The Global Capitalist

The recent proposal by the Bush administration to freeze certain interest rates on sub-prime mortgages is one of the biggest steps away from capitalistic thought since the New Deal era. The proposition essentially will allow the government to hold interest rates below market value for those who are unable to afford them. Hugo Chavez would be proud of any proposal like this that rewards poor financial knowledge by providing the ‘less fortunate’ with greater access to capital than those who were intelligent about their real estate dealings.

The economic ramifications of such an idea are enormous. Most mortgage debt these days are not owned by the banks that sold the mortgages, but rather by investors who purchased these products as a source of steady returns on their money. Let’s say that a 65 year old retiree placed $1 million in these products at a rate of 7%. The retiree has done the prudent thing by diversifying between stocks and fixed income assets such as these debt products backed by real estate (an investment which never goes down, right?). His annual income from this investment is $70,000 a year. He assumes this is guaranteed for life and has virtually planned the rest of his retirement around this income. With the new Bush plan, those who are unable to afford their mortgage adjustment, will have their interest rate frozen. This means the retiree is not making the amount of money off his investment that was agreed upon once he bought it. Rather, the US government has decided that they have something better to do with his money, so they are essentially taking it from the retiree and giving it to the poor soul who didn’t read the fine print on his mortgage agreement. While this is a slightly skewed example, it illustrates the fact that the government is diverting resources where they see fit, against the will of many participants.

Why is this deal so dangerous? More so than the previous example shows, there are two major factors in play. First, it sets the precedence that the US government can intervene in the economy and hurt or help whomever they wish to. In this case, they are hurting bond investors and helping real estate investors, by diverting money from one group to the other without asking permission from the bond holders. The debt market in the United States is 6 times as large as the stock market. If investors become weary that the government can just go in and change agreements any time it pleases, it could wreck havoc on the ability of people to obtain loans for anything in the future - cars, homes, and most importantly, small business loans. In other words, who will lend money in the future for capital investment in anything if the agreed upon rate of return on that money can be switched at any time. This proposition could very well have the opposite effect on the housing market than was initially intended and send the entire real estate market into a tailspin, because of the universal inability to obtain financing from anywhere.

The second reason this proposal is so dangerous, is because it rewards the uneducated for being … uneducated. Lets take investors Mr. Smart and Mr. Dumb. Both have the same profession, both have a wife and two kids, both make the same income, and both just bought a new house with an ARM at the same teaser rate of 4%. Mr. Smart, however, read the fine print and realized his interest rate would jump in the future and thus did the prudent thing by purchasing a smaller home that he could afford, against Mrs. Smart. Mr. Dumb, however, gave in to Mrs. Dumb’s request for the larger home and the big screen TV without realizing what the future would hold. Enter the Bush plan who sees Mr. Dumb’s difficult situation and says to the couple, ‘its ok ..you are bad with money…here’s your Christmas present for the next 5 years - a steady 5% interest rate’. Bush then goes to Mr. Smart and says, ‘what great intelligence you have. You planned properly for your future. You took the smaller house compared to Mr. Dumb and you will now be rewarded with a 9% interest rate as well. Congratulations on being so intelligent.’ When societies begin to reward ignorance as opposed to intelligence, their economies always follow the same way every time. Venezuela is a great example of a vital economy that turned into a basket case because it catered to the less intelligent and brought ‘power to the poor people.’ This latest move by the right-wing President Bush is perhaps the scariest evidence yet of a communistic bent by America.