In Response to Charley and Dalton

Flickr Creative Commons, NTD Barrage Ballon, Nevada Test Site ACE-57-5806

I posted on Facebook No Skin in the Game which was a copy of an August 14, 2000 press release from Wells Fargo posted on Cafe Hayek this week.

Dalton and Charley seem to be concerned about the age of the article. My purpose in posting the article was to illustrate the concept of risk and what happens when the concept of risk and loss are removed from the equation.

Wells Fargo was touting a then-new loan program subsidized by California Housing Loan Insurance Fund (CaHLIF) and Freddie Mac, which allowed teachers working within the state to purchase a home with a minimal down payment of just $500. Who could be against helping teachers?

At the time a new California teacher was earning an average of $29,000/year and the average wage for an experienced teacher was $44,000/year. In a state like California these wages certainly make it difficult for a single teacher to purchase a home.

Frankly, the wages seem reasonable for 9 months of work per year. I also presume that teachers get married and have spouses that work. But, The California State Government came to save the day by providing taxpayer-funded subsidies, with the help of Freddie Mac (Federal Money).

Why I don’t like these programs

When government subsidizes programs like this it implicitly places a bet that the value of the asset purchased will always exceed the debt incurred to purchase the asset.  The bet they are placing is with your children’s future income stream. They don’t tax us now to pay, they borrow the funds from the China, India, and other foreign entities. Taxing you now might raise questions of fairness and cost.

Over the past two years the housing bubble caused by programs like this (there are many) like all bubbles, burst.  I would argue that the Federal Government sigificantly contributed to the run-up in housing prices, well beyond what would have happened under normal circumstances.

Many homes purchased in the last 5 years are now worth much less than the debt incurred to fund the purchase.  Buyers who took the plunge facing the double whammy of the loss on the value of their home and a higher monthly payment due to escalation clauses in the mortgage loan contracts they knowingly signed.

These higher payments are not the result of increasing market interest rates. They were built into the original loan. In other words…by contract the borrower had to know the payments were scheduled to increase at a specific future date.  These borrowers now face two options. 1) continue to pay for the home based on the original contract agreement or 2) default on the loan, walk away from the house and rent some place to live at a much lower cost.

Of course, that would be very difficult choice to make if you invested $10,000 of you own money in the down payment.  But, if you original down payment was subsidized by the Federal Government these borrowers have a less painful set of circumstances to consider.

Many borrowers faced with the reality that they can’t afford the scheduled price increase and the drastically reduced value of their “investment” decided to default on their loans.   The media seem to think this is a phenomena confined to Subprime Mortgages. It’s not.

No Skin In the Game is a term that I used to hear bankers apply in the evaluation of business acquisitions. Bankers always want the buyer to invest a signicant sum of their own money. They know this insures a form of “committment” on the buyers part because the cost of failure is jointly shared by the borrower.

When government takes the skin of the borrower out of the equation the risk of loss is sharply diminished.

I believe without question Federal Government subsidies work. When the government gives away money, people spend it. But, this comes at a cost. We get more of something than market demand would ordinarily produce.  To continue to support the inflated value of housing, more subsidies are required. A cycle emerges that is economically unsound.

It’s easy to blame greedy bankers. The real problem is government meddling in the marketplace. Banks are “too big to fail,” so the government uses more of your children’s money to bail them out.

When will it end?

The Federal Government creates nothing of value. It reallocates. In most cases during the last 40 years your government has chosen to pay for it reallocation using funds borrowed from future generations.  That’s a cowardly act. Our children don’t have a voice today.

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One thought on “In Response to Charley and Dalton

  1. Announcing is one thing; closing loans is another. Why assume any loans were actually made under the program? You should call Wells Fargo or the California insurance fund to find out.

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