As someone who is hoping to buy a home in about a year, I am angry that so much fuss is made over current homeowners. Congress is working to prop up housing prices by preventing more foreclosures, which takes money out of my pocket and gives it to those who chose to ride the current wave. It should be called the Housing Unfairness Act of 2008.

The assertion here that we can discount as a cause the lack of comprehension and/or information on the part of borrowers because similar mistakes were made by better educated parties is logically flawed. It is entirely possible, and in fact plausible, that these concurrent mistakes were made for distinct reasons: borrowers did not understand what they were signing, and bankers, hedge fund managers, etc. were overtaken by greed. Naturally, it is possible that members of both groups made decisions for either reason, or for a third reason or some combination of reasons. The point is that the argument that where the same decision has been made by two parties it must have been for the same reason is facile. Having done a (very) small amount of legal work in the subprime mortgage sector, my impression is that ignorance and confusion, and not irrational optimism, are very often at the heart of poor decisions.

Furthermore, the application of moral hazard as applied to borrowers here lacks sophistication. When evaluating whether a particular bailout action is likely to create a moral hazard, it seems important to consider at least three questions: first, whether actors are likely to engage in this sort of behavior again (regardless of the bailout), second, whether affected actors will understand the bailout well enough to exploit it in the future, and third, whether the bailout will in fact shift the cost-benefit analysis for actors significantly enough to change behavior. In the case of subprime mortgages, I doubt that the first two questions suggest that a moral hazard has been created: even where borrowers would be engaged in subsequent mortgages (or financial transactions of similar magnitude), it is unlikely that they would be confident enough in their understanding of the government's action to rely substantially upon it in the future. The third question is most dispositive. For borrowers, the experience of mortgage foreclosure and the accompanying helplessness, fear, stress, and uncertainty can be so devastating that government relief would be unlikely to encourage them to continue taking risks; it is possible to provide relief without incentivizing risky behavior. The man who is saved on the operating table from severe injuries suffered during a car crash is nevertheless likely to wear his seatbelt and drive the speed limit for some time afterward.

Becker writes, “Abusive treatment is awful, but still the vast majority of children abused do become law-abiding and responsible adults.”

Yet a high percentage of violent criminals experienced significant neglect or abuse during their childhoods. Similarly, a higher percentage of severely neglected or abused children commit violent crimes than those who did not suffer such treatment. Consider a similar use of statistics - a large percentage of smokers never develop lung cancer. That hardly proves that lung cancer is unrelated to smoking. While severe childhood neglect and abuse do not legally excuse criminal conduct, such a background should be a factor to be considered by courts when determining a sentence (within the sentencing range set by the legislature).

(Also note, a different question is whether severe abuse or neglect occurred or whether the defendant is fabricating such allegations. That is a factual determination to be made by the court and is completely separate from the question of how to weigh that factor when determining a sentence.)

I've heard these arguments for a non-interventionist government before, but I don't buy them.

This essentially boils down to a question of utilitarianism: does the good effects the "lender-of-last-resort" policy outweigh the bad patterns that might form, with investors taking much larger risks. I argue that they do, absolutely.

I don't really see any evidence that a hands-off policy of the Federal Reserve does make investors more cautious. The last bubble was the dot-com bubble, and that burst spectacularly, without the Federal Reserve stepping in to rescue failing companies (at least, not to my recollection). That didn't slow down the sub-prime bubble one bit; you'd think wall street would've learned their lesson, but apparently not.

And really, when faced with the choice of letting Bears Stearns go down in flames, with potentially disastrous consequences for the market, I'd argue that it is the duty of the central bank to step in, simply to stop a domino-effect that might lead to a new depression.

It's such a wonderful blog full of wisdom.

I'm sorry, bu on many cases, I have to disagree. For people who are not (the favourite discussion budy of) a World-class leading law scholar, contracts are impossible to understand. An entire industry rely on this incomprehension: lawyers. Part of this industry is law colleges. If the law was easy to understand for anyone with an IQ higher then 80, Judge Posner's insights wouldn't be needed.

More generally, I think that you are too harsh on many people because some behave poorly, and others are dishonnest. Behavioural economics has piles of example from generally economic students (not the brightest bunch, as you know from teaching to them -- but a fair sample of representative "honnest man") showing bias, misunderstanding and easy influence.

I almost was the victim of a classical phishing scam today: my computer was stollen yesterday, and en e-mail warns me of "Surprising activity on your PayPal account" --- wouldn't you fall into that trap? Thankfully, my browser comes with warning pop-up. Looking at it more carefully, I recognised the simplest phising case; honnesty is limited, but our attention is even rarer. An economist of all people should not consider that trust is over-rated, and ecourage people into hiding important elements in thick, unreadable contracts. You should realise that understanding is the rarest ressource, and encourage having the risks clearly explained in bold, red, large font. Scammers and reasonnable investors would be sorted out this way.

The moral hazard that is not "lurking", but blatant in the present financial crisis is that the decision-makers of most financial institutions gain if the institution shows a profit in the period and do not lose significantly if it makes a loss. Whatever the official regulatory structure of the markets, that set of incentives will lead to the institutions taking more risks than they would if the decisions were taken by the beneficial owners. That is to say, risk will always be underpriced. Governments cannot and should not protect beneficial owners from all the effects of their fool-hardiness, but Congress (and other legislatures) might consider a simple retrospective Bill making Directors and responsible corporate executives liable to pay back to the corporation all benefits other than salary received over (say) the past three years, should the corporation fail to meet its obligations. The main effects would be on future behaviour, but it might mitigate the present sense of injustice felt by, for example, shareholders in Bear Stearns and creditors of other, lesser, failed institutions.

While I have about as much sympathy for defaulting borrowers as I have for bank robbers, as an investor I would also hope that capitalism could somehow provide me with a bank that made it a high priority to avoid being robbed and also to avoid lending money to borrowers who were unlikely to pay it back.

