In what is otherwise a very nicely done piece by historian Niall Ferguson, whose PBS documentary "The Ascent of Money" should be considered required viewing for every individual on the planet (particularly economists and bankers), comes this rather stunning view of moral hazard as it relates to fixing the housing mess.
The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities. About 2.3 million US households face foreclosure and that number is certain to rise. For example, $US97 billion of $US200 billion of option adjustable-rate mortgages will reset in the next two years. The average monthly payment will increase by more than 60 per cent. As a result, up to eight million households could be driven into foreclosure, driving down home prices even further. Few of those affected have any realistic prospect of refinancing at more affordable rates. So, once again, what is needed is state intervention.
The idea of modifying mortgages appalls legal purists as a violation of the sanctity of contract. But, as with the principle of eminent domain, there are times when the public interest requires us to honour the rule of law in the breach.
Another objection to such a procedure is that it would reward the imprudent. But moral hazard only really matters if bad behaviour is likely to be repeated. I do not foresee anyone asking for, or being given, an option adjustable-rate mortgage for many, many years. The issue, then, is simply one of fairness.
Paraphrasing Mark Twain, the housing bubble kind of rhymed with the stock bubble...
My take on things over the last ten years is that the housing bubble was made much worse than it otherwise might have been as a result of the millions of individuals who just sat by and watched equity markets rise, then fall, then get rescued by one percent interest rates.
I can't remember how many wild-eyed individuals I talked to who didn't know a thing about ETRADE or Ameritrade back in 2002 or 2003, but who "understood" the real estate market.