Moral Hazard Argument Re-Surfaces amidst Foreclosure Rescue Plan
Nov 17th, 2008 • Posted in: NewsSome predict that homeowners will intentionally default on mortgage payments in order to qualify for bailout; in related news, banks, automakers and other firms come to Washington hat-in-hand
WASHINGTON
The massive and unprecedented bailout of the U.S. financial system raised a variety of ethics issues in last week’s news.
Foremost was the resumption of debate about the moral hazard dilemma — the question of whether rescuing companies and individuals deeply in debt rewards irresponsible financial management and encourages reckless borrowing and lending.
That question was examined in a TIME analysis of last week’s decision to allow Fannie Mae and Freddie Mac to modify hundreds of thousands of mortgages for people who currently can’t meet their monthly payments.
TIME reports that the program is designed to help the highest-risk borrowers, and kicks in once homeowners have missed three payments. The monthly payment is then reduced to 38 percent of gross income if the borrower can illustrate some form of financial hardship as well as proof of income.
“They’re saying to everyone out there, don’t make your mortgage payment, be 90 days late, and then we’ll help you,” Bruce Marks, CEO of the Neighborhood Assistance Corporate of America, a nonprofit that works with servicers to modify mortgages, tells TIME.
The Los Angeles Times echoes a similar view, quoting investment manager Peter Schiff: “In a classic case of unintended consequences, the plan will encourage homeowners to rearrange their finances to qualify for the benefit,” Schiff says. “Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices…. The intentional reduction of income is also a possibility. In many cases, dual-income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work-related expenses will likely exceed the after-tax value of the lost paycheck.”
Meanwhile, a variety of firms lined up for government assistance last week, as Friday marked the deadline for many businesses to apply. CNN reports that while the Treasury’s $250 billion capital purchase program is designed only for banks, other types of firms were attempting to convert their structure and qualify for a thrift or bank charter.
The auto industry also came to Washington with hat in hand, with the U.S. Senate poised to take up a proposal to bail out General Motors, Ford, and Chrysler. Reuters reports that the Senate measure would allocate $700 billion to help Detroit survive its financial crisis. In return, the government would get an equity stake in the car companies and enforce limits on executive compensation.
Sources: San Francisco Chronicle, Nov. 16 — CNN, Nov. 14 — Reuters, Nov. 14 — TIME, Nov. 12 — Los Angeles Times, Nov. 11 — MarketWatch, Nov. 11.
For more information, see: Related Newsline story, Nov. 10 — Related Newsline story, Oct. 27 — Related Newsline story, Oct. 20 — Related Newsline story, Oct. 14 — Related Newsline story, Oct. 6.
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