It seems, though, that we are still in the Middle Ages of capitalism. Just as peasants in the Middle Ages needed governments but hadn't yet figured out how to compel the government to act in the interest of the entire population rather than the government leaders, individual investors have yet to figure out how to compel the top management of financial firms to act in the interest of individual investors rather than the top management. Just as kings in the Middle Ages enriched themselves while making poor leadership decisions, top management of financial firms enrich themselves while also making poor leadership decisions.

We keep hearing from the conservatives how top management is only compensated so richly because they deserve it. Well, looking at this mess in the financial sector, I'm finding it hard to believe that top management deserves their lavish compensation. Sure, kings in the Middle Ages could always point to a worse king and say "If I wasn't compensating myself so aggressively, I'd be as bad as that other guy." The thing is, when the founders of the USA finally got around to devising a better form of government, the better form of government wasn't just that the kings got even more compensation than in the Middle Ages.

Ultimately, it's not about checks and balances or regulation. It's about attitude. Until the public gets real about the limitations of corporate leaders in the same way that the founders of the USA got real about the limitations of government leaders, we'll be stuck with a system where the corporate leaders get rich and everyone else suffers.

There is an error of logic, common in newspaper reasoning: the assumption that 'responsibility' is mutually exclusive. There are two ways that the word is commonly used: responsibility to perform an act (such as mowing the lawn), and responsibility for a condition (such as the condition of your children).

Responsibility for acts is naturally mutually exclusive: if one person acts, another need not. Responsibility for conditions is not so straight-forward. Of course, if you are writing a contract, it makes sense to allocate as much as possible responsibility unambiguously between the parties. But I am not convinced that the moral responsibilities allocated to us by our place in the world are divided so neatly.

What happened was that banks and other mortgage lenders had a financial incentive to originate these loans. They sent salesmen to people who were unlikely to understand the risk involved in these loans. These loans were primarily sold to the poorest, least educated homeowners. Sales techniques included lying and cheating.

The loans were packaged and sold on the market to investors who did not insist on quality.

It looks to me like the banks and the investors are counting on a federal government bailout. I'd be surprised if the homeowners got any relief.

You've got to understand this if you want to apportion the blame.

Mr Becker, I believe you have pay homage to one of the great thinkers in western history when you said:

"people who are accustomed to having other persons or governments make their decisions for them lose the ability to make good decisions for themselves. Free societies lead to better decision-making partly because men and women accumulate more experience at making decisions that affect their well-being and that of others."

Kant, in his famous essay, "What is enlightment?" said:

"Enlightenment is man's emergence from his self-imposed immaturity. Immaturity is the inability to use one's understanding without guidance from another. This immaturity is self-imposed when its cause lies not in lack of understanding, but in lack of resolve and courage to use it without guidance from another. Sapere Aude! [dare to know] "Have courage to use your own understanding!"--that is the motto of enlightenment......But that the public should enlighten itself is more likely; indeed, if it is only allowed freedom, enlightenment is almost inevitable."

Wes,

Nice, literate response.

However, money, interest, credit, debt and the pricing system are an information system. By printing so much fiat money, the governmnet inserted "lies" to that information system and caused the problems for both banks and consumers.

As an investor you should have, at the time, held the bank accountable, otherwise you're just claiming ignorance.

But given that data processing (computers) have centralized bank talent (and intellectually impoverished the banking system) and any trivial conversation with any banker, regardless of bank, would immediately demonstrate that these people have little if any understanding of what it is that they do, and certinaly no understanding of economics, and finally, no understanding of the limits of quantitative formulae or models.

So, we are all at fault here. And you as an investor, if you have this knowledge cannot say you were unaware of the situation.

Cheers

I've been put off by this whole mortgage mess plan from the beginning. These big financial institutions were trying to make a buck by pulling the wool over peoples eyes and they got caught in their own bubble. It was greed, and they need to learn from it. This bail out stuff will only make things worse. Our economy needs to learn, and this kind of interference is just that...interference.

Becker and Posner ... ya'll rock in your writings. LOL at Posner's comment: "maybe I don't have enough imagination." I would hate to see someone without imagination if Posner does not have an imagination coupled with a fast pen driven by a brilliant mind and desire to express himself. I liked Becker's comments about Bears Stearns ... first thing I thought of was Enron, World Com, Merril Lynch ... 14,000 employees without jobs and their Bears Stearns retirement invements have been wiped out ...someone(s) has(ve) profited from this ... if discovered, will they commit suicide like many think Lay did? Will they be able to enjoy their new found wealth the Pope in Italy has characterized as obscene ... along with global economic environmental toileting by major corporations ... people have gotten more eager to shift blame as they watch legal shows ... read legal thrillers. First thing every good lawyer does is sue everyone and then the true defendants are sifted out during the litigation process; it seems, today, no one takes personal repsonsibility any longer. When the average person sees a woman getting millions for a hot coffee spill etc. etc. no puzzle to see that from age 6 people learn to point the finger. Pride, anger, greed, gluttony, envy, lust and sloth are not eliminated by coporate or government veils. In Las Vegas, NV persons with no education have purchased homes by working 2 to 3 minimum wage jobs ... now they are losing those houses not realizing any benefit except the time they hopefully enjoyed living within the structure ... the banks don't want these houses back do they? What are banks going to do with a bunch of empty houses no one can afford to buy? The displaced former homeowner is left without housing ...

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

it is forbidden to clarify the facts of the sub-prime problem.
a large proportion of the defaulters are african americans and hispanics.how can we debate the issues when all are afraid to say so?
let us have the facts and we can debate sensibly.

