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You know it has to be election season, because politicians of all stripes are making dimwitted proposals on how the Federal government can fix the U.S. economy.  I’ll ignore some of the crazier proposals, such as Newt Gingrich’s “moon colony” scheme.  Instead, let’s focus on Obama’s new home loan refinancing plan.  Obama’s plan would allow homeowners to refinance loans through the FHA and has an estimated cost to the Federal government of $5 – $10 billion.  Doesn’t sound so horrendous thus far, but the devil is always in the details.

Here’s where it gets problematic:  in order to pay for the program, Obama proposes a new tax on the banks.   At first blush, this is something that most American voters probably won’t give much thought to.  After all, it’s the banks paying the tax, not them.  But that’s where they would be incorrect.   If the banks are paying the tax, then the tax gets passed on to consumers in the form of higher credit costs.

With higher credit costs, the demand for housing will fall, as fewer people will want to take out loans in order to buy homes.  And a lower demand for housing, of course, results in more downward pressure on housing prices.   This, in turn, harms the banks (not to mention homeowners who are actually making their payments!) and leads to less credit available in the economy.  Less credit available means fewer loans to small businesses, which tend to be net “job creators”.

Basically, the plan would try to solve one problem by creating several more problems.  And this is generally the problem with centralized schemes to “fix” the economy.  It was, after all, the Federal government that helped fuel this mess to begin with, with Greenspan’s loose monetary policy, and a host of housing subsidies, meant to entice people into taking out big loans to buy a home, whether or not they could afford to take the risk.

And make no mistake about it — buying a house is a huge risk.  It’s not different than buying into the stock market.  In many ways, it’s much riskier, because the average homeowner is taking on at least 4-to-1 leverage, and normally more like 9-to-1 leverage.  At the height of the boom, banks were even allowing people to take on 33-to-1 leverage!  Yet, the Federal government continues to insist that this is a low-risk venture that everyone should gladly pursue, regardless of income or risk tolerance.

The Solution

For the record, the best solution to the “housing crisis” right now is no solution.  While housing prices might still decline a small bit from here, we are finally starting to see a pick-up in construction, which is the important thing.  Our high unemployment is a result of little demand for construction, which resulted from an excess supply and inflated prices. With prices finally low enough, new homes are getting built again, and we’re seeing the unemployment rate gently fall.

Given this minor recovery, the last thing we need to do is enact some dimwitted scheme to “fix” something that the private sector is fully capable of solving itself, given enough time.   Btw, this isn’t the only dimwitted housing proposal coming from the Obama administration recently.  As investment author Tom Brown notes, the Treasury is modifying HAMP in a way that will now bail out housing speculators.

But it’s an election year, so I doubt this will be the last poorly thought out economic policy proposal we’ll see.  Politicians are always under pressure to “act”, even though they do not understand these issues very well.  And that’s the problem — the private sector is filled with “experts” who live and breathe these issues every day of the year.  The US Federal government is filled with generalists who don’t understand the issues at all.