Biden promises to destroy the American housing market

Gerard Van Der Leun is right - this is simply mind-numbing to consider:

Biden -"Number two, with regard to bankruptcy now, Gwen, what we should be doing now -- and Barack Obama and I support it -- we should be allowing bankruptcy courts to be able to re-adjust not just the interest rate you're paying on your mortgage to be able to stay in your home, but be able to adjust the principal that you owe, the principal that you owe." -Transcript of Palin, Biden debate - CNN.com

Now, I'm not trying to be pedantic here, but just to be sure everyone starts from the same place, the principal amount on a home mortgage is the amount you actually borrow. And the interest on a mortgage is the amount of money you pay the lender, in addition to the principal repayment, to compensate the lender for the use of the money over the term of the loan. The amount of the interest is determined by the rate and the length of the loan.

What Joe (and he says Barack Obama also) wants to do is force lenders to do is to accept both less interest repayment than the mortgage contract calls for and less repayment of the principal.

The fundamental rule of free-market capitalism is, "The value of a thing is what the thing wll bring." It's a bit of a tautology, but it's true nonetheless: nothing is worth more than someone is willing to pay for it. There is no better illustration of this than eBay, which, like all auctions, is one of the last bastions of pure free-marketism left. The items that actually get sold are, in the great majority, those offered on "high bidder gets it, period," terms, rather than those offered only with a buy-it-now price, or a high-bidder-gets-it once a reserve price is met.

But mortgage lending, like all lending, is a futures market, meaning that borrower and lender alike have to agree not only on what the house is worth now, but what it will be worth in the future, namely over the life of the mortgage.

So if you try to borrow $200K on a house that Mortgage Bank, Inc., thinks will retain at least that value over the life of the loan, then the bank is much less worried that it can recoup its principal, the $200K, if you default. But if the bank thinks that the house will depreciate, it will adjust the amount of principal it will lend to account for that.

Likewise, you won't want to borrow $200K on a house that you think has a significant chance of depreciating faster than you are repaying the principal. (This happens to auto-loan borrowers routinely, but the amounts are typically 10%-15% of home mortgages and the terms are much shorter.)

But for lenders and borrowers to function well (well, function at all) in a futures market, there has to be some significant predictability in the market. While no one can predict what home values or rates will do much over a year out (and often not even a year), the predictability that allows the market to function is based on is the stability of the financial structure, the rules and regulations that govern the transactions.

Pre-eminent is the legal sanctity and enforceability of contracts. Contract law is what makes futures market work. Contract law governs the exchange of value, which is in mortgages the relationship of property, money and services and the obligations among the parties to the mortgage contract. (I wrote last February how the evolution of the ability to make abstractions about futures markets is a big thing that distinguishes human beings from chimpanzees, who do barter, but have no concept of property protections or future value.)

A better way to destroy the mortgage market than what Biden-Obama propose could not possibly be imagined. For what Joe said (said twice, count 'em above, twice) is that the government will decide, completely arbitrarily, what the future value of a home will be by adjusting the principal balance to be repaid. Because Joe will never adjust the principal upward, there will be no bottom. Lenders will not be able to predict with assurance whether they will even be able to recover their principal, much less recover their opportunity costs of the loaned money plus enough profit to run the business.

One of the basic rules of monetary policy and governments is, "That which the government subsidizes increases." And the reverse is also true: "That which the government punishes decreases." The Biden-Obama plan is only punishment. Guess what it will do to the housing market?

Mortgage lenders will require a much larger down payment ratio than they do now. Usually, lenders will require the borrower to down-pay 20 percent of the home's appraised value in order to write the loan with no PMI, private mortgage insurance, that protects the lender from financial loss in case the borrower defaults. You can expect this percentage to go up, probably way up, certainly to 30 percent and probably higher.

Here's why. If a lender loan $80K on a home appraised at $100K, it's reasonable to believe that the risk of default is much lower than if it loans, say, $95K on the same house. With a 20 percent stake in the house, the borrower is also heavily invested and his self interest is to pay the loan off, raising his stake to 1oo percent. But suppose the borrower, having borrowed 20 percent of the appraised value, pays the loan down from 80 percent to 70 percent. He owes $70K. Then he files the paperwork to have a court reset the principal from $70K to $60K. He's just made $10,000 at the bank's expense.

So mortgage lenders will have to account for this possibility within the terms of their mortgages. Raising the no-PMI buy-in by the borrower is one way. Another is to require the borrower to take out PMI regardless of the down payment, but this is unlikely since it does not incentivize deep investment into the property by the borrower. Still, the lender's increased risk of loss because of interventionist government must be offset somehow. So what's left?

Higher interest rates, that's what.

But wait, as TV hawkers say, there's more. Let's say you own a house worth $250K. Your next-door neighbor has a similar house and he gets a principal readjustment on his loan of minus 15 percent. Congratulations, your house is now worth $121,500. Why? Because today, house appraisals push loan values, but when the government steps in as Biden-Obama want it to, revised loan values will push appraisals:

Appraiser; "I appraise your house at $250,000.

You: "Great! That's what I'll put it on the market for."

Buyer: "I'll pay your price if I get financing approved."

Bank to buyer of your home: "The next door house's principal value just got reduced by 15 percent. So we will lend you $180,625." (($250K*.80)-15%, and more likely minus 20%)

Buyer: "I don't have $70,000 for a down payment!"

Bank: "Sorry."

Your real-estate agent: "Credit is too tight to sell your house for $250,000. I think you should lower the price."

If you think houses aren't selling now, just wait for Biden-Obama to start obviating private contracts. Speaking of which, just where in the Constitution does Biden purport to find the delegated power of the government to break the terms of private contracts?