Cui bono?

There's a mildly interesting tiff taking place on the web right now. On one side are those who are confused, and more than a little outraged, to see people complaining about the bailout on the grounds that people who bought too much house shouldn't be rewarded for their folly. I estimate that none of these people, plus or minus five percent, are homeowners with fixed mortgages on sensible, boring properties.

On the other hand, there are those who are outraged that their neighbors who bought too much house are being rewarded for their folly.

On a moral level, I'm with the latter group: people who qualify for the bailout are mostly people who really should have known better; they will now be bailed out mostly by people who did know better.

On a macroeconomic level, placing blame is somewhat counterproductive. Those who have sensible, fixed mortgages will not really be made happier if the credit crunch turns into a liquidity crisis, the economy plunges into a deep recession, and they lose their jobs, forcing them to default on their sensible, fixed mortgages.

In my opinion, a willingness to tolerate high levels of moral hazard--to give people second, and third, and eighth chances without inquiring too closely about how they got into so much trouble--is one of the great strengths of the American system. It makes us happier as people, and it lets our society make use of human capital that is too often left moldering in (metaphorical) debtor's prison under the more punitive and moralistic regimes that prevail in the rest of the world.

Comments

Qui Bono indeed.

I'm sure you wouldn't approve of the government confiscating their capital gains had the gamble been a good one, so why should the government pay the price when it turns out to be bad? And believe me, this is a government bailout, no matter how Bush and Paulson spin it.

http://www.nypost.com/seven/12072007/postopinion/opedcolumnists/ws_disastrous_mortgage_fix_767611.htm?page=0

Part of believing in free markets means believing that people should bear the consequences of their actions, for good or ill.

Posted by Christina | December 7, 2007 4:14 PM

The point, Christina, is that the wise and cautious either pay for the bailout, or pay much more for the collapse of the economy. It's a devil's choice where the criteria should be which costs less, not who gets away with murder.

Posted by Justin JJ | December 7, 2007 4:23 PM

And as morally satisfying as poverty being the reward of foolishness might be, I'm sceptical that the next time an opportunity to gamble comes along, the population generally would look back on this as a cautionary tale. People's memories just aren't that long.

Posted by Justin JJ | December 7, 2007 4:25 PM

communist in libertarian clothing, you are.

Posted by Jim | December 7, 2007 4:29 PM

What are the costs, beyond cash outlays, of the gov't propping up house values though?

As a renter and prospective home buyer in the next couple of years, I for one was looking forward to some bargain shopping. But when homes are being kept off the market by the bailout, the odds are less in my favor. And to the extent that the banks need to cover their losses on the current batch of mortgages, I'll get stuck with a worse rate when it comes time to buy. So I get shafted there, too.

Posted by Matt B | December 7, 2007 4:36 PM

I'm sure there's a middle ground whereby we can prevent macroeconomic crisis and at the same time make people who "bought too much" feel the consequences of their decision.

My idea is: bail out homeowners on the condition that for the next 20 years, they pay a 10% higher marginal tax rate, which would go into a fund that would pay out* to anyone who rented or took on a standard fixed mortgage over the time in question, after the bailout money is repaid. Since there is hard, conclusive evidence that raising marginal tax rates does not reduce the amount of taxable labor in any way, whatsoever, the gain in tax funds should cover it.

-Idiots keep their homes.
-Banks get repaid.
-Idiots are worse off than if they had been sensible.
-People who were responsible get a bonus, which sets a good precedent.
-No taxes on innocents are necessary.

That looks like win, win, WIN.

*For those of your born before 1960 or have IQ under 90: Read this as "would go into a big bucket of cash, and then they'd mail checks to..."

Posted by Person | December 7, 2007 4:38 PM

If it's a small price to pay compared to the alternative, that would imply that it is only affecting a small segment of the population. Otherwise it would be a large price to pay.

If it only affects a small segment of the population, I don't think we need to worry about all of us losing our jobs because of a recession as the result of people with ARMs being unable to afford their dreamhouse at the age of 30.

I'd go even further to say if you can't pay your bills that's good for the housing market because prices are way too high as it is. And I bought my house last year so it's not like I'd benefit from the pricing dropping.

