Subprime Rate Freeze: A Force Fed Solution?

Published December 13, 2007

The subprime mortgage crisis has affected the overall economy as well as the lives of individual people nationwide. Families from coast to coast have been forced out of their homes by escalating interest rates on mortgages they no longer can afford.

Nowhere is this clearer than in Chicago, where the foreclosure rate is among the highest in the country. Recent studies have shown the subprime crisis reaches far beyond poorer families, affecting middle-income households at an increasing rate.

Politicians and the public have placed the blame largely on the mortgage and lending industries. Many articles in the Chicago Tribune and other newspapers across the country have documented lender abuse, citing instances where minorities and seniors have been targeted and exploited through predatory loans. Many predatory lenders have suffered the consequences of their own actions as the real estate bubble has burst.

The Bush administration is attempting to address the public’s concerns with what appears to be a simple and obvious response: an interest rate freeze on adjustable-rate mortgages (ARMs). The freeze is intended to help borrowers struggling under growing mortgage payments stave off foreclosure. It essentially allows borrowers to break their contracts and stop their interest rates from increasing as scheduled and previously agreed upon.

The initial reaction to the plan from the media and the public is to argue over who would be eligible for the freeze and ask whether the plan goes far enough. They are missing the forest for the trees.

The reality of the problem is nowhere near as simple as either the Bush administration or the press makes it out to be. The rate freeze proposal ignores the fundamental causes of the subprime crisis.

The 2001-2006 housing boom rose out of an irresponsible Federal Reserve policy that artificially and dramatically pushed interest rates to historic lows. That led to an explosion of building activity and a dramatic increase in housing prices.

Many people began to see buying a house not as a long-term investment, but as a get-rich-quick opportunity. Encouraged by the freewheeling Fed policy, many lenders and borrowers began to take on increasing amounts of risk, including a tremendous expansion in loans with low, or even zero, down payments, and subprime lending. The current crisis simply reflects an end to the euphoria and a return to economic reality.

Those who made bad investments during the heady times will presumably learn from them and be more cautious–and hence better–investors in the future. But that will happen only if the government doesn’t bail them out. A rate freeze would serve to embolden homeowners and investors to make even worse decisions in the future, knowing no president will allow them to lose their houses just because they cannot afford to pay for them.

To oppose a rate freeze is not an argument for the status quo. It is clear certain steps need to be taken to address the growing subprime mortgage crisis. However, responses should be made within the lending market, with economic considerations in mind.

Foreclosures are costly for all parties involved, and it is in the interests of both lenders and borrowers to try to make existing loans work or refinance as necessary. If falling consumer demand forces changes in the lending market, those changes will be a result of people’s choices and will thus undoubtedly be the best alternative for both lenders and home buyers.

Government mandates, by contrast, reduce the supply of whatever is being regulated, so freezing interest rates will make mortgages more costly for future home buyers. Coercing lenders to freeze rates is a sure way to worsen the current situation.

The solution to our housing market woes will come only when we recognize and address the root causes of the housing boom, most importantly the artificially low interest rate stimulus still being pursued by the Federal Reserve. A sound recovery will come only through the establishment of a long-term policy that practices government restraint and a return to sound market fundamentals.

Knee-jerk government intervention in private agreements is the last thing we need during a crisis.

Matthew Glans ([email protected]) is a legislative specialist for The Heartland Institute.