Bailouts and the Moral Hazard
At this point its fairly clear that the housing market is crashing. It’s also clear that the lending markets have tightened substantially. Many people are poised to have their homes foreclosed upon. Unfortunately I can’t help but cheer for this housing crash. As someone who is currently renting due to what I perceive as absurd prices, declining prices do nothing but benefit me. It’s an anomaly that prices in Massachusetts went up at all since the population actually decreased during the years of the housing boom. In economics speak, the supply of housing went up and the demand went down, this is supposed to result in decreasing prices. Obviously something was wrong and we are now finding out just what was wrong.
Not surprising, in the wake of foreclosures, there have been many calls for a bailout. Certainly there are arguments in favor of a bailout. Substantial wealth has been created by the housing boom and if the markets are left to their own devices its possible that most of that wealth will be destroyed. If the foreclosures continue many people will be forced out of their homes.
On the flipside, we see the problems with a bailout. People who really never should have been homeowners in the first place get a free ride at the expense of those who are not homeowners. Those who were irresponsible have been rewarded for their behavior, possibly leading them to expect future bailouts the next time they are irresponsible. This problem is described as a moral hazard. It’s been claimed that people simply did not know what they were doing, I think this is far from the truth. Public records searches on homeowners show far more than is typically reported: such as patterns of cashing out equity and second loans. In one well known case in the Boston area, the woman claiming she didn’t know what she was doing was actually a licensed real estate agent!
There are those who describe the Bear Stearns rescue plan as a bailout. I agree that it is a bailout but nonetheless the investors have paid a substantial price. At the beginning of 2008 Bear stock was trading at over $100 a share, it’s currently going for just over $10 a share, sure this is more than the $0 it would be worth without the bailout but its still a hefty price to pay for investors.
What has been proposed to bailout homeowners does not seem to involve any price/penalty to the homeowners. The plans suggest that lenders simply write off the lost equity and reduce the payments to a level that the homeowner can pay. The homeowner gets to stay in the house and pays nothing for their irresponsible behavior. While I’m not exactly sure of a solution, I know a bailout is not it. If there can somehow be a way to hold the borrower accountable for the entire loan we must do it. If there is no way the homeowner can ever meet the obligation, they must be evicted.
