Moral Hazard Everywhere

Here are my talking points for my Fox Business News interview.

Watch my interview.

  1. Why should all the bailout money be focused on financial institutions? It is seems a matter of fact but no one has really challenged the logic.
  2. We must act now to prevent the second wave of the credit crisis. The first wave was partially caused by people with jobs buying houses well beyond their means. The second wave will be people with prime mortgages who have lost their jobs. They are paying out of savings right now (and that accounts for the lull) — but savings will run out.
  3. Fed stress test had unrealistic 2-4% assumption for loan losses in prime mortgages.
  4. Prime is by far the biggest market. Close to $9T. Hence, every percent mistake in the Fed assumption is worth $90B. So a small error in prime loan losses could make many financial institutions insolvent.
  5. We can’t afford any more spending – hence, we should redirect some funds.
  6. Will be moral hazard problem (people want to be bailed out that don’t need to be bailed out). But not a valid critique of mortgage loan restructuing. The current policy has an even more extreme moral hazard problem. Financial institutions faced with coin flips where “head I win., tails you lose” — you being the American tax payer.
  7. Target: 1) responsible borrowers – those that put at least 25% down on their houses; 2) simple means test based on 2008 tax filing + investment portfolio information; 3) priority in the process to recently unemployed. Reckless borrowers should be foreclosed.
  8. Restructuring should be handled by bank or service provider — not the government or the courts. Not much has happened because little capital has been directed to the individual mortgages.
  9. Proactive action to head off second wave. All of this could have been done two years ago and muted the impact of the sub-prime problem.

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One Response to Moral Hazard Everywhere

  1. Pedro says:

    Professor, you have boldly address some very important points on this brief interview. I totally agree with the relative moral hazard approach. Regards, Pedro

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