NO NO NO NO NO!!!!

Yesterday, Paulson said, “…the most important thing we can do to mitigate the housing correction and reduce the number of foreclosures is to increase access to lower cost mortgage lending.”

GAH! Ok, why does he think that lower cost mortgages will be helpful? They were, to a large extent, what brought us to this current mess. I have already talked a bit about the “correction” (see my last post), but let’s think about what a mortgage rate is.

A mortgage rate is the rate of interest someone will charge you so you can borrow money to buy a house. What that rate is is determined by what it costs them to get that money, your likely ability to pay that loan, and the availability of higher rates of return on other lending options. None of those things are created out of thin air, they’re all important The company with the money wants to loan money, that’s how they make money, but they need to charge the right amount in order for it to work. In addition, they have to make sure they don’t lose money, it’s can be a tricky thing.

So along comes the federal government and decides to lower interest rates. Hmm, what can they do? Well, they make it less expensive to get money to lend. That makes the bank more willing to lend to people that have shaky credit, and it makes it more profitable than lending money for other purposes. In addition, the government guarantees risker mortgages through Freddie Mac and Fannie May. The end result? More houses are sold than would be otherwise, and through our friend “Moral Hazard,” more houses are sold to people that can’t really afford them. That drives the cost of houses higher than it should be (supply and demand being what they are) and also causes a large amount of resources to be spent on the building of houses that shouldn’t have (labor in particular). Poof! Instant bubble… Because the feds made this so profitable, various kinds of mortgage derivatives were formed which were then heavily invested in by banks. In short, it’s a huge distortion, it’s something that wouldn’t have happened if things were left to their own devices.

But they weren’t, and now we have what we have. The good news is that the mortgage market is trying to correct itself, the bad news is that Paulson (and a lot of others on capital hill) want to get back to the same level of house buying and construction that started this whole mess. Someone, somewhere has to start thinking, “Well, maybe we should let the market get back to where it would have been if we hadn’t screwed around so much..” I’m not holding my breath. This is how depressions last, by trying to force markets to go uphill…

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