Amidst housing prices in free fall and the rising tide of foreclosures, Washington is on the brink of yet another policy disaster. And the one man who has shown clarity and restraint is beginning to crumble.

For the last two months, proposals to bailout the subprime mortgage market have become the new political football in the upcoming presidential election.

As a result, we are in danger of ignoring the moral imperative which lead people into this mess in the first place.

In her March 21 editorial column at Bloomberg.com, Caroline Baum summarized the Beltway perspective.

” During the housing boom of the last five years, people with bad credit histories, many of whom lied about their income and nature of employment, got mortgage loans they weren’t qualified for to buy houses they couldn’t afford. Now that house prices have stopped rising, and the house can’t be refinanced or sold at a profit, Congress wants the taxpayer to subsidize the mortgages so these folks can remain in their unaffordable houses. “

Specifically, Sen. Chris Dodd (D-Conn.) advocates a multi-million dollar aid program for about 2.2 million households at risk of defaulting and losing their homes. Sen. Hillary Clinton (D-NY.) has been advocating a moratorium on foreclosures and an increase in the maximum income level for Federal Housing Agency loan assistance.

Both of these proposals are fundamentally flawed. As Baum alluded to above, both of these plans force prudent taxpayers (read middle-class Americans) to assume an unfair tax burden, subsidizing those who bought houses or assumed debt they could never hope to repay.

What’s worse is that the pro-bailout sentiment has infected the McCain campaign, who has up until recently has approached the issue from an objective point of view.

On March 26, a day after Clinton first made her proposal to suspend foreclosures, Sen. McCain (R-Arizona) responded succinctly, saying that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.”

Therein lies the heart of the issue.

The problem with a government bailout isn’t just the tax burden.
The problem isn’t that a bailout would reinforce artificially inflated home prices by keeping irresponsible borrowers in homes they can’t afford.

The greatest problem of all is a bailout would work and we’d become used to it.

If a bailout plan is approved, we will be entering the greatest moral hazard of the industrialized world. We will create an environment where speculative buyers expect to have their losses covered in full by the federal government and in turn, by the fiscally responsible taxpayer.

On April 10, after being roasted in the press, McCain backpedaled away from his earlier comments, alluding to aid for homeowners rather than banks.

Now matter how you package it, McCain has now flip-flopped and it’s the wrong move. Empathy is not part of the cure; neither is a government handout.

Additional reading:
“Don’t hate me because I’m solvent” – NYT
“Debt may be a factor in suspicious house, car fires” – LAT