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The Foolish Foreclosure Moratorium

Wednesday, October 13, 2010

Democrats are calling for a nationwide end to mortgage foreclosures. It’s hard to imagine a more shortsighted policy under our current economic circumstances.

The weekend’s newspapers were full of stories about Democrats—including the embattled Senate Majority Leader Harry Reid (D-Nevada) and Deputy Majority Whip Rep. Debbie Wasserman Schultz (D-Florida)—calling for a nationwide end to mortgage foreclosures. It is hard to imagine a more shortsighted policy under our current economic circumstances. For a party that claims it wants to put Americans back to work, the Democrats are instead advertising their willingness to sacrifice jobs and economic recovery for salvation in November’s election.

Without question, disclosures about bank employees signing affidavits without reading them are troubling, but calling these technical deficiencies in the foreclosure process “frauds on the courts” and a reason to halt all foreclosures is a reaction wildly out of proportion to the seriousness of the fault and—if it succeeds—potentially disastrous for the economy.

For a party that claims it wants to put Americans back to work, the Democrats are instead advertising their willingness to sacrifice jobs and economic recovery for salvation in November’s election.

Clearly, people who are in danger of foreclosure will be helped by a moratorium, but who will be hurt? The first victims will be the nation’s banks—not only the large ones, but also the small ones, the local banks that kept these mortgages on their balance sheets. If they are not going to receive any revenue from these mortgages, and they cannot foreclose, they will be weakened. If that happens, they cannot continue to make loans to small businesses, to consumers, or to those people who would like to take advantage of today’s low interest rates to buy a home, whether or not it is a foreclosed property. So the foreclosure moratorium will further weaken local economies and produce yet more unemployment.

Another victim of the moratorium will be pensioners. Pension funds for public and private employees are major holders of mortgages and mortgage-backed securities. If people are not paying principal and interest on their mortgages, these funds will not receive the revenues they have been counting on to meet their pension obligations. They will be required to borrow to make the payments required, and the cost of those borrowings will weaken their long-term ability to pay.

Yet a third set of victims will be Fannie Mae and Freddie Mac. These two government-sponsored entities hold or have guaranteed well over $5 trillion in mortgages and mortgage-backed securities. Because they became insolvent in 2008, they are currently under the control of the government, and have thus far received about $150 billion in taxpayer funds to keep them afloat. If they do not receive the principal and interest on the mortgages they hold, the taxpayers’ costs for keeping them financially solvent will increase, adding directly to the enormous deficit that is already a problem for the United States. So the moratorium is another direct burden on the taxpayers.

The foreclosure moratorium will further weaken local economies and produce yet more unemployment.

The housing industry, which amounts to almost one-sixth of the U.S. economy, has always been the economic sector that led the United States out of recessions. This time, because of the huge buildup of weak and high-risk mortgages in the housing bubble that deflated in 2007, the housing market has been much slower to recover than in the past. This is because the inventory of unsold homes remains high, and potential buyers know that prices still have further to fall. As long as there are large numbers of unforeclosed homes—homeowners that are neither paying principal or interest on mortgages nor making their homes available for sale to buyers who will make these payments—the  housing market will continue to languish, extending the recession indefinitely.

Voters who are paying their mortgages, who are looking for jobs and can’t find them, who are taxpayers hoping to reduce their burdens as well as the U.S. deficit, and all Americans who are worried about the weakness of the economic recovery, should recognize that the politicians who are calling for a nationwide moratorium on foreclosures are not their friends. 

Peter J. Wallison is the Arthur F. Burns Fellow in Financial Policy Studies at the American Enterprise Institute.

FURTHER READING: Wallison wonders “When Economic Policy Became Social Policy” and observes “The Troubling Resolution Revolution.” Derek Kan criticizes “TARP without Strings” and Vincent Reinhart revisits the Fed “Getting Lehman Profoundly Wrong.”

 

Image by Darren Wamboldt/Bergman Group.

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