Moral Hazards Grow: Renegotiating Mortgages

The moral hazard argument has been dismissed in recent weeks as the financial crisis deepened. Basically, it’s so bad now we can’t be concerned about the moral hazards of the bailouts.

But should we be blowing off moral hazard?

Suggestions have been made, most recently by Senator McCain, to have the government buy all the “bad” mortgages and renegotiate them with homeowners so they can afford the payments.

It’s a nice idea in concept, right?

But if my neighbor is in trouble on his house payment and he gets to renegotiate, why can’t I?

If he paid $500k and I paid $500k for the house next door but now they’re both worth $400k- we’re both in trouble. If he renegotiates down to $400k - where he can “afford” the payment- what does that mean for me?

I’m screwed. I’m left with a $500k mortgage on a house that is worth much, much less.

I would then have the incentive to simply stop paying the mortgage, get into “trouble” and then renegotiate my own loan with the government.

Soon, it means that the government must bail out EVERYONE. The incentive to stop paying the mortgage would be too great.

What’s the cost of “Renegotiation”?

A second question to ask is- how would we afford this renegotiation? There are at least a trillion dollars of Alt-A mortgages- of which a big percentage will get into trouble.

How will the government pay for trillions of dollars of mortgages?

No one knows. No one says how we’d pay for it.

But nevermind. The country has endless money, doesn’t it?

Beware of the moral hazard. It can have unintended consequences.