The Subprime Lending Bailout in Retrospect
http://www.npr.org/templates/story/story.php?storyId=16734629
This semester, I have taken a couple courses that seem to be entirely independent of this Networks course yet week after week I find myself applying information science concepts to the material learned in these other courses. One example is a course I am taking on urban neighborhoods and housing policy. Naturally, a large part of the course is devoted to discussing the impact of the 2008 mortgage crisis on the housing market. The housing bubble formed, in part, due to asymmetrical information between mortgage lenders and prospective homeowners. When our class conversation in Networks turned to information asymmetry, I began to wonder how much this concept affects our daily lives from small, personal decisions to potentially world-changing decisions. In the article “Subprime Bailout: Good Idea or ‘Moral Hazard?’”, the author presents two sides to the U.S. government’s debate on whether or not to rescue both financial institutions and homeowners who went underwater. This article is especially interesting to read today as it was nearly a decade ago in 2007 prior to the recession hitting in full force. Back then, the argument for a bailout rested on the belief that the economy could not survive if subprime lenders were not propped up as investment banks, hedge funds, pension funds, homeowners, and renters were all dependent on mortgage performance. On the other hand, many argued that a bailout would create a moral hazard. That is, those involved in subprime lending would willingly make more risky decisions moving forward if they knew that the government would essentially pay for their mistakes. One analyst that contributed to this article even stated that the bailout was not worth the risk of creating moral hazard as the industry was “not in danger of collapse by any means”.
When the economy was finally in a true emergency, bailing out the economy still took precedence over preventing moral hazard but the long debate over whether or not this was the right move presents an interesting opportunity to examine the effects of moral hazard. Moral hazards inherently stem from asymmetrical information. We know that information asymmetry is inherently present in most markets as either the buyer or seller has significantly more information than the opposite party. In the mortgage industry, lenders have more information on the quality of the loans than those purchasing the loans. Over time, many lenders exploited the asymmetric power they had by purposely selling bad loans to the most vulnerable (least informed and often poorest) consumers in predatory lending schemes. In fact, the information asymmetry involved in knowingly or even unknowingly lending subprime loans was in itself a moral hazard since mortgage companies knew that banks would take on the risk and thus did not care about whether or not the consumer could actually repay their mortgage. This initial moral hazard which stemmed from information asymmetry thus helped create the mortgage crisis that would later be corrected with another moral hazard (the bailout). Based on what we know today about how the economy has been shaped post-recession, the fallout from the bailout has not necessarily created the moral hazard that many pundits speculated would happen. New regulations passed after the bailout countered the potential moral hazard by mandating more transparency between lenders and banks/consumers thereby reducing information asymmetry. It will be interesting to see what will happen to the economy as parts of these regulations are now being relaxed to reduce regulatory burden in the face of a stronger economy. Will information asymmetry lead to another economic decline?