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

do we know why there are so many sub prime defaulters in the usa in comparison to europe?

i believe philantrophy is the answer to the sub prime mess.the gates foundation and other similar organisations can use their wealth to help minorities in the usa buy homes on terms that are easily affordable.
as for the banks they have made such a mess they should be regulated.they obviously cannot police themselves.

In the ideal capitalist world, the government would stay out of the economy. In the real world, governments at least have to decide how much new money to print (create). If the government floods the markets with a bunch of newly printed money then inflation will go up and interest rates will go down. This is good for borrowers and bad for savers. If the government doesn't print up new money (or even takes existing money out of circulation) then interest rates will rise and inflation will slow. This is good for savers and bad for borrowers.

The things is, over the last eight years the US government has been running massive deficits and become more and more of a borrower itself. So, as a borrower itself, the US government has a bias toward helping the borrowers at the expense of the savers. There's all this talk of how people should save for retirement but then the government prints up a whole bunch of new money and the inflation rate far outpaces the interest rate and pretty soon everyone's retirement savings are worthless. But, at least the US government doesn't owe as much in real terms anymore.

That's not to say that there aren't problems with the banks. If I stop by a restaurant for a burger and ask to do a detailed inspection of the facilities (assuming I even had time for that), I would get laughed out of the restaurant. Similarly, if I go into a bank to open a checking account and ask to do a detailed inspection of their security system, I would be laughed out of the bank. The expectation is that when I buy a burger at a restaurant, the burger is safe to eat and that when I deposit money at a bank, the bank will take necessary steps to prevent my money from being stolen.

I also expect when I deposit money at a bank that the bank will not loan that money out to people who won't pay it back. That's not something I should (or even could) verify for myself. That's the basic product that the bank is supposed to be offering. From what I can tell, though, most banks in the USA did go ahead and loan out peoples' retirement savings to other people who weren't expected to pay it back.

However, at the end of the day, the bank management may have been the smart ones because they knew that, not only would the government bail them out, but that they would personally wind up with all kinds lucrative bonuses.

I think might just practice some "individual responsibilty" by not commenting on the deregulation of the Financial Industry, the rise of liars, cheats, thieves, frauds, scroundels and Corporate malfeseance. Any one ever heard of a "pig in a poke"? I won't even mention speculative mortgage backed securities, hedge funds, derivatives, etc.. You'd think Bear-Stearns and others would be smarter. Nah! They were the most vociferous in demanding Deregulation.

And now we've got to bail them out. That money going into the industry ought to come with some "strings" attached.

While I generally agree re personal responsibility, there are obviously limits. I don't think some intervention to soften the hardest blows would eradicate the lesson. And the people must have some faith that the system is working for them.

But responsibility goes both ways. If you give high credit card limits to college kids, guess what? I guess we needed to change the bankruptcy laws so the college kids will learn their lesson [I know, not necessarily your position]. Also, there are issues regarding the ever growing complexity and volume of information about our economy, our financial system, technology, consumer products and our ability to understand all of this and take personal responsibility.

That said, I agree that intervention should be based on what's good for the economy, the financial system as a whole and our country.

Get real, folks. Nowadays, and it has been so for years, you cannot close a mortgage loan transaction without having reams of paperwork shoved at you that discloses the terms that the lender wants. Should you read it, you'll understand the deal. Should you not, you'll join many others in the electorate who vote for cake and parades, having no clue about how grown ups conduct business.

Bah.

Jake and others: Once upon a time there were Banks and Savings and Loan company's that took deposits and made loans under ratios strictly regulated by governing agencies.

In those olden days of several decades ago, typically naive and financially illiterate prospective home buyers went, with confidence, to their banker and asked, in essence, whether they were loan-worthy. The postive reply was for a given loan limit, and but for VA loans some amount of a down payment that covered the bank's potential losses.

S&L's prior to the $100 billion S&L meltdown that came on the heels of their deregulation and forays into loan biz they did not understand at the time were party to the loans they made.

Today, the "loan officer" is most often nothing but a broker and more like a salesman living entirely on commissions, fees, and yield spread premiums derived from finding SOME way of stuffing a client into SOME sort of loan. It is only recently that SOME states are even licensing these loan salesmen who are as likely to have come from car sales as from any experience in a financial institution. THE payday derives from making a loan, and......... once it's approved and funded there exists NO downside for the salesman or his brokerage.

As for "disclosure" there is not one in 100 who can spot a the yield spread premium that pays thousands to the mortgage broker for adding 1/4 point to the interest rate. And it is easy for a slick salesman to assure the client that there is little danger of a variable rate going up rapidly? and, of course, it may have been the only way to make the numbers work, anyway. Cool eh?

That loan is then quickly packaged with a pile of other loans of similarly suspect "quality" to be "sold" to investors.

Now does everyong here? or anyone in the nation? understand "derivatives?" In short that means stripping off the risky part (say the most vulnerable 10% of a no-down loan)as a "derivative" of the underlying security and selling it to "investors" who enjoy high returns at the risk of possible losses. The safer 90% is then packaged as something of a Triple A bond with lower yields and in theory, low risk.

Trouble is the packet with the Triple AAA stamp too is of unknown quality and as we ARE seeing today a quality FAR lower than AAA. There are trillions worth of these things out there in the "ownership" of investors who have NO idea what they are worth, even the "brightest guys in the room" at the top of Bear Stearns and JPMorgan who just "bought" them for a dime on the dollar plus some massive help from the FRB (ie taxpayers)

Now stir in a decade or more of rapidly rising housing prices, and hordes of realtors chanting the truism: "Well you better grab it now before it goes higher and you've completely missed the market" working closely with mortgage salesmen who can "work magic" to get the buyers "qualified" and you've the outline of the problem.

