Imagine walking into a car dealer, seeing a shiny new sedan on the floor, asking the salesman “what’s its price?”, and having the salesman ask you how much money you earn. You answer $80,000 and he says “half a year’s pay — $40,000.”
As you stand pondering, you overhear the salesman talking to another customer about an identical car. That customer says he only earns $50,000 per year. So, the salesman quotes him $25,000 — half of his annual pay.
Sound absurd ? It should because its commercially and legally problematic The practice is called price discrimination based on ability to pay, and any merchant who tried it would probably be stoned by the public while being hauled off to court.
This technicality didn’t faze Team Obama in the development of their mortgage foreclosure plan. In fact, price discrimination based on ability to pay is the plan’s central operating principle.
Consider the example that Team Obama circulated on the day the President unveiled the plan. A person (call him Able) is holding a $220,000 mortgage at 6.5% with a 30 year payback term. Able’s principal and interest payment is about $1,370 per month, or $16,365 per year.
Team Obama’s magic ratio of payment to income is 31%, so if Able earns more than $53,000 then he doesn’t qualify for a government induced loan modification. Let’s assume Able makes just over $53,000 and doesn’t qualify.
Able’s neighbor (call him Skipper) lives in an identical home with an identical $220,000 mortgage at the same terms – 6.5% for 30 years. But, Skipper only makes $40,000 per year and is falling behind on his payments.
Enter Team Obama’s loan modifiers. Since Skipper only makes $40,000, Team Obama says that he should only be expected to pay $12,400 — 31% of his income — towards his mortgage. No problem. The lender – subsidized by the dwindling number of taxpayers – just lowers Skipper’s interest rate to about 4% (3.93% to be precise) and he’s officially modified. And, if Skipper doesn’t start skipping payments again, he gets a check for $1,000 for each of the next 5 years. Is this a great country, or what?
Let’s look at Skipper’s loan modification another way. Assume that the lender holds the interest rate constant at 6.5% — the same rate that Able is paying. How can the lender get Skipper’s payment down to $12,400 ? Simple. Write off about $53,000 of Skipper’s principal balance — getting it down to about $167,000 – which amortized over 30 years at 6.5% crams the annual payments down to the magic 31%.
In other words, Able and Skipper bought the identical houses at the same prices. Because Skipper didn’t earn enough to make the payments, the lender, in effect, gave him a $53,000 price rebate to make it affordable. We taxpayers then give him an additional $5,000 rebate if he makes his reduced mortgage payments. So, Skipper gets the house for $162,000.
Able – since he is able to pay — gets no rebate. He still owns his house at the original price — $220,000.
Whether Skipper’s mortgage is repriced by adjusting the interest rate or by reducing the outstanding principal balance, the economics are the same. It is price discrimination based on a buyer’s ability to pay – a morally bankrupt tactic that should be illegal if it’s not.
Otherwise, why not sell cars that way? Or for that matter, why not force all merchants to price all their goods proportionate to customers’ incomes? Why should I have to pay the same price for a can of Coke as Warren Buffet does? That’s not fair, is it?
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