I and other consumer advocates have been arguing for an effort to head off the coming new wave of foreclosures, primarily by writing down the principal of mortgages that were based on unrealistic, bubble-inflated home values. But we keep running into an argument against such a program that many seem to find persuasive: the idea of "moral hazard."
Back in November 2007, when the subprime mortgage crisis was starting to come into clear focus, National Public Radio summed up the "moral hazard" argument as "a concept any parent of a 5 year old can understand: Bail out someone who has engaged in risky behavior and you're likely to encourage that behavior in the future."
Back then, lots of experts warned that bailing out either lenders or homeowners would be a mistake for just that reason: If the lender reduced principal for struggling homeowners, it might encourage their neighbors -- possibly still making their payments, but finding it burdensome -- to walk away, or at least threaten to do so unless they get the same deal.
But we did bail out the financial industry to the tune of $700 billion, without much worry about moral hazard. And while no one much liked to do it, the government has now gotten most of that money back, with a net cost to taxpayers of only $25 billion. And the program did what it was supposed to do: stabilize the financial system and avert another Great Depression. All in all, not a bad deal.
And, as the film Inside Job lays out in disturbing detail, most of those whose reckless and self-serving actions helped tank the economy haven't experienced any serious consequences. Some companies, like Lehman Brothers, are no more, but individuals who oversaw dubious activities often simply moved to the next step in their career paths, often getting huge bonuses to help them along.
If it's okay to let these guys go merrily along, it's hard to get worked up about the alleged moral hazard in giving relief to homeowners in danger of foreclosure. The far more serious hazard, it seems to me, is this: When a homeowner who could have reasonably paid their mortgage at current market value experiences foreclosure, that results in a loss of wealth that extends far beyond the homeowner. Property values plummet, unemployment is impacted, and the decrease in property taxes collected by the municipality impacts vital services. The homeowner isn't the only one that loses when they lose their home, the whole community suffers. And given how many foreclosures are coming, that scenario will be repeated millions of times over.
Yes, the foreclosure crisis is messy, and yes, it's impossible to resolve it in a way that's neat and pretty. No one, including me, likes the situation we find ourselves in, but here we are. Get used to it. We need to bite the bullet and recognize that a failure to provide principal reduction will have far more disastrous consequences than if we act sensibly and compassionately -- and soon.
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