But prices are too high and more foreclosures may help to bring housing prices back in line where they should be. I have no dreams that houses will become super cheap, simply because lumber is expensive thanks to protesters and lawsuits against timbercutters, but there's no reason why we should have to prop up housing prices so some people can continue to live in a house they can't afford.

Posted by sm | December 7, 2007 4:53 PM

"Part of believing in free markets means believing that people should bear the consequences of their actions, for good or ill."

Well said, Christina. Some wish to minimize the problem of moral hazard, but it is a serious one. The S&L debacle in the United States shows how costly it can be. For a till more dramatic example, look at the East Asian crisis of the late 90's, where implicit government gurantees helped to fuel speculation and eventually an economic downturn that demolished the middle class.

Bailing people out who took riskes and lost might seem compassionate, but it is a perilous policy in the long run.

Posted by rwe | December 7, 2007 5:01 PM

it lets our society make use of human capital that is too often left moldering in (metaphorical) debtor's prison under the more punitive and moralistic regimes that prevail in the rest of the world.

Being held responsible for your failures (in some form, even if it is bearing the cost of insurance) could very well provide a much stronger incentive to productively use human capital.

Posted by bil. | December 7, 2007 5:07 PM

It seems that we go through this credit crisis every few years. Why is this?

Remember the farm crisis. The farmers were unable to keep up payments and all their equipment and land was being auctioned off.

Then it was savings and loans.

Here in Texas the banks were crashing like crazy in the mid 80's. They loaned money on over valued oil reserves.

Is there some basic flaw in our banking/credit system? Is securitization causing lenders to go loosey-goosey?

Comments?

Posted by Bill | December 7, 2007 5:15 PM

Bailing people out who took riskes and lost might seem compassionate, but it is a perilous policy in the long run.

But this is just what's in question: how many of the people who bought houses they couldn't afford and now risk losing them, looked back at, say, the S&L scandal and said to themselves "I know I'm taking a huge risk here, but history shows that the government will bail me out if it goes bad." The people most likely to foolishly risk a subprime mortgage, who most deserve to be allowed to fail, are exactly those who wouldn't look at economic history and bet on a government bailout.

The object lesson of allowing people to fail is of dubious value if it has no deterrent effect in the future. If it has no deterrent value, it's probably not worth the extra economic costs incurred.

Personally, I'm against the bailout because I want the correction in housing prices caused by widespread foreclosures so that I have a prayer of actually owning a home one day. But a lot of those pushing the moral hazard line seem more motivated by a 'just desserts' approach rather than the rational appreciation of the economic environment that they wish had been more prevalent earlier.

Posted by Justin JJ | December 7, 2007 5:27 PM

Is there some basic flaw in our banking/credit system? Is securitization causing lenders to go loosey-goosey?

Setting aside the obvious explanation that human greed overwhelms common sense with depressing regularity, is it even possible to regulate the economic environment to prevent widespread excessive risk-taking, without hobbling the economy as a whole?

Posted by Justin JJ | December 7, 2007 5:29 PM

A couple of things here:

(a) As Slate and other articles/posts have so often noted since this plan was announced, this is just one facet of the liquidity crisis/credit crisis. SVA’s and other exotic securities are suddenly a mystery to all (even their owners) as to what they are worth. Secondly, corporate credit is going to come under pressure as we move forward.

(b) As for the bailout, if we all lived in our own little vacuums, then I am all the more willing to let those who took foolish gambles or overspent suffer the consequences of their losses. However – we do not live in a bubble, and the economic impact from letting the housing boom unravel will impact all of us, and not in a positive way. I still think housing prices in many communities will continue to fall, regardless of the bailout or not. And this bailout, for all intents and purposes, was not about propping up property values, as much as it was trying to put a stop to foreclosures, at least enough so that banks, investors and wall street can get a handle as to what the damage is. Prior to the bailout, the biggest risk was not that there was a decrease in real estate values, but that no one, not even the people who created or bought these investments knew what the value was anymore, because no one could predict the total impact from the credit/liquidity crunch. Without the bailout, there was a feeling that it was a cycle that self-perpetuates itself, causing more losses after more losses with no end in sight (i.e.- the impact from the current wave of foreclosures depresses the economy enough as to cause a new wave of foreclosures, resulting in a further economic decline).

Unless you are independently wealthy, with inflation protected investments, you should be happy the government stepped in and helped at least give the markets and economy enough of a pause as to allow us to see what the damage is.

