Tuesday, September 23, 2008

Moral Hazard

Three years ago, my brother-in-law Ira, an accomplished blacksmith in North Carolina, called to ask my advice regarding a home equity loan. He was considering buying an adjacent property and needed about twenty-five thousand dollars. Ira owned his own small house and forge, which were free of any mortgages or liens, and he was old enough to be pretty much on a fixed income. Now, equity lines go up and down with the prime. So I figured, why not a 30-year fixed mortgage? Then he would know precisely what he'd be obligated for, month-in, month-out, and might even pay off his credit cards.

Ira's local bank, Wachovia, was not willing to hold this kind of paper anymore, which did not exactly surprise me. I had been an editor at the Harvard Business Review in the late 1980s when the securitization of debt, including (after the S&L crisis) mortgage debt, was first being touted as the next big thing for retail banking and the word "global" began to mean something serious. So--purposefully, and with a certain pleasant curiosity about a maturing financial product I had seen at its conception--I started calling around to various mortgage companies: 800-numbers that got me to offices (with the background noise of call-centers) in Texas or Minnesota or Hawaii.

I seemed always to be talking to "senior associates" (mostly named Mike, for some reason) who sounded more like ingratiating Direct TV salesmen than the laconic mortgage brokers I had filled out stacks of pages for when I bought my first home in Brooklyn back in 1979. Would Ira need a home inspection (I thought I should tip him off to tidy up some)? Not necessary. Would he need to bring proof of income? No, he owned the home outright, right? Could the points be added to the loan amount? Of course. Oh, but the mortgage company would not consider a loan of less than seventy thousand. (The commissions and transaction fees would not be worth the trouble, one of the Mikes confessed. Was I sure Ira could not use the extra money?)

This cheerful offer, of course, got my attention. There was no way Ira could afford such payments and no reason, given his circumstances, for the loan to have been entertained. I was skeptical, but not greatly alarmed--not the way I was when, say, West Bank settlers went to the hills above Nablus in 1976. This offer seemed to me just another way for the Mikes of the world to cash in on a boom, you know, like the real estate agents in LA a few years before. I felt vaguely happy for them. Now, of course, I see this was the DNA of the monster that ate Wall Street and is still hungry. (Ira took the smaller equity loan.) 

MY POINT, WHICH is not terribly original, is that Mike had no incentive to judge Ira's capacity to repay because he was not exposed to what economists (pretentiously) call "moral hazard": he had no stake in the risk of a default, only a positive benefit from the size of the loan. As with the managers and share-holders of Fannie Mae et al, he profited from the upside, while the downside was, in effect, insured by all of us.

Then again, I am writing this (quietly) from my wife's bedside at Mass General, where she is recovering from knee-replacement surgery, funded in large measure by Medicare. If the hospital suggests discharge on Wednesday instead of Tuesday, will I say no? The extra five grand is, shall we say, insured by us all; there is a moralizing hazard, too, which I would feel a little odd indulging in just at the moment. By the way, thirty-percent of what we pay to medical providers during our lifetimes comes in our last year of life. Imagine the size of Medicare's "bail-out" when boomer spouses have to decide on when to pull the plug, with others (that is, "us all") footing the bill?

LET ME BE clear. I am not upset that the bail-out is happening. It had to, just like the S&L bail-out did. The commonwealth is, among other things, a kind of insurer of last resort, the enabler (writes Adam Smith) of "commerce in general." I am not even upset that our Mikes made a buck. I am vaguely sorry, of course, for the people who, unlike Ira, recklessly took easy mortgages, or put "extra" money into mutual funds. But these people are now creating a good day for young home buyers (like my children), bankruptcy lawyers, etc. Nor am I particularly nervous about global capital not flowing back to our shores again, and fairly soon. What will the freshly-minted MBAs--the Mikes of the Kuwaiti or Chinese sovereign wealth funds--do with ten trillion dollars over the next decade? Invest in Ghana?

What I would be upset about is five foot leaps over seven foot pits, the continuing (mostly Republican) pretense that the prerogatives of commonwealth are temporary or do not legitimately exist: that the insurance the commonwealth provides comes along with dumb freedoms parading as market freedom. (Imagine a bail-out for car insurance companies in a roads system without traffic lights.) Paul Krugman shrewdly observes that the commonwealth has a right to own and manage a good part of what it invests in. People arguing for accountability should not fatuously be accused of socialism.

If insurance is a good thing, and government is a legitimate insurer, then we must end (to the extent that we can) triangular relations where the gainers of service have no stake in the cost of service; where people profit without moral hazard. This means more than new, harsh financial regulations for mortgage buying or rules for banking. It means, also (finally), single-payer health insurance, as in Canada, for example, where the buyers of health care negotiate with providers of health care in behalf of patients. It means government funded high speed train systems funded by gas taxes, so we are not all stuck with the catastrophes from global warming. It means more public universities, so we don't face an unemployment catastrophe in a generation. It means, in short, citizenship and social contract.