Thursday, September 25, 2008

Bernanke & Paulson: "No One Can Breathe Against Their Will"

Yes, the squeaks from the wheel are getting louder. How could they not when the Wall Street Journal, presumably the champion of free markets, endorses what is a short road to socialism, if not socialism itself? Please feel free to borrow pieces of this letter to compose your own — who knows what might get the Journal to wake up?

Dear Sir(s):

While I can understand the mindless desire to "do something . . . anything" that is driving the current push to write Messrs. Bernanke & Paulson a blank check and put a virtual monopoly over money and credit in their hands, there is a viable alternative to the panic-stricken reaction. In yesterday's "Review & Outlook" ("The Paulson Sale," WSJ, 09/24/08, A28) you opine, "We wish there were a way around this outcome, but the price of doing nothing now is likely to be far higher both for taxpayers and the cause of free markets."

There is "a way around this outcome," a way I have been repeating for months, and (at the risk of repeating myself) will continue to state until someone wakes up and begins paying attention. First, however, it would be very useful for the Wall Street Journal to explain, in clear and simple language, how handing over near-total control of the financial markets and the creation of money and credit to the State is in any way promoting "the cause of free markets." Your dictionary may be more up-to-date than mine, but mine states that State ownership or control is socialism, not "free markets."

You are correct, however, that "doing nothing now" is likely to carry a high cost for taxpayers and further undermine the free market. Nevertheless, you fail to realize that doing the wrong thing can carry an even higher price. Given a choice between something that concentrates power in the State, and something that returns power to individual people, reason dictates that we choose the latter.

A better choice than State socialism is for the federal government to make it possible for people to solve the problem, rather than attempt another clumsy and counterproductive program that further erodes private property and establishes a condition of society in which, as Pope Pius XI explained, a pair of unelected bureaucrats "regulate the flow, so to speak, of the life-blood whereby the entire economic system lives, and have so firmly in their grasp the soul, as it were, of economic life that no one can breathe against their will." (Quadragesimo Anno, "On the Restructuring of the Social Order," 1931, § 106.) The federal government should therefore immediately begin studying the feasibility of an innovative "rent to own" vehicle that would be called the "Homeowners' Equity Corporation" or "HEC."

Assuming appropriate legislation could be passed, a HEC would be a for-profit stock corporation whose shareholders would be homeowners in danger of foreclosure. HECs — and there should be many, to provide redundancy, lower risk, and ensure competition in a community — would purchase distressed properties at the current market value. HECs would obtain acquisition loans from commercial banks, which in turn would discount the loans at the local Federal Reserve at a rate reflecting transaction costs and a revised risk premium to spread the risk and pool it, similar to the manner in which conventional insurance operates. The homes could then be leased at a realistic market rate to their former owners or new tenants.

The tenant would earn shares in the HEC as lease payments sufficient to cover debt service, maintenance, and taxes were made. When the acquisition loan for a particular property was fully paid, the tenant could exchange his or her HEC shares for title, or continue as a tenant/shareholder at a reduced lease payment, sufficient to cover maintenance and property taxes. Financing the purchase of properties through the Federal Reserve System and its member banks would cost the taxpayer nothing and be the first step in restoring a currency backed by hard assets instead of government debt — to say nothing of taking care not to add another $5 trillion or so of unserviceable debt to the already staggering burden of the federal government.

This innovative alternative would require some enabling legislation from Congress to give it powers similar to those currently enjoyed by leveraged ESOPs. Then let the private sector HECs take over the whole mess in a way that delivers the greatest good to the greatest number of people at no cost to the taxpayer without creating another government agency or burdening taxpayers with more debt.

Every community with homes subject to foreclosure that will be acquired by the federal government or the Federal Reserve could establish a "Community Auction Board" (CAB). Each CAB would be chartered by the State Government, have a balanced board of directors made up of leaders from the real estate industry, lawyers, accountants, and bankers. The CAB would hire or contract with professional auctioneers to determine the new fair market value of the loan in default through an open bidding process among competing HECs organized by local real estate management professionals.

The "winning" HECs would negotiate a new 100% leveraged loan to purchase the auctioned home mortgages with the commercial banks serving the community, with the acquired property serving as collateral at its real fair market value. The commercial bank would in turn bundle all HEC loans and sell them at the regional Federal Reserve's discount window in exchange for new, asset-backed money. The cost of the loans to the HEC borrowers would be on a service fee plus risk premium basis.

Rental agreements would reflect the debt service costs, home mortgage insurance premiums, real estate management fees and profits of the HEC, plus any maintenance contracts with the renter of each home. This would allow the overall rent-to-equity process (auctions and real estate management functions) to be expedited efficiently at the community level rather than dealing with a bureaucracy within the national entity now holding the defaulted mortgage paper.

The benefit to the State, the Federal Reserve, and (especially) the taxpayer is that the State and the central bank would be able to unload the foreclosed properties quickly, and use the money-creation power of the Federal Reserve to keep most, if not all occupants in their homes. Due to the lower cost of the loans and the acquisition of the properties at a realistic market value, rent payments would be less than the mortgage payments they would otherwise have had to pay. Those families in need could be offered a sliding scale of rental vouchers in amounts necessary to make the new rental payments affordable, as under the Section 8 program of HUD.

To the extent such a strategy requires time to organize at the federal, state, or community level, the Congress can pass a moratorium of 3-12 months on foreclosures of Federally-acquired mortgages in default while the HEC and CAB entities are being formed throughout the nation.

Once this program is up and running, the Congress can take steps to enact the Capital Homestead Act, which contains structural reforms to inhibit and, in most cases, prevent anything like the current crisis from happening again.

The alternative, as you point out, is to hand over control over the life's blood of the economy — money and credit — to the State in the persons of Bernanke and Paulson, an arrangement known to every economics student as "socialism." While the urge to do anything that promises to "save" us from the current predicament is strong, we should do well to remember the warning of Dr. Benjamin Franklin that, "Those who would give up Essential Liberty to purchase a little Temporary Safety, deserve neither Liberty nor Safety."

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