The Mortgage Bailout: A Little From Here Makes A Little For There

The Senate is poised to vote on a massive mortgage bailout bill. So, no worries if you bought a house that was more than you could afford. And if you made a bad loan to someone who clearly wasn’t qualified, you’re in the clear.

Policies like this can have disastrous effects on our financial system. It reminds me of a book Mama Eltringham used to read to me when I was little: Hiram’s Red Shirt.

Here’s the gist of the story: Hiram was a farmer whose daily uniform consisted of a red shirt, which he adored to the point that he wore it every day. Predictably, farm work took its toll on the shirt and the elbows wore out. Hiram fixed it by patching the elbows with the shirt’s cuffs – his philosophy was: “A little from here makes a little for there.” When his wrists became scratched, he shortened his jeans to make cuffs for the shirt – “a little from here makes a little for there.” When Hiram’s ankles were scraped by the brush, he finally resolved to suck it up and buy a new shirt – in fact, he bought a new red shirt exactly like his previous one.

There are some plot holes: Did he buy new jeans, too? Didn’t he have any other shirts? How did someone so obviously oblivious to resource allocation manage to run a farm?

That’s appropriate, since Congress’s mortgage scheme isn’t much better than Hiram’s misguided laundry preservation plan. Congress wants to spend tax money that could be used on any number of things (schools, roads, you name it) to bail out irresponsible businesses and citizens who acted irresponsibly and recklessly. A little from here makes a little for there.

It may work for a while – most quick fixes do. It also proves that a lender can loan someone $200,000 or more without worrying about whether he or she can pay it back.

That means risky loans are only risky for the borrower. Currently, if you ask a bank for a $200,000 loan, they will evaluate how likely you are to pay them back. They do this because if you default, they lose money and you get a big black mark on your credit score, which hurts the next time you try to take out a loan – for things like a new house, a car, or your kids’ college tuition.

In other words, under the current system, the bank has an incentive to look out for you. A foreclosure has two losers: the lender and the borrower. If there is no consequence for the bank, their incentive to look out for you is gone.

But subsidizing the lender’s potential losses still leaves the lender with a stain on his or her credit report – goodbye future home, goodbye new car, and hello “Proud Bubba Community College Parent” sweatshirt.

Maybe, like simple Hiram, Congress just doesn’t understand the consequences of their actions.