PIMCO on the bailout: “A handout to the fool”

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If you’re up for some pragmatic, pro-bailout, big-picture thinking, check out this interview with PIMCO economist Paul McCulley. I’ll summarize and highlight, but encourage you to read it for yourself.

McCulley’s take on real estate right now is that no-money-down, underwater homeowners are making a rational business decision by walking away from their mortgages (where have we heard that before? From readers of this blog). ‘When you have no skin in the game ... it’s eminently rational to go into early payment default.’ This, McCulley argues, is creating a deflationary spiral in home prices.

One problem with a deflationary spiral like this, he argues, is that smart buyers (of homes) refuse to buy into it. Who wants to catch a falling knife? So prices continue to fall. But won’t investors buy the homes as rental properties at some point? McCulley says prices are so far above that point that the decline would be hellish: ‘That would conceptually be your floor, but that is so far away from here that the economy would have to go through absolute hell to reach that point.’

The solution? Like many others, McCulley looks favorably on the Barney Frank proposal, in which banks would write down problem loans rather than foreclose, and then the government would guarantee new loans at lower amounts, in hopes of keeping underwater buyers from walking away. Is it a bailout? McCulley says it is -- it puts taxpayers are risk in the likely case that the re-written loans go bad. McCulley: ‘.. The inequities smell to high heaven, and that is one of the huge problems in dealing with it. It runs against the streak of basic fairness in a lot of Americans. You’re going to provide a handout to the fool. The fool is going to be rewarded and I, the taxpayer, will be put at risk at the margin for that handout to the fool. When all I did was exactly what I was supposed to do. Where is the fairness here? It’s a hard question to answer.’

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Hat Tip: TW