Let Sleeping Dogs Lie

by Steven M. Cohen  •  Jan 2, 2008 at 9:11 am

http://www.buyselljump.com/2008/01/let-sleeping-dogs-lie

Evidently President Bush is leaning on Congress to do more to "help make the [housing] market more stable," according to one of his spokespersons. This development should make everyone nervous. Congress can be counted on to make a bad problem worse, so it is odd that Bush should be prodding it into action at such a precarious time.

It is hard to believe that Democrats have much of a vested interest in really addressing the housing mess, even if there was something meaningful to be done. As the economy stumbles and home prices drop as defaults increase, a wonderful election issue is developing, and Democrats won't be able to resist making the most of it.

This inevitably leads to two possibilities, neither one of which is pretty. The Democrat-controlled Congress will either balk at enacting Bush's modest but possibly useful suggestions--like allowing ARM refinancings through the FHA or increasing the cap on Fannie Mae loans--or, more likely, it will seek to outdo Bush with a more comprehensive plan involving massive taxpayer-financed bailouts of subprime borrowers.

Some of the "remedies" already suggested by the House leadership and other prominent representatives have been particularly loopy. Chief among them is the possibility of legislation that would drastically shift the burden of credit due diligence to the lender. Replete with vague terms and conditions impossible to comply with, such an onerous shift of liability would be sure to scare the daylights out of lenders and would certainly dry up whatever liquidity is left in the mortgage markets, proving once again that Congress has an uncanny ability to convert a problem into an intractable mess.

Of course, this unintended consequence is of little importance to the politicians proposing these remedies, as their real agenda is to appear to be "doing something" in the face of Administration inaction.

Needless to say, various presidential candidates have chimed in with their own fixes, chief among them Hillary's notion that perhaps it makes sense to freeze rates on ARMs for five years. This is tantamount to the tearing up by government fiat many thousands of private contracts signed at arms-length, but this does not appear to bother the candidate one iota. Perhaps she is particularly comfortable with the notion of tearing up documents.

In any event, the mortgage mess will run its course and dent the economy to whatever extent regardless of any brainstorms our leaders come up with. This inexorable process has already been reflected in the massive writedowns taken by financial institutions saddled with mortage-laden collateralized debt obligations on their books that are impossible to value or even sell at any price. This process will continue until opportunistic buyers, hedge funds chief among them, think that these securities have hit bottom and a new market for them develops.

The ongoing, seemingly black-hole nature of the problem is also reflected in the huge increase in defaults, including many borrowers that should never have been given a mortgage in the first place. However, this may be partially offset by lenders who, even in the absence of new laws governing their conduct, voluntarily agree to be flexible with borrowers who at least have a hope of paying off their loans, in order to forestall or prevent default.

In any event, at some point this problem will be behind us. That point will come much sooner if lawmakers let the markets sort it out. That is why the President ought to think long and hard about encouraging Congress to get in the mix.

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