Wikinvest Wire

Niall Ferguson on moral hazard

Tuesday, March 03, 2009

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.


Vespucian said...


What about his point that the mistake is not likely to be repeated (at least in housing)? I think he's right that bat-sh*t crazy stuff like interest-only, negatively amortized JUMBO's won't be seen for a very ,very long time.

Tim said...

He's right about that - my point is that the moral hazard is manifested elsewhere (i.e., it rhymes).

Anonymous said...

I remember hearing stories six or seven years ago how organized crime just picked up and moved from the stock market to the mortgage market. Where are they headed next?

Anonymous said...

Utterly stupefying how otherwise intelligent folk fail to understand where the capital to waste on bailouts must come from. First, it isn't communal property. Second, it is mostly being taken from future generations.

I'm Not POTUS said...

Being certain of something is not the same as being correct or right about it.

No shite shirlock that this dog won't hunt anymore. They will come up with another way to perpetuate moral hazard.

You can only sell "Pet Rocks" once.
Next time you have to call it something else.

Lins said...

Tim - an additional HUGE potential problem...that seems not to be the number of homeowners that refied over and over again (capturing credit card debt/cars/hd tvs/new furniture/appliances...god only knows you name it). These people have wrapped their "spending" in their homes and now qualifiy for modification!!!??? I think this a moral hazard that we can't even begin to quantify and yet another reason I'm totally against bailouts for home owners!

Anonymous said...

"moral hazard only really matters if bad behaviour is likely to be repeated."

But if bad behavior gets rewarded, why shouldn't it get repeated?

Heck, I didn't behave badly.

But if bad behavior gets rewarded, then next time count me in.

And no more mr. Nice Guy, too.

staghounds said...

I was an IDIOT not to overbuy a house! Debt free moron, that's me!

barnaby33 said...

Ultimately the argument for foreclosure and against any kind of homedebtor bailout is that each homedebtor you save is a responsible buyer you sacrifice.

I still can't afford a home. I'm in the top 20% income bracket and I can only afford in marginal neighborhoods in San Diego.

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