The real estate blog.

One can hardly visit a news site or open a newspaper without hearing some discussion of the problems in housing. In many instances, some magic bullet solution is proposed to solve all the problems that exist. Unfortunately, the real estate problem was caused by many factors and one solution, one action, one piece of legislation isn’t going to fix it. It certainly won’t be fixed overnight.

The latest magic bullet solution comes from Treasury Secretary Henry Paulson who is proposing a freeze in rates for those home owners with adjustable rate mortgages.

If you’ve got a 7% adjustable mortgage that’s about to skyrocket past 10%, getting a break may get a lot easier. One solution to the foreclosure problem gaining traction would freeze rates at lower levels.

The

Hope Now Alliance, a coalition of lenders, servicers, investors and community groups, put together by the Treasury Department, is working on a version of a freeze that could be annouced this week.

Lenders quietly began offering such freezes during the summer. Last week California officials announced a rate-freeze deal with four major lenders.

Details of the Hope Now plan have not been finalized, according to Kurt Pfotenhauer, a senior vice president for government affairs with the Mortgage Bankers Association, which is part of the Alliance.

It has been pointed out this plan excludes many in danger of losing their homes. That point is true. We didn’t land in this current situation because too many people took out adjustable rate mortgages. We’re in this situation because of excess speculation in certain markets, mortgage fraud, real estate fraud, shyster mortgage brokers, shyster real estate agents, lower lending standards and a dozen other reasons. With a problem created by so many different factors, the solution won’t be tied up in a neat little package.

More than 50% of the increase in delinquent mortgages are actually investor-related, said Wachovia senior economist Mark Vitner. “It’s hard to conceive how many people are actually going to meet this criteria. There’s nothing at all in there that addresses investors,” said Vitner, who added he doesn’t support an investor bailout.

As the severity of the housing problem becomes more evident, various solutions like the one proposed by Paulson will have their place. The FHA will have to further step up as a lender for first time buyers, borrowers with troubled (but resolved) credit and for those with little to no down payment. Tighter restrictions on mortgage lenders will also have to be implemented.

At the end of the day it seems those who took the most risk are now getting the most help and are getting a free pass from the consequences of their actions. The so called “moral hazard” of providing a bailout to embattled homeowners and the lenders that authorized risky loans seems quite unfair. Those homeowners that didn’t take risks seem to be unduly punished for simply fulfilling the obligations they agreed to. The rub is particularly poignant as the bailout could be shouldered by the most responsible of citizens.

Is the cost to society for allowing consequences to play out naturally more than letting several hundred thousand homeowners slide on their mortgages? Should the sense of fair play outweigh the good of society? Financial Times columnist Lawrence Summers argues the pain of the consequences of the mortgage meltdown far outweigh any perceived moral hazard. Indeed, he argues a moral hazard doesn’t exist in this situation.

The term “moral hazard” originally comes from the area of insurance. It refers to the prospect that insurance will distort behaviour, for example when holders of fire insurance take less precaution with respect to avoiding fire or when holders of health insurance use more healthcare than they would if they were not insured.

In the financial arena the spectre of moral hazard is invoked to oppose policies that reduce the losses of financial institutions that have made bad decisions. In particular, it is used to caution against creating an expectation that there will be future “bail-outs”.

Moral hazard fundamentalists misunderstand the insurance analogy, fail to recognise the special features of public actions to maintain confidence in the financial sector and conflate what are in fact quite different policy issues. As a consequence, their proposed policies, if followed, would reduce the efficiency of the financial sector in normal times, exacerbate financial crises and increase economic instability. They are wrong in three crucial respects.

For those of you whose sense of fairness ushers an emotional response demanding justice, consider the drastic implications of letting the real estate downturn play out without any government intervention. We now understand how closely tied the financial markets, both domestic and international are tied to U.S. real estate. To let this unwind naturally would cause negative effects that would impact everybody - jobs, investments, real estate, taxes and so forth.

It is in everyone’s best interests to support the prevention of a real estate collapse. Even though the concept seems unfair, ultimately it serves the greater good. Hopefully we can learn a lesson from this situation and put in safeguards to insure it never happens again.