Treasury Secretary Henry Paulson today stood strong against rising calls for a taxpayer bailout for the struggling housing industry. Paulson rejects the notion that the only way out of the housing mess is for government to engineer a giant bailout using taxpayer money. In an interview yesterday, Paulson said that a bailout would more likely rescue reckless lenders, investors, and speculators than be of any real assistance to the stated targets of such a plan-struggling homeowners who cannot afford the rising mortgage rates they now face. Paulson and the Bush Administration are in favor of encouraging mortgage lenders to voluntarily ease up on borrowers that are current in their payments but probably will not remain so as their rates adjust upward. At Ockham, we always appreciate fiscal solutions which are grounded in free market principles rather than those based on Keynesian interventionism.

Data released earlier this week demonstrates that the housing market is worsening, as the fourth quarter 2007 S&P/Case-Shiller national home-price index fell 8.9% from a year earlier. This represents the biggest such decline in 20 years. Furthermore, mortgages guaranteed by Fannie Mae and Freddie Mac declined in number by 0.3% last year, the first year over year drop in 16 years according to the Office of Federal Housing Enterprise and Oversight. Paulson himself estimates that last year some 1.5 million Americans were foreclosed on and he expects that number to climb to 2 million in 2008, whereas a normal rate would be about 650,000 homes a year.

Armed with such bleak data in an election year, numerous politicians are anxious to put their name on a bill that will save homeowners. However, is that what is best for either the economy or said homeowners? Barack Obama would like to set aside $10 billion to help homeowners avoid foreclosure and to assist first time home buyers. Hillary Clinton would put a 90-day moratorium on foreclosures and also freeze rates on adjustable rate mortgages for 5 years. These proposals are not sound economic policy but rather an attempt to pander and glean votes and they will not be able to reverse market forces. Paulson referred to plans such as these and those being considered in the House of Representatives: “I’m seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes. Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street.” In sharp contrast to the bi-partisan support afforded the recently-passed economic stimulus package, debate over a homeowner bailout plan presages a fiercely partisan battle in Washington.

Paulson is correct to trust in the efficiency of the free market to work through this crisis. Housing slumps are not a unique economic circumstance. When prices drop, buyers are incentivized to in enter the marketplace and the situation self-corrects until it reaches equilibrium again. Government intervention, no matter how well-intended, only interferes with market forces and results in complications and distortions which often have unintended consequences-typically worsening and prolonging the correction. That explains why some of the greatest economic minds in the country-Bernanke and Paulson for instance-believe that any government intervention should involve the original lenders and be targeted to a specific class of intended beneficiaries, the well meaning homeowners current in their debt but at risk going forward. Financial markets do not always go up and, in situations such as these, the best fiscal policy is to “first, do no harm”.