Mark A. Calabria pours cold water on the proposal to make Fannie Mae and Freddie Mac give all underwater borrowers an automatic reduction in their interest rate.
The thinking, as illustrated by that world class economist Matt Yglesais, is “with a lower monthly interest payment, an indebted household can pay down other debts more rapidly. A less-constrained household will increase its consumption of goods and services.” What this misses is that a mortgage is one person’s liability, but another person’s asset. By replacing a mortgage that yields 6% with a mortgage that yields, say, 4%, you decrease the value of that mortgage (or mortgage-backed security). So whatever increase in consumption you get from making the borrower better off is reduced by making the investor worse off. There’s no magic in wealth redistribution.
Here. The market mechanism coordinates mortgage borrowers and investors to determine what those rates should be. Mandating it give a free ride for one party and coerces the other party. Mr. Yglesais does not take into account what is not seen. Mr. Calabria did.