Should Home Owners Get a Bail Out?

Should Home Owners Get a Bail Out?  As long as one assumes that we are going through a difficult albeit reasonably typical economic cycle where the forces of greed and excess are purged, irrational behavior punished and prudent behavior rewarded then perhaps the answer is no. 

Without doubt the government programs that help homeowners are also serving to bail-out banks. In doing so these programs create a moral hazard that discourages self-discipline within the financial sector.
 
Perhaps I give them too much credit, but from my perspective the financial industry is the most culpable party in the housing market/foreclosure episode. They created the financial products that enticed homeowners and consumers to engage in reckless behavior. They succeeded in compromising the rating agencies by playing one against the other and by offering enticing fees on mortgage backed security offerings. They succeeded in changing our laws and regulations – effectively eliminating interest rate ceilings, reserve requirements, regulation and oversight. It is wrong from both a free market and in my mind a moral perspective to bail out these firms. To do so promotes all sorts of inappropriate behaviors that will do great harm in the long term.

However, if the economy is not undergoing a severe but never the less typical business cycle, but rather is and continues to be on the precipice of an economic collapse, then these government homeowner programs are perhaps a distasteful but necessary medicine. Chemotherapy for the cancer patient.

Whether or not this is the case depends on the economic consequences. What would be the consequences if the government stepped away and allowed market forces to dictate housing prices, foreclosure levels and banking costs/failures? Would the actions of efficient markets and creative destruction serve to quickly reprice assets, clean out excessive inventories of housing stock and purge the system of irresponsible banking practices so that the economy can once again grow? Or are the excesses of such a great magnitude that the market would excessively over correct on housing prices, force large numbers of responsible homeowners into foreclosure and bankrupt the responsible/well managed banks?

Here is my definition of the difference between a recession and a depression. A recession results in the destruction of poorly managed or inefficient assets (aka “creative destruction”) which is good but a depression results in permanent destruction of the very creative assets that are needed for long term economic prosperity, which is bad.

If the government were to “stand down” on housing and the result was still a recession, then this would be the correct action to take for long term economic growth. However if it resulted in a depression, the consequences might be permanent damage to the economy that would impede long term growth. I personally am not yet confident enough in the long term economic prospects to agree with pulling the plug on these programs.

Until it is more certain that we are not at risk of economic collapse, I would rather see meaningful financial reform to prevent future excesses, honest accounting to identify the failed banks, allowing them to be taken over and unwound, and a continuation of homeowner programs as a measure to avoid permanent long term economic destruction.