The New York Times discovers the moral hazard lurking in the various plans to save homeowners from their bad investments. "Experts say it is difficult to devise programs to aid distressed homeowners without giving everyone else a reason to mail the keys back to their lenders," it reports. You think?
The story opens with Todd Lawrence, an airline pilot in Norwich, Connecticut, who "has a traditional 30-year mortgage that he has no trouble paying every month" but who "owes more on his house than it is worth, like millions of other people." Lawrence feels like a chump, continuing to pay his mortgage while his taxes go to more reckless people who overborrowed and have begun to miss their payments. Such homeowners can take advantage of government programs that reduce their interest rates and principal. "Why am I being punished for having bought a house I could afford?" Lawrence asks. "I am beginning to think I would have rocks in my head if I keep paying my mortgage."
Financial experts agree that there is some sort of hard, naturally formed mineral or petrified matter where Lawrence's brain should be. "From a purely economic standpoint, there's not a whole lot to be gained from staying," says one. Another "says he thinks just about everyone who is underwater and has few other assets should stop paying." The Times does note in passing that "many people…consider paying their debts a moral obligation."
The story closes with an unnamed homeowner who owes $350,000 on a house in a Los Angeles suburb "that is worth only $150,000." As a former Los Angeles resident who looked into the housing market there a few years ago, I find it hard to believe you can buy a house anywhere near L.A. for $150,000 even today, but never mind. The point is that the homeowner who owes more on the house than it's worth realizes he is more likely to get government help if he stops regarding paying his debts as a moral obligation. "I guess they are forcing me to deliberately stop paying to look worse than I am," he says. "Crazy, don't you think?"
Under John McCain's mortgage bailout plan, you don't even have to default. He is promising anyone with negative equity a fixed-rate, 30-year mortgage at 5 percent, with the principal reduced based on the decline in the home's market value. If you're lucky enough to have made a really bad gamble on rising home prices, this deal might be enough to root for a McCain victory.
But even the government's current mortgage assistance programs provide plenty of reason to grumble for taxpayers who don't qualify. "This is not about trying to create fairness," says a Federal Deposit Insurance Corporation official who is working with the Treasury Department on its latest homeowner rescue plan. "The goal is to keep people in their houses." The implication is that they don't necessarily deserve to stay in their houses, but allowing foreclosure would further undermine house prices, which in turn would make economic conditions worse. McCain makes a similar argument for his plan, although he also implies that homeowners are in distress through no fault of their own and therefore deserve taxpayer-funded assistance.
For all the talk of a "foreclosure epidemic," foreclosures remain rare. "Estimates are that foreclosures will surpass one million this year," the Times reports. That's a rate of around 1 percent. Although the overall rate is up from about 0.6 percent in 2006, the increase has been driven almost entirely by subprime borrowers in particular parts of the country. The government (OK, one guy at the FDIC) now concedes that digging them out of the holes they dug for themselves is "not about trying to create fairness." But is the claim that it's about reviving the economy any more credible?