Our financial crisis came about because of flawed thinking about how to help the poor.
Financially sophisticated parents would never tell their children to borrow to the ceiling to buy a house or anything else. And yet, lawmakers thought that the way to help the poor was to encourage them to borrow heavily. The mass inducement to the poor to borrow beyond their means was nothing short of an act of incredible cruelty. So how can we help the poor and get out of the mess we’re in?
There has been talk about bailing out homeowners so that they can make their mortgage payments. But this is just more of the same flawed thinking. Imagine the misery of just being able to make payments year after year. Dinner consists of macaroni and cheese, entertainment is renting a movie once a month, life revolves around hovering on the brink of disaster. These mortgage bailouts aren’t “relief,” they’re an act of cruelty designed to extract the maximum possible. And in-trouble homeowners throw good money after bad, hanging on in the hope of a bailout…
We need to let borrowers who got in over their head default.
The transition back to an apartment will hurt, but then life can begin again. Cash will be freed up for consumer purchases and saving for a comfortable retirement—possibly replacing the car that should be scrapped anyway. Instead of an economy full of people who don’t have a spare dime due to their mortgage payments, we will have an economy of people who can spend again. This will stop the layoffs. The more people who have jobs, the more of a base we will have to tax, which, ultimately, will help us pay off the massive debt being incurred. Jobs are everything; they are the key.
Yes, this will cause real estate prices to fall more. But propping up prices is worse.
It makes it even harder for those who wish to buy to afford it, and less able to spend when they do. And if the economy has jobs, ultimately, house prices will recover to a better level in the long run.
If we want to help the poor then we should create programs that teach them to save to buy a house. We could have a rehabilitation program where defaulters that save over time can have their bad credit removed sooner.
The second part of the process is to take the bad loans off the bank’s books. A resolution trust corporation worked during the savings and loan crisis and despite the fact that it won’t be easy, it will work again.
Let’s just start over. We can hit the reset button.
Stop people who can’t afford their mortgages from hanging on in hope of a bailout, provide counseling for people who are losing their homes, and take the bad mortgages away from the banks. It’s going to cost money, but the more that we free up consumer spending, the more we preserve jobs, and the more we are able to pay for the mess.
What we should not do is massively spend on projects that will not help right away, and will not create jobs that create other jobs.
With the economy in the tank, spending on improving the highway will not create jobs when little is being shipped. Every penny needs to be spent wisely. Let’s use our pennies to free up more pennies.
Joetta Forsyth, PhD, is an Assistant Professor of Finance at the Graziadio School of Business and Management.
Related in the GBR
- What Happened to the U.S. Housing Market? by Peggy Crawford, PhD, and Terri Young, PhD
- Learning to Love Financial Market Barbarians by Joetta Forsyth, PhD
- The Top 10 Embracements for Difficult Economic Times by Darrol J. Stanley, DBA
- Crisis in America: A Nation at Risk by Darrol J. Stanley, DBA