Thursday, March 5, 2009

More on Loan Modifications and Moral Hazard

I’ve previously argued that moral hazard risks are overrated for a number of reasons (see this post). Niall Ferguson has a piece in the Australian which identifies another really good reason not to worry too much about moral hazard in the context of granting loan modifications. You need to evaluate how often a similar set of circumstances is likely to occur, and if a reoccurrence is unlikely, moral hazard risk is low. An excerpt:

The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities…Another objection to such a procedure is that it would reward the imprudent. But moral hazard only really matters if bad behaviour is likely to be repeated. I do not foresee anyone asking for, or being given, an option adjustable-rate mortgage for many, many years.