Aug222013

Another appalling example of bail-out mentality ruining America

Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the king’s horses and all the king’s men
Couldn’t put Humpty together again.

Have you ever wondered why we tell out children such ghastly stories? I remember how I felt when I first heard and comprehended that nursery rhyme. It scared the hell out of me. It made me realize that actions have consequences, and some mistakes can’t be undone.

Americans are losing this basic understanding of behavior having consequences. The elders in charge of our society are telling the next generation that consequences can be avoided. If you behave in ways that cause you problems, someone, probably the government, will be there to bail you out. I discussed this issue at length in the post Moral hazard is central issue in housing bust.

The purpose of a bailout is to prevent an individual or family from enduring the consequences of their bad decisions. It simply is not possible to have a bailout without moral hazard, it’s only a matter of degree. … 

The people who sacrificed and saved get rather upset when their money is given to those who were irresponsible. Ask the Germans how good they feel giving billions of dollars to the Greeks. The Germans work hard, take very little time off, and save prodigiously. The Greeks party hard, have some of the longest vacations in Europe, and spend prodigiously. The Germans don’t mind lending the Greeks money to earn a return, but giving it away is a different story. And it should be.

The same is true of the tension between savers and spenders in the US economy. Savers sacrifice current consumption to earn a return and enjoy greater consumption in the future or to acquire wealth. Spenders maximize current consumption and hope future austerity never comes. When producers and savers are punished with onerous taxes and low returns on safe investments, they lose their incentive to produce and save. Without producers and savers, what would spenders consume?

When policy makers worship spenders as the backbone of our economy, they completely miss the point. Economic growth comes from production and savings, not consumption. Our policies now encourage spending and discourage saving. While this may maintain some illusion of growth in the short term, it hurts our economy in the long haul. Here we are five years after the housing bust, and although we are officially out of recession, does the economy feel robust to you? I don’t feel it, and neither do most Americans.

The latest bailout proposal concerns student loans. Excessive student loan debt is another long-term drag on housing, and the current default rates on student loans is very high. Some kind of bailout is brewing despite the problems it entails.

Here’s a Way to Flood the US Housing Market with One Trillion Dollars

I’m offended by the headline. First, it tries to provide justification for an egregious bailout by linking it with another egregious bailout. Haven’t we done enough for housing already? Second, it assumes this trillion dollars is free money. The government will just print it, right?

by Morley Winograd and Michael D. Hais 08/20/2013

Members of the millennial generation – born between 1982 and 2003 – carry a student debt burden of close to one trillion dollars. This is the group that includes many just entering the stage in life when people tend to settle down and start families. Even though Millennials are marrying later than previous generations, they would still be the prime market for sales of single family starter homes, if only they could afford them.

If we were really worried about housing affordability, we wouldn’t be working so hard to reflate the housing bubble, would we?

As interest rates rise along with home prices, the only way this key consumer segment will be able to afford to buy a house is if the nation, out of its own self-interest, finds a way to relieve Millennials of their crushing student loan obligations.

Out of it’s own self-interest? How is it in my best interest to bail out someone else’s debt so they can help inflate house prices beyond my reach? The way I see, I lose twice.

Millennials are the first generation in American history that has been asked to self-finance the cost of the education needed for America to be economically successful.

Bullshit. I had to get student loans, and so did my parents. My parents generation and my generation had lower school costs because such large loans were not available to help inflate tuitions. Further, we had to work in order to get through school in addition to getting student loans. Would I have had more fun partying? Sure. But would I be a better person for it today? I rather doubt it.

Shortly after the ratification of the Constitution, Congress passed legislation setting aside land in the new territories for the establishment of the iconic one room school houses to assure its newest citizens had the skills required to be good farmers and domestic servants. Even as the country was engaged in a devastating Civil War, a state-by-state movement to mandate universal and free primary education for every child swept the nation and became a permanent part of American society. Then, when the Industrial Revolution generated a demand for factory and office workers with a high school education, the nation expanded the concept to make such an education available equally to young men and women without any requirement to pay tuition.

The situation has changed, but the need for an educated young generation has not. The difference is that at least two years of post-secondary education has become a must-have ticket for a young generation seeking to make its way in the world. Yet we have suddenly yanked the universal, free education rug out from under them and asked them to pay for it by not only going into debt, but assuming a debt that is not even dischargeable in bankruptcy court.

The real injustice has been caused by the widespread availability of debt without regard to the potential return on the investment. Does it really make sense for a history major who might make $35,000 a year to borrow $120,000 to get a degree from Harvard? Further, once this debt became available, institutions of higher learning responded by raising tuition costs, expanding their bloated administrative bureaucracies, and absorbing the huge influx of borrowed money. We now have a higher education tuition bubble to deflate.

The result is a rising tide of student debt that threatens to undermine the economic vitality of the nation. According to the Federal Reserve, student debt rose by a factor of more than eight between 2001 and 2012, twice as fast as home loans and far in excess of the modest increases in other forms of indebtedness during the same time period. A recently released report by the Consumer Financial Protection Bureau indicates that about one in four student loans is now either in default or in programs designed to help borrowers in distress. This analysis looked only at loans made through the direct student loan program totaling about $570 million, not older ones that may have been offered by banks and other private sector lenders. If borrowers are unable to repay their loans in the long run, the federal government and taxpayers will have to absorb the losses.