Some, as Becker-Posner, want to hold the consumers who buy only a few homes in a lifetime more "accountable". But, leaving out aggressive "house flippers" and speculators for a moment, what exactly is a growing family to do in the rapidly rising markets such as So Cal etc? Simple, a young couple, say a pair of teachers? at first buy whatever level of "first time buyer" shack they can, and as their family grows does there best to leverage it into something more suitable.

In fact, as in LA county where median prices were half a million and a LOT of the housing stock is worn out post WWII stucco bungalows of 1200' how does a pair of teachers, a cop and a nurse manage to house their family at all? How do those of yet lower pay manage? Greed at the root? Or necessity for all including the mortgage salesman and the realtor?

Now somewhere near the top of the heap are graduates of Wharton and Harvard MBA's with 20 years in the game, and some regulators, who SHOULD have known better and been able to play the role of a grown-up, yet they are testifying before Congress that:
\
"Well with rising home prices, we found we had few losses even with 100% loans..... why not go to 105%? and roll in the very closing costs divvied up by the industry? after all they'll soon be absorbed by.......... rising home prices and all of us can continue to be fat dumb and happy. At least until housing prices plateau or begin to decline.

Does Wharton and Harvard still bother to teach anything about history? business cycles? tulip, stock, and housing bubbles? Played a round of Monopoly to see what happens when one player has hotels on Boardwalk and Park Place?

According to Professor Becker, “moral hazards”--shielding people from the consequences of their actions--threaten “free society” by eroding our ability to make sound decisions. Bailing out reckless borrowers and lenders will only beget more bad decisions in the future, so we should avoid doing so without good cause.

This concept is familiar. Abortion on demand creates a “moral hazard” by shielding promiscuous (or careless) persons from the social and economic consequences of an unplanned pregnancy. Welfare creates a “moral hazard” by shielding the indolent from poverty.

In the credit crisis, there seems to be plenty of “moral hazard” to go around. Professor Mankiw writes on the Bear-Stearns bailout:

“Here is another off-the-wall idea that someone proposed to me: Why not make senior management personally guarantee the loans made in any such bailout? (I presume they have significant assets beyond their equity stake in the firm.) Given the sums involved, that won't offer the taxpayer a lot of protection. But at least it will make some of the guys responsible for the mess squirm just a little bit more.” http://gregmankiw.blogspot.com

So: Shielding individuals from the consequences of their actions erodes the decision-making faculties and thus threatens free society (Becker). And, modern corporations shield their investors and management from the consequences of their actions through limiting shareholder liability and by vesting culpability for wrong doing in the corporation as a legal person.

Therefore, the modern corporation threatens free society. Q.E.D.

This is fun. Let’s play “moral hazard.”

Shielding telecommunications firms from liability for participation in unlawful domestic wiretaps erodes our privacy rights and makes future abuses by the executive more likely.

Shielding the administration from congressional investigation of its decision-making in the U.S. Attorney firings by evoking a broad claim of executive privilege and by refusing to act on congressional contempt warrants erodes our system of checks and balances, weakening our government generally, and encouraging the further politicization of federal prosecutions.

Shielding the people from the human cost of war by relying on a volunteer army instead of a general draft reduces the perceived cost of the war and makes future wars more likely.

Shielding the people from the economic costs of policies—such as the war in Iraq--through deficit spending distorts the public’s awareness of and response to policy.

Shielding one’s descendants from having to earn a living through making intergenerational transfers of wealth erodes their incentive to become useful participants in civil society (think Paris Hilton rather than Bill Gates).

Shielding ourselves from the consequences of environmental degradation by dying before the effects of our activity are realized and leaving the problem to future generations to confront commits ‘waste’ and violates our responsibility of good stewardship.

What a useful concept! It's like playing Whac-a-mole! But with so many “moral hazards” threatening our free society, why focus in on reckless borrowing? Well, if you are predisposed to blame society’s woes on the erosion of personal responsibility and to blame people who fail for their own lot, Professor Becker’s argument probably resonates with you in a way that my examples do not.

But I think to take Becker’s concern for “moral hazards” at face value opens my Pandora’s box. Isn’t Professor Becker using the concept of “moral hazard” here as a 'rationalization' rather than a rationale?

(BTW, for those readers dismissing me as a communist or a socialist about now: Lincoln considered corporations a threat to personal and economic liberty; Jefferson considered the heritability of property inconsistent with democracy and wrote one of the first laws limiting entailments; the Federalist warns against professional armies and points to the citizen army as a natural check on executive adventurism. Just saying.)

Judge Posner gets it right, I think: “Moral hazard is . . . not a defect of the will, but a rational response to one's opportunity set.”

This opportunity set for private economic activity is largely determined by the market, but determining the scope of permissible private economic activity is an essential government function; when private economic activities threaten the public safety or other public goods, one or the other must give way.

The policy questions to ask in the present crisis are whether intervention is in the general interest and whether we can or should alter the opportunity set in the future to encourage people to act more appropriately, to place risk on the decision makers, without causing further economic harm. Doing little or nothing may well be the best course, but intervention should be carefully considered.

Many free market advocates fail to recognize that they rely on state intervention on their behalf to create opportunities for the market to function, so much so that they fail to see it as intervention. Lenders are apt to see obligations of disclosure, limitations on interest, and moratoriums on foreclosures as unwarranted government meddling in the free market. But they welcome the court's help in foreclosing and the sheriff's help in enforcing eviction. Ask them why the state has any interest in enforcing their private contract. Why should the courts not simply say that a dispute between a borrower and a lender is a private affair? 'Be more careful to whom you lend in the future. Hire your own security force to reclaim your property (but be careful not to commit an assault).'

Shouldn’t the state be able to say which contracts are enforceable and which are not? Shouldn’t a city be able to say what standards a building must meet to merit fire protection? Shouldn’t the state be permitted to specify the terms under which it is willing to grant a corporation the rights and privileges of personhood and limited liability.

