The Principal Of Moral Hazard
Yesterday Ben Bernanke suggested that banks and other mortgage holders need to consider "principal reduction" in order to keep the housing bubble inflated. Well, the last three words are mine, but the idea that lenders should reduce the principal that borrowers owe on loans is his. His reasoning, I believe, is that pushing rate resets on ARMs off a couple years or simply lowering the interest rate on a mortgage won't be enough to keep the housing bubble from deflating. Statistics are showing that the majority of mortgage defaults are occurring before the rates reset.
In other words, defaults are occurring for two primary reasons. First, there are speculators walking away from homes that failed to increase in value, preventing them from refinancing to pull out more equity to pay the mortgage. Second, there are unfortunate home buyers who were empowered by loose lending standards and inflated valuations from tame estimators to get in over their heads. Which leads us to the principal of moral hazard, and how it applies to the reduction of principal.
People living in a democracy, even a heavily socialized democracy like all of those of the West have become, like to think that bad behavior has it draw-backs. It's accepted by pretty much everybody that gamblers can't expect to come out ahead all the time. If you live in a state with a casino industry, and that industry began to suffer, laying off employees and paying lower taxes because the gamblers were getting tapped out, you wouldn't expect the state government to simply give the gamblers money to keep the casinos going.
But that's exactly what the government is talking about doing when they offer to subsidize or guaranty changes to mortgage terms in order to help out homeowners, by which they really mean to prevent banks from failing. The bail-out is couched in terms of helping American homeowners, but in truth, it's all about helping out the financial industry speculators. Homeowners who got conned into overpaying for houses SHOULD walk away from their mortgages, every additional dollar they spend is throwing good money after bad. And those of us who didn't speculate on housing shouldn't have to foot the bill for the gamblers, but of course, we'll have to in the end. We're already paying through losing our savings to inflation, as the Fed has lowered the interest rate to laughable levels and intends to keep going. Reduction of principal clearly creates a moral hazard for all future financial transactions.
In other words, defaults are occurring for two primary reasons. First, there are speculators walking away from homes that failed to increase in value, preventing them from refinancing to pull out more equity to pay the mortgage. Second, there are unfortunate home buyers who were empowered by loose lending standards and inflated valuations from tame estimators to get in over their heads. Which leads us to the principal of moral hazard, and how it applies to the reduction of principal.
People living in a democracy, even a heavily socialized democracy like all of those of the West have become, like to think that bad behavior has it draw-backs. It's accepted by pretty much everybody that gamblers can't expect to come out ahead all the time. If you live in a state with a casino industry, and that industry began to suffer, laying off employees and paying lower taxes because the gamblers were getting tapped out, you wouldn't expect the state government to simply give the gamblers money to keep the casinos going.
But that's exactly what the government is talking about doing when they offer to subsidize or guaranty changes to mortgage terms in order to help out homeowners, by which they really mean to prevent banks from failing. The bail-out is couched in terms of helping American homeowners, but in truth, it's all about helping out the financial industry speculators. Homeowners who got conned into overpaying for houses SHOULD walk away from their mortgages, every additional dollar they spend is throwing good money after bad. And those of us who didn't speculate on housing shouldn't have to foot the bill for the gamblers, but of course, we'll have to in the end. We're already paying through losing our savings to inflation, as the Fed has lowered the interest rate to laughable levels and intends to keep going. Reduction of principal clearly creates a moral hazard for all future financial transactions.
posted by Morris Rosenthal | 7:56 AM
<< Home