What happens when you lend people money they can’t afford to pay back? Just ask Lehman Brothers, AIG, Merrill Lynch, Countrywide, Fannie Mae, Freddie Mac, and many others. Also, ask your next door neighbor, your co-workers, your boss, or your dentist. Everyone has been affected one way or another from the recent credit crunch. Everyone has an opinion as well.
The government has had to do some bailouts, which is good for the overall economy… for now. The Fed just took over AIG, so the consequences are yet to be seen. Sure they now have an 80% stake in the company, but is that good for anyone? Did they at least reduce the CEO’s pay to that of a government executive (which caps out at around $165,000)? Are the stock options gone? The fine details are yet to be seen. What we do know is that we just rewarded poor performance, which punishes good performers. Let’s take a look.
Basic supply and demand says that if more people have money then prices will likely rise. That is what happened to the housing market. If you are among 10 people on the market looking to buy a $300,000 home, then you will each most likely find one priced between $290,000 and $310,000. But if 100 people are looking to buy a $300,000 home, you can bet that the final price each will pay could creep up above $400,000. But what if the other 90 people really could not afford to buy the home, but instead got a subprime mortgage? Now they cannot make their payments, so they start short-selling, getting foreclosed upon or they get some type of government assistance. Where does that leave you, the person who did the responsible thing and got a conventional mortgage, albeit at a higher price?
Imagine going to an auction where there are dozens of people bidding up prices of goods without the money to backup their bids. Now those people who really want the item and can afford it simply have to keep increasing their bids. But what if you later found out the other bidders had no way of actually backing up their bids with real money? How angry would you be once you found out you could have purchased your item for a lot less if only legitimate buyers were allowed to bid? Auctions work based on bidders having the money to pay the items. Housing markets should work the same way, but over the past several years they have not.
Well, due to the other folks who artificially drove up the price of your home when you bought it, then caused it to sink when they stopped making payments, you just lost about $75,000 in home value. On top of that, some of your tax dollars get to go and help the bailouts. Add to that part of your interest rate that helps subsidize the risk banks must take since some people don’t make their payments, and you just suffered from a hat trick of punishment. You don’t get any government bailout or assistance since you have a conventional mortgage, but you got ripped off because of the temporary influx of people who had no business buying such expensive homes, thus driving up your costs.
In addition, just think of all the businesses who suffered by not taking on the high risk mortgages for the past several years. They lost out on millions of dollars of profit, while their competitors raked in the cash. Now that the smarter companies have been proven right, where is their justice? Their competitors just got bailed out, so once again, they would have been better off joining the crowd. Because they did the right thing, they lost profits over the past several years, only to see their competitors get bailed out. So much for risk vs. reward.
Will the bailouts help our economy? Hopefully. Will they hurt those of us who tried to do the responsible thing? Most definitely.
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Bill Pratt is a former credit card executive turned student-advocate. He is the author of Extra Credit: The 7 Things Every College Student Needs to Know About Credit Debt & Ca$h. Bill speaks at colleges to educate and entertain students about real-life issues in money, leadership and success. His goal is to help students succeed personally and financially so they can improve the lives of those around them.