No! No! No! Freedom of contract! Property rights!

I believe the zeal of some free market advocates—those whose commitment is based more in belief in inviolable individual rights than in the utility of free markets--can be—has been--an impediment to good decision making—intelligent decision making in the interest of the public good.

I also believe that many who have voted for free market advocates have been sold a pack of simplistic lies about government intervention: regulations are bad, taxes are bad, social services are bad, estate taxes are really bad.

So who is to blame for selling free market economic theory at this level of bumper-sticker slogans and convincing a lot of simple folks to vote for huge tax give-aways and deficit spending against their own economic self-interest, convincing them to mortgage their economic security for an unfulfilled promise of a fair share of the phenomenal wealth their work creates?

Who has been shielding the wealthy from having to bear a fairer share of the burden for the protections and privileges they enjoy through participation in our free society?

Will either the politicians who managed to sell us this mess or their owners ever have to face the consequences of their actions? My money is on no.

The god of markets is efficiency. As market participants, every tool that we acquire to raise our own productivity in the market, to that extent also reduces our self sufficiency.

Compare the abililty our ancestors had to provide for themselves, crossing the plains in their covered wagons in the 1850's, with ourselves, deeply grooved to our work, and hopelessly dependent upon that market in the provision of all of our needs.

The god of markets is efficiency. As market participants, every tool that we acquire to raise our own productivity in the market, to that extent also reduces our self sufficiency.

Compare the abililty our ancestors had to provide for themselves, crossing the plains in their covered wagons in the 1850's, with ourselves, deeply grooved to our work, and hopelessly dependent upon that market in the provision of all of our needs.

I thought the guarantee to JP Morgan was only for 60 days and was given so that the illiquidity of BSC assets would not quickly overtake the value of JPM.
It seems like on all sides of this credit crisis, there was a preference for ignorance. To paraphrase my psychiatry chief, 'If you set out to purchase ignorance, there is an inexhaustible supply of it.'

Hopefully,it will act as a "firewall".

Who has strong counterexamples for Becker's "use-it-or-lose-it" argument? This is also an important part of his "moral" principle.

Just too shed a little light on the subject, the following is an aphorism borrowed from the "American Gospel of Success", "there's a sucker born every minute" (and no it wasn't P.T. Barnum), why do you think it's called speculation. Now, I can understand why God created so many "rubes". Someone has to be taken advantage of. Otherwise the system just won't work.

"An important foundation of the philosophy behind the arguments for private enterprise, free economies, and free societies more generally, is that these societies rely on and require individual decision-making and responsibility."
Great, but you have already blown it with old fogey moaning about people claiming abusive childhoods.

As a comment points out, this - "Abusive treatment is awful, but still the vast majority of children abused do become law-abiding and responsible adults." is very bad use of statistics. It can objectively be shown, I think, that adults abused as children make up far more of the incarcerated population than they should.

If this is true, then a case can be made that trauma (and I mean clinical trauma) can rob an adult of the ability to take responsible decisions.

How this might or might not be dealt with by courts is up to them, but I would argue that if child abuse is able to rob in some way the later adult of the ability to make responsible decisions, then to make free societies societies we should target child abuse as a priority, hard and unflinchingly.

Two things: first Richard- much of Europe still hasn't had their housing bubble burst. Spain in particular has a housing bubble that is actually more significant in their economy than the bubble here. England will also be in a lot of trouble, but these are just delayed 6-18 months for their problems. Germany on the other hand aggressively deflated their housing bubble and shouldn't have problems in that sector. The problem wasn't subprime, subprime was the pin that burst the bubble.

Second- a part of the moral hazard was market experts and economists. Are any of the economists who wrote op-eds or went on cable news to tell the world that the housing market was going to keep going up going to lose their tenure? Are they going to get ignored by the media and have their books flop? Are the TV hosts who claimed there wasn't a housing bubble going to get fired and be prosecuted for fraud because of the poor advice they gave? According to economic theory these guys should all be fired and consumers should know that they were totally and utterly wrong, but instead major newspapers and networks keep bringing them out. At least Dean Baker points them out.

Please visit:

http://online.wsj.com/article/SB120485275086518279.html?mod=opinion_main_commentaries

"Freedom Means Responsibility" from WSJ.

Please visit:

http://online.wsj.com/article/SB120485275086518279.html?mod=opinion_main_commentaries

"Freedom Means Responsibility" from WSJ.

"Human" I did go to the WSJ expecting to find the pathetic whack-right mutterings we've come to expect from the Opinion side of the WSJ. It's particularly puzzling that the WSJ is fairly good on their news side but can have such a band of faith-based ideologues in the same building. Sadder yet was that of seeing Senator McGovern's name on the byline followed by a batch of vague and wandering paragraphs that look as if they were written to conform to an assignment from one of WSJ's top political operatives.

Saddest of all is to see Mcgovern "standing tall" for payday loan sharks and the "pawn" shops that dot our landscape these days. Wait! no! Saddest of all is to see a former man of the people's conclusion that dumps ALL of the responsibility for the current financial mess on the people he once worked to protect. Sad indeed.

"The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else."

Freedom Means Responsibility
By GEORGE MCGOVERN
March 7, 2008; Page A15

Nearly 16 years ago in these very pages, I wrote that "'one-size-fits all' rules for business ignore the reality of the market place." Today I'm watching some broad rules evolve on individual decisions that are even worse.

Under the guise of protecting us from ourselves, the right and the left are becoming ever more aggressive in regulating behavior. Much paternalist scrutiny has recently centered on personal economics, including calls to regulate subprime mortgages.

With liberalized credit rules, many people with limited income could access a mortgage and choose, for the first time, if they wanted to own a home. And most of those who chose to do so are hanging on to their mortgages. According to the national delinquency survey released yesterday, the vast majority of subprime, adjustable-rate mortgages are in good condition,their holders neither delinquent nor in default.

