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During one of the Presidential TV debates, Representative Ron Paul was asked whether a person who does not choose to purchase health insurance coverage should later be refused medical treatment if he/she is unable to pay for it, even if it is life-threatening. Rep. Paul—a physician who opposes the new "Obama care" health insurance mandate—responded (to loud audience applause) that people should accept the consequences for their decisions. In other words, the needy person should be allowed to die.
This was a particularly egregious example of the currently fashionable economics term "moral hazard"—the idea that a person should pay for their voluntary bad decisions, whether it be failing to purchase health insurance or defaulting on their home mortgage. In both cases, so the reasoning goes, people should have known the risks, and "irresponsible behavior" should not be rewarded. This would only encourage more of the same.
There is, in fact, much evidence that our innate sense of justice and fairness includes the principle of "just deserts"—due rewards for merit and, conversely, equivalent punishments for our transgressions and the harm we may inflict on others. For instance, many Americans are still angry about the taxpayer bailouts for the Wall Street banks in 2009 followed by a quick return to giving multi-million-dollar bonuses to the bank executives who had caused the financial meltdown. It seemed they were being rewarded for their malfeasance.
There is also much evidence, both in economics and in psychology, that our behavior is influenced by various "incentives"—the potential for rewards and the risk of penalties. Thus, health insurance co-pays are often used to deter the overuse of covered services. Likewise, good health habits may be rewarded with lower premiums, a good driving record may result in lower auto insurance premiums—and vice versa. And gambling casinos can be depended upon to keep your money when you lose.
But many situations in life are more complicated, especially when it involves public policies that encompass a large class of our citizens. There is an old saying "you can never do just one thing"—meaning that there may be many indirect and unintended consequences associated with your actions, and these unanticipated effects may outweigh what you intended to do. Thus, a moral hazard may be the lesser hazard in some cases.
A prime example is the current debate over government assistance for distressed home owners. Early on, the Florida Attorney General opposed the idea with the warning: "Don't reward those who simply choose not to pay their mortgage." More recently, the CNBC TV commentator Rick Santelli opposed the new $26 billion package of mortgage relief measures saying that we should not "subsidize the losers' mortgages." Indeed, is it fair toward those who have conscientiously continued to pay their mortgages to aid those who have not?
What these and other critics seem to be saying is that, if a homeowner fails to make the payments on their mortgage, it's their own fault. But wait a minute. The mortgage mess in this country is a lot more complicated than that. The vast majority of those who have fallen behind or defaulted on their mortgages are victims of the financial meltdown and the worst recession since the 1930s.They lost their job or saw their income dry up.The few who "chose" to stop paying their mortgages are already paying a price with a bad credit rating that will follow them for years to come and perhaps hinder their ability to get a future job. Do we refuse to help the many who involuntarily stopped paying their mortgages to avoid rewarding the undeserving few? Why not screen the applicants to weed out the "cheaters"?
Then there are the many millions of homeowners who have not defaulted but are struggling with high payments and can't refinance at today's lower interest rates because the current value of their home, thanks to the recession, is worth less than the mortgage. Helping these "underwater" mortgage holders to refinance is hardly a case of moral hazard.
Of course, there are also homeowners with mortgages they should never have taken on in the first place. Some no doubt can be blamed for these mistakes. But what about the predatory mortgage brokers who knowingly seduced people who were not qualified to take on "toxic" mortgages that they could not pay, or who trapped mortgage applicants with "teaser rates" and well-hidden escalator clauses? Who is really to blame?
There is also another fairness principle that needs to be considered here. Most of us are more than willing to help those who have what could be called "no-fault" needs (to borrow an insurance industry term)—needs that are not the victim's fault. Hurricanes, tornadoes, earthquakes and tsunamis are obvious examples. We don't blame the victims in these cases. Nor should we blame the victims of an economic tsunami.
Indeed, most of us are inclined to give people a second chance if they are willing to learn from their mistakes. We do this for corporations when they are allowed to declare bankruptcy and start over. And even our all-knowing credit agencies allow people to rebuild their credit scores over time.
Finally, there is the huge indirect benefit that the $26 billion mortgage relief program could provide to every homeowner if it helps to revive our moribund housing market and increase home values.
So let's keep moral hazard in its place and stop the hypocrisy of applying it to homeowners while excusing the banks.
