Bush Bailout of Mortgages Will Create Terrible Precedent.

Investor’s Business Daily features a column that describes many of the negative things that will happen if the Bush Administration responds to troubles in the mortgage industry by bailing out borrowers and lenders. The column clearly outlines the “moral hazard” danger, which occurs when people make risky decisions in the expectation of handouts from the government if things head south.

One point that deserves more attention, though, is that a bailout will result in a misallocation of capital. And since every economic theory – even Marxism – acknowleges that saving and investment is the key to long-run growth and higher living standards, this may be the biggest long-term danger.

First, the deal will reward irrational behavior and encourage such behavior by homebuyers in the future. It was not logical for people to take out mortgage obligations they couldn’t afford, but it will become logical for them to do so in the future if they can reasonably expect that the government and their lender will later bail them out when the going gets tough.

Second, the deal will thwart the market by keeping home prices artificially high.

Read the whole thing.


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