There's no question, however, that delinquency and default rates are far too high. But some of this is due to bad investment decisions by real-estate speculators. These losses are not unlike the risks taken every day in the stock market.

The real question for policy makers is how to protect those worthy borrowers who are struggling, without throwing out a system that works fine for the majority of its users (all of whom have freely chosen to use it). If the tub is more baby than bathwater, we should think twice about dumping everything out.

Health-care paternalism creates another problem that's rarely mentioned: Many people can't afford the gold-plated health plans that are the only options available in their states.

Buying health insurance on the Internet and across state lines, where less expensive plans may be available, is prohibited by many state insurance commissions. Despite being able to buy car or home insurance with a mouse click, some state governments require their approved plans for purchase or none at all. It's as if states dictated that you had to buy a Mercedes or no car at all.

Economic paternalism takes its newest form with the campaign against short-term small loans, commonly known as "payday lending."

With payday lending, people in need of immediate money can borrow against their future paychecks, allowing emergency purchases or bill payments they could not otherwise make. The service comes at the cost of a significant fee -- usually $15 for every $100 borrowed for two weeks. But the cost seems reasonable when all your other options, such as bounced checks or skipped credit-card payments, are obviously more expensive and play havoc with your credit rating.

Anguished at the fact that payday lending isn't perfect, some people would outlaw the service entirely, or cap fees at such low levels that no lender will provide the service. Anyone who's familiar with the law of unintended consequences should be able to guess what happens next.

Researchers from the Federal Reserve Bank of New York went one step further and laid the data out: Payday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy. Net result: After a lending ban, the consumer has the same amount of debt but fewer ways to manage it.

Since leaving office I've written about public policy from a new perspective: outside looking in. I've come to realize that protecting freedom of choice in our everyday lives is essential to maintaining a healthy civil society.

Why do we think we are helping adult consumers by taking away their options? We don't take away cars because we don't like some people speeding. We allow state lotteries despite knowing some people are betting their grocery money. Everyone is exposed to economic risks of some kind. But we don't operate mindlessly in trying to smooth out every theoretical wrinkle in life.

The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.

"Human" I did go to the WSJ expecting to find the pathetic whack-right mutterings we've come to expect from the Opinion side of the WSJ. It's particularly puzzling that the WSJ is fairly good on their news side but can have such a band of faith-based ideologues in the same building. Sadder yet was that of seeing Senator McGovern's name on the byline followed by a batch of vague and wandering paragraphs that look as if they were written to conform to an assignment from one of WSJ's top political operatives.

Saddest of all is to see Mcgovern "standing tall" for payday loan sharks and the "pawn" shops that dot our landscape these days. Wait! no! Saddest of all is to see a former man of the people's conclusion that dumps ALL of the responsibility for the current financial mess on the people he once worked to protect. Sad indeed.

"The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else."

Freedom Means Responsibility
By GEORGE MCGOVERN
March 7, 2008; Page A15

Nearly 16 years ago in these very pages, I wrote that "'one-size-fits all' rules for business ignore the reality of the market place." Today I'm watching some broad rules evolve on individual decisions that are even worse.

Under the guise of protecting us from ourselves, the right and the left are becoming ever more aggressive in regulating behavior. Much paternalist scrutiny has recently centered on personal economics, including calls to regulate subprime mortgages.

With liberalized credit rules, many people with limited income could access a mortgage and choose, for the first time, if they wanted to own a home. And most of those who chose to do so are hanging on to their mortgages. According to the national delinquency survey released yesterday, the vast majority of subprime, adjustable-rate mortgages are in good condition,their holders neither delinquent nor in default.

There's no question, however, that delinquency and default rates are far too high. But some of this is due to bad investment decisions by real-estate speculators. These losses are not unlike the risks taken every day in the stock market.

The real question for policy makers is how to protect those worthy borrowers who are struggling, without throwing out a system that works fine for the majority of its users (all of whom have freely chosen to use it). If the tub is more baby than bathwater, we should think twice about dumping everything out.

Health-care paternalism creates another problem that's rarely mentioned: Many people can't afford the gold-plated health plans that are the only options available in their states.

Buying health insurance on the Internet and across state lines, where less expensive plans may be available, is prohibited by many state insurance commissions. Despite being able to buy car or home insurance with a mouse click, some state governments require their approved plans for purchase or none at all. It's as if states dictated that you had to buy a Mercedes or no car at all.

Economic paternalism takes its newest form with the campaign against short-term small loans, commonly known as "payday lending."

With payday lending, people in need of immediate money can borrow against their future paychecks, allowing emergency purchases or bill payments they could not otherwise make. The service comes at the cost of a significant fee -- usually $15 for every $100 borrowed for two weeks. But the cost seems reasonable when all your other options, such as bounced checks or skipped credit-card payments, are obviously more expensive and play havoc with your credit rating.

Anguished at the fact that payday lending isn't perfect, some people would outlaw the service entirely, or cap fees at such low levels that no lender will provide the service. Anyone who's familiar with the law of unintended consequences should be able to guess what happens next.

Researchers from the Federal Reserve Bank of New York went one step further and laid the data out: Payday lending bans simply push low-income borrowers into less pleasant options, including increased rates of bankruptcy. Net result: After a lending ban, the consumer has the same amount of debt but fewer ways to manage it.

Since leaving office I've written about public policy from a new perspective: outside looking in. I've come to realize that protecting freedom of choice in our everyday lives is essential to maintaining a healthy civil society.

Why do we think we are helping adult consumers by taking away their options? We don't take away cars because we don't like some people speeding. We allow state lotteries despite knowing some people are betting their grocery money. Everyone is exposed to economic risks of some kind. But we don't operate mindlessly in trying to smooth out every theoretical wrinkle in life.

