McCain’s Bailout: Moral Hazard or Economic Salvation?

October 15, 2008 • Commentary
This article appeared in the Los Angeles Times on October 15, 2008.

During the Oct. 7 presidential debate, John McCain proposed to spend $300 billion of other people’s money to buy “bad” mortgages. This is a very misguided proposal. Even if the myriad details were handled correctly, McCain’s “American Homeownership Resurgence Plan” would be a very costly and risky form of intervention.

The campaign argues that falling house prices and economic uncertainty have combined to put some Americans in the unenviable position of having mortgages that are worth more than the value of their homes — sometimes known as being “underwater.” This certainly is true, though it does not mean that people no longer can make their monthly payments. Nonetheless, there obviously are some Americans who no longer can afford their monthly payments. Moreover, people with underwater mortgages have an incentive to “walk away” from their houses.

While these are genuine concerns, McCain’s cure is worse than the disease. His bailout has several shortcomings:

  • The bailout would reward banks and other lenders who did not exercise proper judgment and risk management. If taxpayers are forced to buy bad mortgages, financial institutions — in effect — are rewarded for their incompetence. Equally troubling, the bailout would send a signal that banks and other mortgage lenders can be similarly reckless in the future because of the precedent that McCain’s plan would create for further handouts.

  • The scheme would punish people who behaved responsibly. Notwithstanding all the trouble in housing markets, most homeowners are not in trouble. These are the people who did the right thing. They saved for a decent down payment. They purchased a house that was within their means. And they have been paying their mortgages. The bailout, for all intents and purposes, would penalize these people by making them pay for the less responsible people who got no‐​down‐​payment loans based on the rather reckless assumption that home values would climb every year.

  • The plan would encourage people to stop paying their mortgages. One of the most perverse features of the McCain bailout is that the responsible people would suddenly have an incentive to become irresponsible and stop paying their mortgages. There are many American households that are living in homes that are underwater, yet they are keeping their promises and paying their bills. Under McCain’s plan, though, they would feel like chumps for doing the right thing.

  • The bailout would reward speculators. Some people saw the housing bubble as an opportunity to make quick profits by buying and selling homes. There is nothing wrong with such speculation — assuming that the people seeking quick profits (or those financing the speculators) also are willing to accept quick losses. McCain’s bailout would socialize the costs of bad speculation. This is morally offensive, but also economically foolish because it would encourage imprudent levels of speculation in the future.

There are other problems with McCain’s proposal, including the big‐​picture issue of whether we hurt economic performance and American competitiveness by subsidizing over‐​investment in housing. What McCain apparently does not understand is that more government almost always is a recipe for making a bad situation even worse.

The bailouts already adopted by President Bush and Congress were bad ideas, and they have not helped the economy. McCain’s mortgage bailout is a bad idea, and it will not help the economy. And the mortgage foreclosure freeze proposed by Barack Obama is a bad idea that will not help the economy (actually, it’s a terrible idea because it undermines the rule of law and is akin to the banana‐​republic policies that have turned nations such as Argentina and Zimbabwe into basket cases).

It does not matter if bad ideas are proposed by Republicans or Democrats. Policies that increase the burden of government and interfere with the free market lead to negative results. The current financial turmoil is largely the result of misguided government policies such as easy money by the Federal Reserve and corrupt subsidies from Fannie Mae and Freddie Mac. Bailouts of any kind are a further step in the wrong direction.

About the Author