Anyone ever heard of the term “Moral Hazard?”
by Tom on July 14, 2009
in Market Musings, banks
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. (definition according to Wikipedia).
So what does that have to do with the article below? Let me lay out a scenario for you:
John and Jane Smith bought a house in San Diego in 2006. They paid $650,000 for it and put $32,500 down when they bought the house. They are paying, between principle, interest, taxes and insurance, approximately $5500 per month (hypothetical situation). Jump forward to now and the house that they owe $615,000 on is now worth $400,000. John and Jane plan on retiring in that home so they are “toughing it out” and making the payments.
Suddenly, they find out that due to a new program from the government, they can default on their loan and then rent the house back from their landlord for substantially less than what they were paying.
So, now we have a situation where we have a borrower who is faced with a choice:
1. Continue to pay $5500 a month and hope that within the next 15 years, his property value rebounds enough so that his approximately $200,000 in negative equity disappears and he actually has some equity to show for his investment.
2. Take a few months and make sure the rest of his financial affairs are in order and then default on his loan and work out an arrangement to lease the house back from his lender. He can turn around and lease the property back for $3,000 a month less than what he was paying in payments.
What sort of incentive is there for a borrower in a situation like that to keep making their payments? We’re discussing some very dangerous programs that are going to really mess with the fabric of society if we keep them going.
Tom Vanderwell
Obama mulls rental option for some homeowners-sources | Markets | Markets News | Reuters
NEW YORK, July 14 (Reuters) – U.S. government officials are weighing a plan that would let borrowers who have fallen behind on their mortgage payments avoid eviction by renting their homes instead, sources familiar with the administration’s thinking said on Tuesday.Under one idea being discussed, delinquent homeowners would surrender ownership of their homes but would continue to live in the property for several years, the sources told Reuters.
Officials are also considering whether the government should make mortgage payments on behalf of borrowers who cannot keep up with their home loans, tapping an unused portion of a $50 billion housing aid kitty.
