Would A Sub prime Foreclosure Bailout Be Risky Business?

Posted on December 5th, 2007 by saman

They’re saying that any sub prime bailout for lenders and homeowners may be a “moral hazard” and “risky business.” Yes! There are many who don’t think the government, be it federal or state, should get involved in solving the current crisis. Critics call it a moral hazard based on the opinion that if you bail out someone who has engaged in risky business, you are encouraging them to do it in the future. Nevertheless, there are dozens of financial institutions in trouble in addition to all the homeowners. And if these companies fail, so might the US economy. Others argue that the government should do everything in its power to help out ailing homeowners and lenders, in the same way that it did for airlines and savings and loans in past years.

Should we subsidize risky behavior?

Many believe that doing so would be a big mistake and say that “bailing out the lenders is unconscionable” since they made a ton of money on sub prime loans and should now suffer the losses they have coming, because in a free market, you have to feel the pain and pay for your mistakes. Whether you subscribe to this opinion or not, many argue that it is important to understand that some companies are integral to the American economy and cannot be allowed to fail regardless of how they got to that point to start with. Meanwhile, more than ninety sub prime lenders have already gone out of business and the losses are already having a definite ‘ripple effect’ throughout the U.S. economy.

People also argue that many of the troubled homeowners got themselves into trouble by ‘fudging’ their incomes on loan applications and most of all by knowingly taking on a debt they really couldn’t afford. Some did, of course, but there were many who were hoodwinked into taking out sub prime adjustable rate mortgages when they could have qualified for safer fixed-rate loans and didn’t, because bonus-hungry brokers sold them a bill of goods. There were those, too, who didn’t know that people working for the lenders overstated their annual incomes without telling them. And, it was not legally necessary for lenders to help mortgage applicants understand all that fine print, understand interest-rate resets or to point out that they were committing to more than they could afford.

The worst part is that all those risky sub prime loans were bundled and sold to worldwide investors. The result of this is simply that America’s sub prime crisis is no a global scourge and it has shaken stock markets all over Europe and Asia.

How about rescuing the homeowners?

This seems to be split 50/50 when it comes to yes or no. The yes people say that the homeowners didn’t understand what they were doing and that the banks and mortgage lenders “pulled out all the stops” to persuade them to the contrary and close the deals.

Perhaps most important, if the 2-million additional loans that reset in 2008-2009 mostly fall to foreclosure, the fall out will depress the value of all the surrounding homes in the area. We’ve already seen how this can spread and effect everybody. If we can prevent this, and save billions of economic losses in the doing, is that a mistake?