Posted by Brad | December 7, 2007 6:01 PM

Mr. Sensible Fixed Rate mortgage here. Since I have friends who are getting burnt by the rising rates, I'm conflicted.

On one hand, I am annoyed that they are getting bailed out of stupid decisions. Some of these people have gone bankrupt twice, have abysmal credit scores and generally demonstrate no responsibility for their own finances beyond "woo hoo, I got $100 extra in checking, let's go out to a fancy steak dinner"

On the other hand, they have nice kids, and are nice people, and being foreclosed upon is no fun (I had to help a neighbor move out of their foreclosed-upon house).

But it does leave me wondering why I should be so careful with my money. Why I put a good chunk into my 401k each month, etc. At the end of the day, the government will make the problem go away. So why not raid my equity and my 401k so I can take that dream vacation and spend a year or two wandering the country?

Posted by jb | December 7, 2007 6:02 PM

How about those of us who are currently saving up for down payments on a house? We'd get stuck paying for the bailout (and guess who doesn't get to deduct their housing expenses!) which will artificially prop up the prices we get to pay for our houses. Joy.

Also, a rate freeze mandate, which looks like the most likely serious intervention (the Bush plan doesn't really do much either way since it is relying on voluntary freezing) would make the credit crunch worse, since the available credit will remain tied up in the loans with the frozen rates.

The alternative of bailing out the debtors with public funds won't work either. The bailout will be financed in the short run by gov't borrowing, which will tighten up credit by soaking up available funds for lending.

The credit crunch is inevitable because the assets in question are overvalued. The economy has to adjust to the fact that there is less total value out there in it that was believed. No policy can magic value out of nothing, but allowing forclosure where it make sense will allow the overvaluation to clear with the lenders and borrowers eating the cost rather than spreading it out into everybody elses interest rates. The policy that should have the least impact on credit availability in general is to allow the foreclosures to proceed where the loan can't be succesfully renegotiated - no bailout, no freeze.

Posted by MattXIV | December 7, 2007 6:07 PM

I disagree.

The US is wonderful IN SPITE OF our "willingness to tolerate high levels of moral hazard".

I agree that the extreme opposite is no good (e.g., debtors' prison).

However, current bankruptcy laws ALREADY strike the right balance. The mortgage fixes being discussed probably make the system worse, on balance... Propping up already-inflated real estate prices (due to tax incentives)... And scaring off lenders.

If you are worried about a credit crunch, you should worry about the fear of government unilaterally renegotiating terms. That creates a big risk premium for lenders...

So the government's solution puts sand in the gears two ways:
1. It props up R.E. prices by keeping people in homes they can't afford (ala NYC rent control apts)
2. It reduces available credit to potential buyers as lenders now anticipate a risk of government watering down their contract rights.

Posted by Stephen W. Stanton | December 7, 2007 6:13 PM

There is nothing wrong with an adjustable rate mortgage (it is usually a better deal than fixed)

There is nothing wrong with a subprime loan

There is something wrong with loaning people who have no equity and inadequante finances money to buy an overprices home. A policy to keep those same people in those houses is lame

Posted by Jozef | December 7, 2007 7:26 PM

What about "bailing the people out" by having the government loan them the money? They can recover it through additional taxation and through confiscation of social security and medicare benefits.

That way the credit crisis is avoided, and the people who behaved irresponsibly still get stuck having to pay for what they did.

Posted by Dan | December 7, 2007 8:26 PM

Actually, the problem is that the risk on the loans was never accurately measured/priced in the first place. If the banks had been forced to hold on to them, they would either never granted the loan, or they would have priced them much higher (and the individuals now suffering wouldn't have bought them, period.)

Also, as mentioned before, banks coasted on a reputation of existing fiduciary responsibility which encouraged lenders to believe that the banks gave them good advice as to what loans they could afford.

For those who are in such a tizzy about the bail-outs, they are the sort of people who would be willing to see 10% of the houses in their neighborhood boarded up in foreclosure with the accompanying effect on tax basis, local property values, and crime levels, rather than see a penny go to their neighbors. This is really a case of cutting off your nose to spite your face.

