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Moral Hazard and Housing Bailouts

Published by Lawrence Roberts | December 26th 2008 | Views:

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All bailout measures have embedded within them serious issues of moral hazard. Both lenders and borrowers were extremely foolish during the real estate bubble. To bail them out at the expense of the wise and prudent will discourage fiscally responsible behavior and encourage wild risk taking and speculation.

For instance, let's say both you and your neighbor bought a house in 1998 before the bubble inflated. You both paid $200,000. You sacrificed and paid down your mortgage in the intervening 10 years, and now you owe $150,000 on your house.

Your neighbor was lured by the free money accumulating as appreciation and took out an additional $400,000 in home equity lines of credit and refinancings and lived the good life. This neighbor was driving around in new cars, taking vacations, buying expensive toys and pretending to be rich.

Now you owe $150,000 on your house, and your neighbor owes $600,000. Your neighbor cannot make the payments and is asking for a government bailout, principal reduction and whatever other handouts he can get. So now, you the taxpayer, is going to be asked to pay off your neighbors bills. You, who was responsible while you neighbor was not, are being punished for your responsibility while your neighbor has no consequences.

What will stop your neighbor from doing this again?

What will stop you from doing this next time?

There is no bailout program currently proposed or enacted that does not have this moral hazard issue.
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