This is truly shocking. Something obviously went wrong. Back when I borrowed money for school, you were limited in how much you could borrow, and many like me were limited in how much they wanted to borrow. For student loan debt to go up 800% in a 10 year period, both borrowers and lenders must not have exercised any restraint whatsoever. Since these are government-backed loans, regulators should have been monitoring this and doing something to prevent it from getting out of control. Either there are no pertinent regulations in place governing the amount of student loan debt young people are given, or regulators did not enforce the rules. With financial industry lobbying, it may have been that regulators were told to back off and look the other way.

Why, then, not recognize the problem now and bail out the borrowers so that they can put the windfall to good use in an economy desperately needing a new boost in consumer spending? …

Why not bail out the borrowers? Perhaps one reason might be because it will encourage them to borrow irresponsibly in the future. Or perhaps it’s because it will cost a trillion dollars, and I will obtain no benefit from that expenditure. I’m sure there are many more reasons as well.

Imagine you were a college student in the 2002 to 2012 period. If you were prudent, if you limited your student loan debt and worked to put yourself through school, you should be rewarded. Many prudent students watched as their imprudent peers partied every night, didn’t work, and borrowed their way through college without sacrificing anything. The only reason any student has to be prudent is to get out of college with minimal debt so they can have a head start in life after school. If that advantage is erased by giving the imprudent party animals a free pass, who would be the slightest bit prudent in the future? Wouldn’t everyone party like mad and wait for their after-school bailout? Does anyone want to fund that? And does anyone want to support that entitled generation when they expect future bailouts for reckless borrowing?

Over the next five years, a quarter of Millennials will enter their peak spending years, making them the best hope for reviving the housing market.

Millennials have expressed a strong preference for living in the type of suburban communities in which they grew up, especially when it’s time, as it is for many of them now, to raise a family.

Most people have a preference for the suburbs when it time to raise a family. Are the millennials entitled to it any more than we are?

Their first home needn’t be “move in ready;” about a third of them say they would prefer a “fixer upper.” And more than 80% of the generation believe they would find a way to pay for the cost of any repairs themselves rather than borrow the money from their parents.

Yeah, they saw their parents get HELOCs and pimp out their pads to the max, so the millennials expect to do the same.

A wave of new home buying would not only give a sharp boost to the durable goods industry that depends on new household formation for its growth, but would also provide a ready-made army to fix up some of the country’s declining, inner ring suburban housing stock.

We should forgive a trillion dollars in debt for that? Give me a break.

There are legitimate public policy issues about how to fix the problem of financing American higher education. Some might argue that we should tackle that problem before dealing with student loan debtors.

Yes, we should.

But with the economic recovery still proceeding at too slow a pace for most middle class Americans, an equally good case can be made that the country should deal with student loan debt either first or as part of a comprehensive reform of financing higher education. The economy could use the boost, as could the morale of America’s largest and most diverse generation.

I couldn’t care less if the millennials spend the rest of their adult lives living in their parent’s basements eating Ramen noodles. If they borrowed too much money and didn’t work hard enough in college to keep their debt levels down, or if they didn’t weigh out the potential for future income versus the cost of the education, too bad. Perhaps they should face the consequences for their decisions.

There is no equitable way to bail out student loan debtors or anyone else for that matter. Any bailout is laden with moral hazard issues and impossible to administer fairly. Should regulators have prevented this disaster in the first place? Probably, but now that it’s here, massive and expensive bailouts are not the answer.

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23 TRANQUILITY Pl Ladera Ranch, CA 92694

$1,270,000 …….. Asking Price
$1,362,500 ………. Purchase Price
8/15/2006 ………. Purchase Date

($92,500) ………. Gross Gain (Loss)
($101,600) ………… Commissions and Costs at 8%
============================================
($194,100) ………. Net Gain (Loss)
============================================
-6.8% ………. Gross Percent Change
-14.2% ………. Net Percent Change
-1.0% ………… Annual Appreciation

Cost of Home Ownership
——————————————————————————
$1,270,000 …….. Asking Price
$254,000 ………… 20% Down Conventional
5.02% …………. Mortgage Interest Rate
30 ……………… Number of Years
$1,016,000 …….. Mortgage
$301,875 ………. Income Requirement

$5,467 ………… Monthly Mortgage Payment
$1,101 ………… Property Tax at 1.04%
$567 ………… Mello Roos & Special Taxes
$265 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$400 ………… Homeowners Association Fees
============================================
$7,798 ………. Monthly Cash Outlays

($1,840) ………. Tax Savings
($1,216) ………. Principal Amortization
$497 ………….. Opportunity Cost of Down Payment
$179 ………….. Maintenance and Replacement Reserves
============================================
$5,418 ………. Monthly Cost of Ownership

Cash Acquisition Demands
——————————————————————————
$14,200 ………… Furnishing and Move-In Costs at 1% + $1,500
$14,200 ………… Closing Costs at 1% + $1,500
$10,160 ………… Interest Points at 1%
$254,000 ………… Down Payment
============================================
$292,560 ………. Total Cash Costs
$83,000 ………. Emergency Cash Reserves
============================================
$375,560 ………. Total Savings Needed
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