When Hillary Clinton fixes the housing market, she really <i>fixes</i> it.

By Megan McArdle

I meant to blog about Hillary Clinton's subprime mortgage plan last week, but I got sidetracked. Luckily, Matthew Yglesias is talking about it, which reminds me that I really ought to say something.

Now one thing to note about this is that a bit contrary to campaign stereotypes, if you take this literally it betrays a certain naiveté about the way Washington works. Were a president to submit a stimulus plan with these kind of provisions in it to congress, it'd be bad news. You'd end up delaying legislative action on the overall package, and delays are a big problem with fiscal stimulus. You'd also open the door to all kinds of not-strictly-stimulus measures that various members of congress want to tack on. What Barack Obama proposed -- a much cleaner, more streamlined stimulus package that really just focuses on juicing short-term aggregate demand -- is a much better idea.

But that's if you take it literally. Things being what they are, both campaigns stimulus plans were really just smoke and mirrors, with Obama signaling that he can play grown-up technocrat and Clinton signaling that she's got a solution for every problem in her swiss army knife-like arsenal of policy measures. And while it's probably not a good idea to link the foreclosure freeze proposal to a stimulus package per se the underlying idea does seem like a pretty good one. As I wrote in my article on foreclosures there are a lot of neighborhood externalities associated with foreclosures, so it's really worth taking action to minimize them.

It may well be, but only if those measures are not actually completely insane. The good senator is proposing a temporary mortgage holiday, followed by a five-year freeze that will keep at least all subprime mortgages, and possibly all ARMs (there is some disagreement on this) at their teaser rates.

This is a terrible, horrible, no good, very bad idea. Yes, multiple foreclosures can be bad for urban neighborhoods, and it would be nice if there were some way to prevent this. But the way to prevent it is not to have the government unilaterally rewrite the terms of mortgage contracts massively in the favor of the borrowers. The teaser rates these people got can be lower than the rate on a prime fixed mortgage. This is, of course, very nice for the people who bought more house than they can afford. It will not be so nice for anyone who wants to get a subprime mortgage in the future, since this move will probably destroy that market for at least a decade or so to come. It will, of course, be very bad for anyone who happens to be a mortgage lender--aka the people the rest of us want to borrow money from in order to buy houses. This move will leave them with a lot less money to loan out to anyone else, so hello, higher mortgage rates. Higher mortgage rates, for those following along at home, generally mean lower house prices, which means that the problem of negative equity will get worse.

In other words, Senator Clinton would like to destroy the mortgage market in order to save it.

I see this problem as roughly the same problem of pharmaceutical price controls. Yes, we can help some people now, but only at the cost of hurting a lot more people in the future. Those people, of course, don't vote, either because they aren't born, or don't know who they are yet; hence, politicians often ignore them. But that's no reason that the rest of us should follow suit.

This article available online at:

http://www.theatlantic.com/business/archive/2008/02/when-hillary-clinton-fixes-the-housing-market-she-really-lt-i-gt-fixes-lt-i-gt-it/2726/