No kidding! Alex Higgens -- I never said in this post that this is going to happen. If they wanted to make this a requirement, they should have put it in the original legislation. Instead they gave Paulson basically unfettered authority to spend the money as he saw fit. There was no requirement for him to ensure the banks use the money for lending. I was just passing on the latest news being reported.

If you've read anything I've written here at BTM over the last several months, you would know that I have been following both the housing bust and the bailouts very closely. I called and wrote to my Senators and Representative daily before this bailout was signed asking them to oppose it. (I also actively protested against the previous bailouts for “homeowners” (really for banks and lenders), Fannie/Freddie (really for Chinese and other foreign banks and investors), Bear Stearns, etc.)

The reason Congress was giving to the public for this bailout being necessary was that they needed to "free up" credit to Main Street so that people would again be able to get loans to buy houses and cars. In my calls to their offices, I explained to them that their plan would not work because there was absolutely nothing in the legislation that would ensure that the banks would use the money to start lending again. I told them that credit had tightened for a reason. Lending standards over the last several years were too lax as banks had not been making sure that the money they were lending could be repaid by the borrowers. I explained that the tighter lending standards are a good thing because banks are once again making sure that borrowers can repay the loans. Tighter credit standards are also good because people will have to start living within their means and saving for their purchases. I further explained that, if their plan actually did work and the banks did resume lending like they were prior to the downturn, it would only prolong and deepen the crisis.

I opposed the bailout legislation not only because it was deficient in achieving their stated goal, but because it unconstitutionally used taxpayer money to cover the losses of private banks. I also oppose the unconstitutional use of taxpayer money to buy up mortgages and reduce the both principle and interest owed to relieve mortgage debtors of their private obligations. All of these bailouts scream moral hazard! By privatizing the profits and socializing the losses, they are rewarding the borrowers and lenders who got us into this mess while punishing those who acted responsibly and made prudent decisions.

Congress keeps saying that the problem is that house prices are falling. They say we need to stop housing prices from falling to restore confidence in the market. Basically, they are saying that if people think that their houses will not continue to lose value, but will start increasing in price again, they will feel wealthy and again start buying houses and spending money. Since 70% of our economy is based on consumer spending, everything Congress and the Administration are doing is aimed at getting people to spend again (e.g. stimulus packages). This is the opposite of what needs to happen for our problems to be solved. We need to stop spending, pay down our debts, live within our means, start producing things of value, and start saving.

Congress has it backwards. The problem is not that housing prices are falling, but that housing prices are too high in relation to incomes. The government cannot stop housing prices from falling. All of these bailouts are just throwing good money after bad. Just as Congress can’t force the banks to use the bailout money to make risky loans, they cannot force people to buy overpriced homes. People cannot afford today's asking prices with down payments and traditional 30-year fixed loans. Also, people have finally become aware of the dangers of buying houses with ARMs. Because they now know that the tsunami of foreclosures we are facing is related to these types of loan products, they will be less willing to use such products. Furthermore, banks are in too much trouble to resume reckless lending despite the recent bailouts. These bailouts have merely been a drop in the bucket. The banks must make sure that future loans will be repaid. Therefore, credit will continue to be what Congress is calling "tight", but what I would call more responsible.

Another misconception held by Congress is one that was put forth by a guest on CNBC yesterday who said that we need to stop housing prices from falling because Americans have most of their wealth tied up in their houses. Although this might have been true traditionally because people made down payments and were earning equity by paying down their principle on their fixed loans each month, it is no longer the case. The increase in equity of the last several years was nothing more than illusory. People’s equity in their homes is not real wealth unless they can sell their homes to willing buyers for the prices they think their homes are worth. Any “wealth” they may have in their homes is not theirs until they sell. Until they sell, the increase in value is only on paper. When homeowners “extracted equity” by taking out HELOCs they were not taking out their own money to spend, they were actually borrowing against their homes, the values of which could fluctuate.

Also, during the housing boom people were allowed to buy homes with no down payments. In many cases, people borrowed up to 125% of the "value" of their homes. Because they did not put any of their own money into the houses, they never had any of their own wealth in their homes to begin with. Those who took out loans over 100% even started out with negative equity. Also, many people used option ARMs and interest only ARMs, which meant that they were not necessarily paying any principle. In the case of option ARMs, many were actually ending up owing even more money than they had borrowed in the first place because, if they chose to pay less than the full amount of the interest, the unpaid interest was added onto the principle owed. Because people could not afford boom-time prices, stated income loans (or "liar loans") also became prevalent. One study showed that 90% of the people who took out these types of loans lied about their incomes. All of these risky products were used because people could not afford to buy houses with traditional loan products and down payments. These "creative financing" products allowed home prices to artificially increase to the point that they bore absolutely no reasonable relationship to incomes.

Thus, people were not really wealthy during the housing boom, they only felt wealthy. Houses do not create wealth because they do not produce anything of value. This is why they traditionally went up in price in accordance with inflation. Houses are merely places to live and should be bought when the cost of “owning” is close to the cost of renting. During the boom, housing prices went up because of: (1) lax lending standards which allowed people to borrow beyond their means and in some cases (liar loans) commit fraud, (2) legislation that encouraged banks to lend to risky borrowers or else be accused of redlining, (3) the Fed keeping interest rates artificially low which encouraged banks to lend to borrowers at lower rates without adequately pricing in risk, (4) a lack of down payments by recent buyers which would not only have given them a stake in the property but also a cushion during a downturn in prices, (5) homeowners who may have had equity but “extracted" it by borrowing against the "value" of their homes to make improvements, buy cars and big screen tv's, go on vacations, etc., and (6) tax laws that allowed sellers to keep the profits from their house sales tax-free if they lived in the homes for 2 of the last 5 years (therefore, many flippers/speculators committed fraud by lying on the paperwork about being owner-occupants to keep the profits tax-free when they flipped), etc. For all of these reasons prices were driven up artificially. Home prices no longer have any reasonable relationship to incomes. Therefore, they must and will come down. Congress can do nothing to stop it. The jig is up.

In fact, everything that Congress and the Fed are doing will result in even lower home prices. By devaluing the dollar, they caused an increase in food and gas prices which left people with less money to pay their mortgages, thus, causing more foreclosures and driving home prices lower. Higher food and gas prices also took money out of the hands of potential buyers, leaving them with less money to spend on home purchases -- again driving prices lower. Interest rates on mortgages have gone up because banks need to price in risk and cover their losses from the bust. Higher interest rates will also drive house prices lower. All of the unemployment we will be facing from the result of our economy centering around housing and consumerism will also drive foreclosures up and home prices down. Another factor that will result in lower prices is the oversupply of housing. During the boom, builders were building to meet demand by speculators, not real demand from people needing shelter. Thus, vacancy rates are the highest they’ve ever been. We have an oversupply of housing. Until demand catches up with the supply, prices will have to fall.

When I saw this article yesterday, I found it ironic that Congress is now trying to make sure that the bailout money will be used by the banks to make loans -- after they already passed the legislation with no such requirement. I guess they finally figured out part of what I was telling them -- that the legislation did nothing to guarantee that banks would resume lending. They still haven’t figured out, however, that more borrowing and spending is not the answer. Too much borrowing and spending is the problem.