Moral Hazard, the Subprime Market and the Nanny State

Foreclosures tick up a bit, and government officials are falling all over themselves to save people from themselves. Ohio is planning on issuing a $100 million bond to bail troubled borrowers out. See this article in USA Today for details. And now, Freddie and Fannie already under significant pressure for their financial shenanigans, are rolling out new products to deal with the fall out.

Fannie and Freddie innovating to help out is not as big an issue for me personally. Though, I suspect the political pressure being brought on them has something to do with it.

Here is where the moral hazard comes in though. If states like Ohio, or probably California soon, or even the Federal Government spend tax dollars to essentially bail out borrowers who made poor decisions, then what is the incentive for those borrowers or any borrowers to do their due diligence and make sure they can afford a home? There is none. This was not a failure of the private market. People made bad decisions, and companies made bad decisions in extending credit. The rush of politicians to shield people and companies from their poor decision is one step further down the road of infantalizing the populace.

This is bad from an economic standpoint because of the moral hazard, and how it distorts future market decisions, and even worse from a policy perspective because it reinforces the idea that the government is the answer to everything.

So, maybe next time, I have difficulty paying the bills, I'll send a request to my buddies in Washington, they can pay it for me. We can call it an earmark, after all, there's no reason I should starve because I spent too much money going to Vegas. (ed: is it possible to spend too little money in Vegas?)

Subprime (Again....)

Felix Salmon over at his new blog points an article at Bloomberg, which I hadn't noticed. Fremont General, a large-sized originator of "subprime" loans, has recently sold several chunks off at a loss. The latest was a $2.9 billion chunk of loans, while we don't know the explicit quality of these loans, we can make a few assumptions here. First, Fremont sold these at a $100 million discount. Do the math and that is an expected loss of about 3.45%. If we make the assumption that this particular chunk of loans is representative of the market, then the so-called meltdown in subprime is not something to feared, it'll hurt, but it is not the end of the world.

Also, I would point out, this how healthy financial markets work. They discount and work through the bad stuff. Just as we did after the S&L crisis. In the apartment market we are already seeing that, with reversions of condo-conversions happening, and some minor REO stuff on failed conversions. There is significant amounts of "vulture" capital waiting to make a play.

Watch the subprime market, but if Fremont General is any indication, it won't be as bad as some are prognosticating.

More on Subprime

And this is what passes for analysis from Nouriel Roubini:

"This fairy tale spinned by free market supply side voodoo fundamentalism zealots will blame the otherwise appropriate current Congressional action on predatory lending for being one of the main causes of the credit crunch that will lead to a painful recession (as the WSJ editorial page recently claimed) while forgetting that predatory lending practices developed by free unregulated markets created the toxic waste that is subprime and near-prime mortgages.. This voodoo religion cabal will also incorrectly blame regulators"

I am not sure if this whole sentence qualifies as "analysis." I recognize that we as the blogging community are not all that filtered, but as an economist, we do like approach things from an objective manner. Roubini clearly does not, and lets his emotions color his analysis, which is very unfortunate. It may fire up his fans, but hardly leads to intelligent debate.


Dave Altig, over at macroblog covers this ground from a less excited perspective yesterday. The risk is two fold From a housing perspective, how long does the reduction in credit to the riskier borrowers last? And what effect does that have on housing demand? Secondly, does the default risk as Altig points out spread to commercial mortgages?


The answer remains... we shall see.


As a side note, apartments will likely benefit from the lack of liquidity in the subprime market. This will be very regional, but could spell good news for places like North Scottsdale, and other prime Class A buildings / Locations, who lost a lot of renters to conversions and for-sale housing.

More Thoughts on Subprime

Alex Tabarrok at Marginal Revolution hits the nail on the head on what really distresses the whole bubble blogger / subprime bear contingent. It comes through in their language (McMansions, Housing ATM, 'binge' borrowers, reckless, etc etc, ) (ed: we get the point) . It really is about expanded access to credit, that the poor and unwashed, might (gasp) actually be able to buy a house. As the Instapundit would say.... read the whole thing