaction, the investment, the details of the financial instruments, and who owns what. If the mortgage or asset is sold, the borrower should be notified immediately if there are any changes in the terms. Any government action should be readily transparent, posted on the Web for all to see, and any potential conflicts of interest posted or disclosed. Generally, investment firms send out quarterly statements in the mail, thus notifying their customers well after the fact of any upturns or downturns in their investments. A better practice would be to notify consumers on at least a monthly basis of the activities in their accounts.

Third, there must be accountability. Now is the time for an investigation and an analysis of the current rules and regulations. It appears there has been fraud and market manipulation, and relaxing of restrictions or best management practices in accounting. Once the problems have been identified, consequences must be imposed. No large-scale bonuses for CEOs or financial officers of investment firms or banks that require government funding to get out of the financial mess. Sanctions, fines, and jail time should be imposed in accordance with current law.

Fourth, in determining government’s role in all of this, we must first look to the U.S. Constitution. Treasury Secretary Paulson’s request for an expansion of government goes far beyond the authorities granted to the executive branch of government under the Constitution. Any new appointments or resignations of officials should be viewed with a discerning eye to scour for any breach of authority or conflict of interest between the personal holdings or financial interests that may be at stake.

In reviewing the role of government, perhaps there is a need for consideration for a safe harbor for citizens who may choose to move their assets or savings from the failing marketplace until they feel confident again. As in treating some other addictions, perhaps there are some measures that could ease the pain of withdrawal and move more quickly to recovery. Is there a real moral hazard in raising a governmental guarantee for the banks to enable people to deposit their investments safely until the market is functioning appropriately again?

Such a safe harbor would allow freedom of choice for consumers who feel trapped in the market and want to preserve what they can during any coming downturn. When the markets improve and consumer confidence increases, they will ease back into the market without a fear of losing everything. The government could waive the tax penalty of withdrawing retirement funds early if depositors are concerned about a crashing market and wish to deposit the funds into their savings accounts.

Another possible reform would be to eliminate false markets such as the Chicago Climate Exchange. It is but another poor example of a faulty financial instrument that has no basis in property rights and no firm accounting methodology, operating outside of market constraints.

It’s also important to look at state and local factors. As Heartland Institute Senior Fellow Wendell Cox has noted, overzealous land use regulations escalated housing prices in many major metropolitan areas around the country, by cutting the housing supply. Since 2000, fully 85 percent of the escalation in housing costs relative to incomes was in the 25 most restrictive land markets, which comprise only 30 percent of the population. The governments that instituted these policies should be made to pay for the losses they caused.

Tax cuts and spending cuts are going to be imperative on the part of the government to disseminate cash to the population for use in the market in the near future and long term. That will be the most painful part of ending the borrowing habit by consumers and by the paternal government. The era of enabling poor choices has to end, but like all bad habits, it will not go quietly.

Finally, we must have the courage to let a recession happen if it must. Bad ideas lead to bad results, and we will not learn from the policy mistakes that caused this disaster unless we accept the need to pay the price for them now instead of papering over the problems and suffering a worse catastrophe later. A growing economy depends on our ability to show the courage to learn from our mistakes and reap the rewards of good fiscal discipline at all levels of government and society.

Sandy Liddy Bourne ([email protected]) is vice president for policy and strategy at The Heartland Institute.