The nature of freedom of choice is that some people will misuse their responsibility and hurt themselves in the process. We should do our best to educate them, but without diminishing choice for everyone else.

Cultures have never been "led" to destruction. They are "pushed" by the characteristics of the worst impulses within them. Hence the whimper at the end.Truisms are called that because many of them are true. Power corrupts is probably more true now than ever. The worst among us seek it and misuse it. Your average idiot knows that any power is diminished by its use and that the only effective power to lead is moral authority, a concept mostly lost on our current crop. Perhaps we need a completely new approach to social and political leadership. Something like, "alright, Gary or Richard, you are bright and articulate, apparently accomplished and honest and are admired widely. It is your turn to be a member of Congress. Please go, don't steal too much, use common sense and we will have your homes, job and assets here for you when your turn is up." In other words, send only those who don't want the job. Sort of a national service.

The other major problem pushing the internal rot of our society is the media, populated by inaccurate intellectual midgets who in many instances create their own fodder in a society already looking for the lazy way of getting information and incapable of synthesizing it into knowledge.

Personally, I have developed a set of rules to maintain some sense of well being while existing in The United States but they are a bit spartanesque and not many would accept then since there is a fair amount of self discipline and awareness contained within them. Don't worry. The list is just for me.

Cultures have never been "led" to destruction. They are "pushed" by the characteristics of the worst impulses within them. Hence the whimper at the end.Truisms are called that because many of them are true. Power corrupts is probably more true now than ever. The worst among us seek it and misuse it. Your average idiot knows that any power is diminished by its use and that the only effective power to lead is moral authority, a concept mostly lost on our current crop. Perhaps we need a completely new approach to social and political leadership. Something like, "alright, Gary or Richard, you are bright and articulate, apparently accomplished and honest and are admired widely. It is your turn to be a member of Congress. Please go, don't steal too much, use common sense and we will have your homes, job and assets here for you when your turn is up." In other words, send only those who don't want the job. Sort of a national service.

The other major problem pushing the internal rot of our society is the media, populated by inaccurate intellectual midgets who in many instances create their own fodder in a society already looking for the lazy way of getting information and incapable of synthesizing it into knowledge.

Personally, I have developed a set of rules to maintain some sense of well being while existing in The United States but they are a bit spartanesque and not many would accept then since there is a fair amount of self discipline and awareness contained within them. Don't worry. The list is just for me.

"Freedom", "Freedom", "FREEDOM"! The cry of the scroundel and scalliwag. The only individual responsibility I'm aware of, is not too get caught playing the sucker. Welcome to the wonderful world of "Free" Enterprise.

Freedom and free enterprise are great when there is self restraint. Otherwise it is just the freedom to destroy yourself and others. Even the scriptures recognize that the sins(Dante's seven)and the consequences will have unpleasant effects for generations not to mention that we have turned the ten commanments from don'ts to do's. Is it that we have no philosophical and moral leaders or are we too ignorant and selfish to follow?

Oskar Sigvardsson - I don't really see any evidence that a hands-off policy of the Federal Reserve does make investors more cautious. The last bubble was the dot-com bubble, and that burst spectacularly, without the Federal Reserve stepping in to rescue failing companies (at least, not to my recollection). That didn't slow down the sub-prime bubble one bit;

Companies which go bankrupt or are bought out by more profitable companies at the least do not perpetuate their bad policies.

We keep hearing from the conservatives how top management is only compensated so richly because they deserve it.

I haven't heard that. Many in top management don't deserve their compensation and I've heard many conservatives say so. Michael Eisner, who has presided over huge losses at Disney, probably doesn't What I keep hearing from liberals is an attempt to paint all management with the same brush. In some cases, there's an argument to be made re: collusion with the board against shareholder interests. Some managers are worthy of exhorbinant salaries, though, because they deliver proportional value.

The financial institutions committed fraud on a massive scale. For example, houses were appraised at above what they were worth in order to get a more favorable loan-to-value ratio. There's been some suggestion that people who got loans for, say, $300,000 on a house only worth $200,000 (because it was appraised for far more than it was worth) accounted for many of those who walked away from their homes in the first few months, or ditched them when the market tanked (thus writing off the hope of 'flipping' the home if the value increased without suffering any risk due to the market drop.)

These loopholes need to be closed, and without serious disincentives, they will not be. Too many people have been rewarded in the firm's heyday and then bailed. Lazio, formerly of Countrywide, is just one example.

Sometimes a bailout is the least bad decision.

For example, had Bear Stearns been allowed to fail, its assets would have been frozen. This could have caused a run on the banks, which would have been far more costly than the bailout. As it was, Bear Stearns investors got pennies on the dollar, while their customers are now JP Morgan customers.

Likewise, it may be better for society to bail out some distressed homeowners than to allow their houses to be emptied. Empty houses have social costs of their own. They become magnets for crime and vandalism. Perhaps it will cost society less to allow renegotiation of the mortgages than dealing with the empty houses?

Aside from not indulging all of the wit above, I believe that Becker's WSJ comments are dead-on. Should one disagree is admitting their own irrelevance. Conscience dictates most of what transpires in any market, free or controlled. The larger argument suggests that an undefined portion of the population is inherently lazy, unmotivated, and simply willing to free-ride. I have no sympathy for any of this. Neither should anyone that attends school outside of the indoctrinating K-12 years. Government is becoming the voice of the useless, while at the same time removing the person from the body.
Economic theory would require a movement from the public to "taboo" this free-riding behavior. Where's the beef? At the moment, the incentive to be a slack is far greater than the incentive to innovate. (yes, there are people making changes everyday- that's not what the allusion is) So, what are your ideas? Longtime follower.