Posted by grumpy realist | December 7, 2007 9:02 PM

grumpy realist,

Any bailout that would be big enough to save a large number of distressed homeowners would also be big enough to cripple the US economy. Plus, house prices will need to come down to reasonable levels sooner or later if the housing sector is going to recover anytime soon. For several years in some places, prices were going up 20% a year, resulting in the Bay Area absurdities documented at burbed.com or in suburban MD's cruddy 50-year-old unrenovated starter houses in iffy neighborhoods with iffy schools for 450K. I realize that some areas are exceptional, but until home prices go down to the traditional 3X income, the market is going to continue to stagnate.

Posted by Amy P | December 7, 2007 9:22 PM

what I find mildly amusing is the utter lack of understanding as to what the Administration did, which is almost precisely nothing.

The only thing the admin. did was to clarify that servicers that already have the CONTRACTUAL right to modify mortgages will not get into REGULATORY trouble by being ever so slightly more aggressive in doing the mods. (See Calculated Risk for the long version.)

Tastes Great! Less Filling!

I'll bet that in 10 years from now, some bright economist will analyze the effect of this policy and find that between 0 and 3% of people who could possibly have been helped by the policy were actually helped, and further find that the effect of the policy on stablizing housing prices was also minimal.

In other words, renters, don't worry. Housing prices should bottom out plenty low by 2010. But if you've found a place you love and you can afford the fixed rate mortgage and you've got a stable job, BUY! It's not just an investment, it's your home fer gods' sakes.

Posted by Francis | December 7, 2007 9:23 PM

Everybody commenting here has complained about moral hazard on the part of the buyers, but let's not forget about the other end of the transaction. The lenders (organizations that make loans because they're in business to make loans) basically decided, “hey, let’s write a loan to someone with no income, no job, no assets!”, and apparently thought that this was a great idea. Sure, the buyers weren’t making great decisions, but I expect that the professionals making these loans on a daily basis ought to be held to a higher standard than home buyers who take out loans on a one-or-twice a decade basis.


Once in a while, can the businesses and investors face some disapproval for market hazard, too?

Posted by moral hazard goes both ways... | December 7, 2007 9:25 PM

Grumpy,

they are the sort of people who would be willing to see 10% of the houses in their neighborhood boarded up in foreclosure with the accompanying effect on tax basis, local property values, and crime levels

I don't for one second believe that would happen, and here's why: because there are still an swful lot of people who want houses but can't afford them because all of the irresponsible jerkoffs buying houses THEY can't afford ran the prices up. If there are massive foreclosures, prices will drop -- and those families will swoop in and buy those houses at the new, more sensible prices. I'm not choosing between bailing out my neighbors or living in a blighted neighborhood -- I'm choosing between bailing out my neighbors or swapping them for a less irresponsible set of neighbors.

And, "moral hazard"? Your post presumes it is possible to make an immoral loan. I don't think it is, so long as the terms are specified up-front. A banker is not your mommy. If there was anything immoral about the way these loans were given out, it is solely that the shareholders in the corporations MAKING the loans were getting screwed by the company's employees.

Posted by Dan | December 7, 2007 10:16 PM

"On the other hand, there are those who are outraged that their neighbors who bought too much house are being rewarded for their folly."

While I don't doubt the truth of this, it's crazy. Each house that gets put up for sale decreases the property values around it. This is some kind of perverse, altruistic spite. "I want my neighbor out on the street, even if it means my house loses value!"

Posted by Njorl | December 8, 2007 3:19 AM

Yes, few people will be helped by this, and its a damn good thing

Servicers by the way, do not have a legal right to unilaterally renegotiate terms of the loans. They can only do so in cases of distressed mortgages. Why the hell would I buy mortgage-backed securities yielding, say, 6.25% if the servicer can arbitrarily lower or freeze the rates on the loans. There will be plenty of lawsuits, believe me.

Also, the banks that are participating only plan to modify loans they have sold into securities. If the mortgage stayed on the bank's books it does not get modified! This is preposterous, but I'm sure that ditz running the FDIC insisted on this - she being a big proponent on this "fix"

And no, Njorl, people don't have altruistic spite. Despite what the leftist mantra is, people can readily perceive and express what is in their own positive and negative economic interests. Nobody really wants the dolts down the street to get foreclosed. They just know that if people who have lousy credit, are in a house they have no equity in and cannot afford, and are generally financially reckless people, well , people understand that there is no free lunch and if those people are living like that then the rest of us must be paying for it somehow. People can correctly deduce that much.

