The Hidden Side of Moral Hazard: What the Intelligent and Responsible Should Take Away From the Government's Response to the Housing Crisis

posted by Curt, on July 27, 2008 06:40 pm

We're only part way through the drama yet, but watching the government response to the housing crisis has been an eyeopener for me. It's made me realize that you should be wary making predictions about the outcome of a "game" based on the current set of rules because the rules can be changed mid-stream. The housing bubble, its crash, and the political response provides a good example. I became interested in the whole thing starting in 2003, shortly after I got married and was getting ready to graduate. My wife and I had some savings in the bank, and I had a decent job for a kid in college--but there was no way I thought that I was secure enough to buy a home. However, a substantial number of my friends were--many with no income outside of student loans or a part-time job that paid less than mine. All the lending excesses that were going on then are now well documented.

At the time, I just didn't believe the people saying that I could afford a home; perhaps in part because my own parents had some bad experiences with their responsible real estate purchases. I didn't think too much of it. I chalked it up to my risk-averse nature more than anything else. However, as time went on, I became more concerned that something was really wrong while I watched prices go up at an astounding pace. I like many others, was first worried that I would be priced out of a home. After just some basic investigation, however, I quickly realized that the whole thing was ridiculous and unsustainable. I just decided that I would wait until everything collapsed, and hoped that by the time it did I would be ready to jump into the market. I became a part of the wait-for-the-housing-crash crowd. As a group, I suppose that we fancied ourselves more intelligent than the average buyer and congratulated ourselves on knowing that the whole real estate bubble would come crashing down on itself. We knew that people wouldn't be able to afford their loans and that prices wouldn't go up forever. We knew that people were spending beyond their ability to repay. We knew that when the bills came do and appreciation slowed down, they would be in big trouble. And we were right about that.

But perhaps we weren't as smart as we thought we were. What most of us, including myself, didn't anticipate was a huge, government-financed bailout. Apparently, the bubble was too big to let pop. Perhaps it was too big to even let it slowly deflate. The government response has been massive. And while it remains to be seen whether it's enough to make a huge difference, there have undoubtedly been some that have been bailed out, and more that will be when Bush signs the housing bailout bill tomorrow. In my mind, I can hear them taunting me:

You thought you were smarter than us. Did you ever think that we saw the bubble too, realized how big it would become, and got in knowing that it was almost certain we'd be bailed out? Who's the one who's laughing now? You're now financing my extravagance with your tax money. You'll be paying for this one way or the other . . . don't you wish that you'd jumped in when you had the chance so that you could be bailing out yourself, rather than me?

Now, I don't regret my decisions. I'm comfortable, and in absolutely no immediate danger of financial overextension. I don't live like a pauper (at least I don't think so). We have plenty of food, and the financial and personal peace of mind that comes from knowing I've made good on all my obligations. I'm not ashamed to have people come to my home because it's too extravagant and my kids can walk on the carpet with wet shoes and I don't worry too much. That's a nice life. I value it more than granite countertops and a two-sink master bathroom or home theater. What I am suggesting is that it seems like it's no longer good enough to understand the rules that govern a game. The rules change. How can you make sound financial decisions when you don't know the rules that will govern your choices? You can't predict outcomes based on on changing game. Under the current "moral hazard" type of framework, you've got to predict what will happen under the present system, and then predict how that is likely to precipitate midstream change within that system in order to try and get the likely outcome. This to me seems to be quite a difficult, if not impossible, undertaking.

I don't think this is anything new, but it's a macro rule of life that I didn't understand before. I see it as the hidden part of the moral hazard problem. Everyone talks about how bailouts encourage irresponsible behavior. But, in my situation, I'm left wonder what they do to the responsible--those who have no desire nor inclination to engage in reckless behavior. Sure, we know that we end up paying for the bailout. But we're also left in a state where we're smart enough to realize what's responsible under the current system but, at the same time, are left uncertain about how we can responsibly proceed when the seemingly inevitable changes come.

So where does this leave us? Well, I'm one that happens to believe that there is a bigger rule-maker than the government, and that there are some basic rules of the game of life that can't be changed, no matter how much influence, lobbying power, or importance that one has. The law of the harvest, i.e. you sow what you reap, is pretty darn immutable (at least in the long run). Same with the golden rule. I'll plan my life according to those rules. But, beyond paying for them, the lack of predictability engendered by bailouts is certainly a frustrating thing.

filed in Economy and Politics

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