BTW- the correct idea used by a few above is "IMmoral hazard" rather than "moral hazard." Where is the hazard if/when one acts morally? oh, and Bear Stearns should have been left to die loudly. This situation should have been the 5-alarm fire bell for wall street. Those who lost life savings should have been diversified. Seriously, why would someone at an investment bank do otherwise? Any argument that ignorant people did what they knew is just as ignorant, if not worse. Again, no sympathy. Happy Easter, if Catholic.

c frey, We're "Prot's", and follow the dictates of own concience as revealed by God, not slavishly following the dictates of the Papacy as revealed to some cranky old Pope. Happy Easter anyway.

"Otherwise it is just the freedom to destroy yourself and others."

Freedom to destroy oneself makes an economic sense.

http://economics.uchicago.edu/download/Suicide_An_Economic_Approach_4.pdf

I did not notice if any of the other comments discussed Bowen's theory of societal regression, but I think it is pertinent to your post:
http://www.thebowencenter.org/pages/conceptsep.html

Re:Suicide

Fascinating analysis. Thank you.

Perhaps we should do the analog. Wouldn't it make economic sense to remove the artificial checks, both physical and social, on evolutionary forces? Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

Malthus was right. He just didn't have the right analytic tools.

Gary,

That was a great piece you did in the Journal this weekend. I address many similar issues in my recently published What Greenspan Can't Tell You: The Inner Workings of the Investment Markets. I strongly recommend that you and readers of your blog take a look at my work.

Best,
Fred Press

I just read an excerpt of this post in The Wall Street Journal. Unfortunately, they left out the part where Mr. Becker questions the merits of the Fed's Bear Sterns bailout. The journal stressed the "moral" arguments, and not the practical ones.

As a taxpayer, I think the Fed should've bought bear Sterns itself, then sold its assets and at least made the American people some money, instead of helping JPM Chase and making Jamie Dimon look like a "genius" and letting the taxpayer take the risk. Some genius...I almost took out a home equity line and tried to buy Bear myself at that price!

As for moral hazard, a Bear bankruptcy would've been a much better lesson. Alas, the uniqueness of the banking industry makes it unlike others in that a large failure affects all citizens and all industries because of the nature of its assets as a medium of exchange..it's not like a car company going bust.

So, all banks that want to recieve help from the Fed should be subject to capital reserve requirements and Fed inspection. Otherwise they should get no help. And Americans with good credit should then be able to borrow directly from the Fed and let the banks be damned...I'd rather borrow fellow taxpayer money anyway.

One of the tennants of our time is the mistake in believing that "slicing" and spreading risk is a reduction in risk....actually, spreading risk to many parties that may all default is worse than having a handful of institutions bearing a large majority of risk.

But I have to say I don't buy the argument that individuals are "shifting responsibility to others." This is basically a media myth. Becker is right to criticize it but he shouldn't believe people actually think it. I have a hard time believing that subprime borrowers were suckered into loans and are trying to throw the blame now. This is just a news story to make people feel good.

In fact, as many have observed, they bought "mortgage options" that mostly ended up out of the money, as options usually do...they also did it with no money down...they were perfect arbitraguers! Take a free gamble on a house..if the price goes up I win, if the price goes down i walk away and the bank loses...No, we shouldn't waste our time thinking that we are facing a society where individuals are shifting responsibility to others....in fact, they were being smart- they knew they had little to lose and that the government would probably bail them out since so many people were doing it. I give them more credit than Becker seems to.

We live in a time when leverage equals success...how else could hedge funds charge two and twenty and people still think them good investments? Individual homeowners were just following the same trend...lever up and be somebody!

So now we're faced with the options of mass bankruptcy or inflating our way out of the situation...Looks like the Fed has chosen the latter. I just feel bad for all those "moral suckers" who actually saved their money to wait for a time when house prices would fall so they could get a good bargain. They might be very responsible individuals, but now they'll miss out on the government bail out while prices will remain inflated.

I guess a quick way to some up my rant above about moral hazard is to say that we should not lose sight of the difference between morality and rationality.

Over-leveraged subprime borrowers with no money down were acting rationally, not morally.

Rationality is for the field of economics, while morality is for the field of religion. In fact, I'm wondering how often it is the case that acting morally is a rational decision. I guess I should consult Adam Smith.

As a person who lost my home to foreclosure several years ago, I can certainly empathize with those who may now be facing foreclosure. However, despite the horrendous pain, shame and guilt, I can truly say that no lesson was ever better learned than the one taught to me and my blameless son when we had to leave our home. As mean spirited as it may sound, there are very, very, very few home owners who deserve help from the government, the rest should just have to learn that hard lesson.

http://strictlyanecdotal.com/2008/03/22/the-american-public-deserves-some-straight-talk.aspx

Jim....... it's important to remember that evolution is not the 'survival of the fittest' but the survival of those fit enough to attract a mate and pass on their DNA.

What sort of "social weaknesses" do you think "we" are enabling prior to mating season?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

Jim....... it's important to remember that evolution is not the 'survival of the fittest' but the survival of those fit enough to attract a mate and pass on their DNA.

What sort of "social weaknesses" do you think "we" are enabling prior to mating season?

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

Why treat diabetes? That entire gene pool would disappear in several generations. Why discourage foolish risky behaviors? Accidents would take care of most of those in a few years. Who knows; if we stop propping up genetic and social weaknesses, the value of life might increase and suicides would disappear.

As the thread winds down, it still appears that more calls for "responsibility" are being hurled at those doing the borrowing, than those doing the lending.

Considering that those doing the lending are lending the money of others, have we forgotten that they used to have prudent standards? and in the quest for commissions have they also forgotten prudence in lending?

Removing freedom/autonomy from smokers is problematic. See

http://medicine.plosjournals.org/perlserv/?request=get-document&doi=10.1371%2Fjournal.pmed.0040185

Also, comitting suicide may be beneficial for very unhappy suicide attempters.