Moral Hazard

More on McCain's housing bailout plan from Ben Smith:

Details provided to reporters by senior adviser Doug Holtz-Eakin Wednesday morning make one thing clear: Taxpayers would directly pick up the tab for the difference in cost between a homeowner’s old, too-expensive mortgage and the cheaper one provided by the government.

This is something that congressional lawmakers, led by House Financial Services Chairman Barney Frank (D-Mass.) specifically avoided when they crafted their own landmark housing bill, which became law July 31 and took effect Oct. 1.Congress’ bill – which Holtz-Eakin says provides at least part of the authority McCain would need to carry out his plan – provided a $300 billion program to help distressed borrowers refinance into cheaper Federal Housing Authority mortgages. But to participate, lenders and mortgage investors would have to reduce the mortgage principal, thus taking a loss on the loan.

Lawmakers argued that the “haircut” would protect taxpayers and mitigate against so-called “moral hazard” that government intervention would encourage lenders to believe they’ll always be rescued from their bad business decisions. To make sure homeowners didn’t get off scott free either, the law requires them to share any future profits from the resale of their homes with the government.“Clearly we face the trade off that we would in fact be taking the negative equity position and putting it on the taxpayers books instead of putting it on the private lenders books or the homeowners books,” Holtz-Eakin told Politico. “We think the balance of risk has shifted to the point where this is the way to go.”