Posted by Jozef | December 8, 2007 8:19 AM

Threads like this are the reason why I read Megan's blog regularly -- to remind myself that libertarians are almost invariably also greedy, selfish sociopaths.

Posted by Alan | December 9, 2007 3:09 AM

Here's a neat little twist, who owns your mortgage after the issuing bank bundled it up with others and sold it as a mortgage backed security. Several court findings in Ohio have ruled that neither the holders of the security nor the issuing bank can foreclose on a defaulted mortgage because the court cannot determine who owns the mortgage. So basically, if you don't default on your taxes your house is free. So I'm wondering how many homes are not really secured with a mortgage that can be identified. I see pigeons and roosts in the future.

Posted by bob | December 9, 2007 5:33 AM

They just know that if people who have lousy credit, are in a house they have no equity in and cannot afford, and are generally financially reckless people, well , people understand that there is no free lunch and if those people are living like that then the rest of us must be paying for it somehow. - Jozef

And yet posters on blogs are unable to explain just exactly how. Interestingly, libertarian blog posters appear also to mostly feel that the terms which someone gets on a loan are somehow that person's neighbor's business. Because "the rest of us must be paying for it somehow." I generally agree that in many cases, one's economic arrangements may also be one's neighbors' business, but this is not an argument I expect to see voiced by libertarians.

Posted by brooksfoe | December 9, 2007 8:59 PM

Once in a while, can the businesses and investors face some disapproval for market hazard, too?

Of course they can, and do. The difference is that there's nobody going around saying, "Boo hoo, poor banks, we should feel sorry for them," so there's no need to argue against that point by noting that they made stupid/greedy decisions.

Threads like this are the reason why I read Megan's blog regularly -- to remind myself that libertarians are almost invariably also greedy, selfish sociopaths.

And, of course, the bizarre leftist notion that wanting to take money other people have earned makes you generous but wanting to keep the money you've earned makes you greedy.

Posted by David Nieporent | December 9, 2007 9:27 PM

And, "moral hazard"? Your post presumes it is possible to make an immoral loan. I don't think it is, so long as the terms are specified up-front. A banker is not your mommy. If there was anything immoral about the way these loans were given out, it is solely that the shareholders in the corporations MAKING the loans were getting screwed by the company's employees.

Dan, you misunderstand what "moral hazard" means. It doesn't refer to people making "immoral loans." It refers to the situation where you take risks because you know that someone else will pay for them if they go badly for you.

If you're a bank, you won't ordinarily make a risky loan. But if you think the government will guarantee the loan against losses, you will.

Posted by David Nieporent | December 9, 2007 9:31 PM

I object to the assumption that everyone who is in trouble today is an idiot and a fool. I was in the housing market a couple of times between 2001 and 2006, and what I remember is this: real estate agents telling everyone that renting is stupid and the home-ownership is the only financially-responsible way to obtain housing; mortgage bankers never saying "no"; experts on CNBC and CNNfn announcing every day that real estate is a great investment, and that those in the market should get in before its too late; the constant fear that by waiting, prices will forever go beyond our reach; not to mention that cultural bias in favor of ownership and "staking your claim," as home-ownership is a non-negotiable part of the American dream: if you're a veteran, here's a VA program to let you buy a house for nothing down, if you're a teacher, cop, or firefighter, here's another program to help buy a house with nothing down; if you're otherwise useless to society, here's an FHA loan to help you buy with almost nothing down. What the critics forget is that everyone was persuaded that by buying a house, even if it stretched their budget for a few years, they were doing a wise thing, not a risky thing.

(I've got a 30 year fixed, by the way.)

Millions of people were essentially screwed by financial experts and economists who, history shows, never, ever, ever know what they're talking about.

Posted by anonymous home owner | December 10, 2007 3:10 PM

What the critics forget is that everyone was persuaded that by buying a house, even if it stretched their budget for a few years, they were doing a wise thing, not a risky thing.

Hence, they're idiots and fools, since those are the only kinds of people who let the yapping of people who are paid on commission override financial reality.

I'd trust my accountant to tell me what kind of mortgage I could afford, but not anyone who stands to profit from my stupid decisions.

Posted by MouseJunior | December 10, 2007 7:42 PM