MORAL HAZARD IN THE HOUSING MARKET

I love sports, and not for the usual reasons. While I played as a kid and I still have a few favorite teams, what really keeps me interested is the way athletics highlight our values, our excellence, and our progress.

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The values behind sports are the same ones that bring success in life. The spirit of competition, grit, and fair play help our kids win little league championships when they’re young and build great companies when they’re older. At the professional level, everybody can see that talent without hard work isn’t enough. Only constant innovation and a relentless drive for excellence is enough to produce results.

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Clear and unambiguous results are a big part of why sports are so compelling. There are clear winners and losers. There’s no shame in losing, but it never feels good, and that’s the way it should be. We need a little hunger for victory to drive us forward in life.

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Now there’s talk of shifting their ownership back to investors. Is this a good idea? Their intended role is to offer government backing to mortgage lending, which makes home ownership more accessible to the public. Unfortunately, this model creates some bad incentives to take extra risk, safe in the knowledge that Uncle Sam is waiting in the wings with unlimited bailout money. Count me as unsurprised that they have shown themselves historically to be poor managers of risk.

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Unlike regular companies, Fannie and Freddie face limited risk of bankruptcy and dissolution in the case of a total failure. In short, they are a classic example of moral hazard — managers taking excess risk with other people’s money.

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And there is clearly a lot of money to be made in mortgage backed securities, as demonstrated by the mortgage-backed-securities feeding frenzy back in 2006-2008. Selling Fannie and Freddie back to investors would mean that profits that are currently going to the US treasury will instead be paid out in dividends, while the new equity holders would assume the risk of Fannie and Freddie’s possible failure.

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None of this directly affects Alliance’s commercial real estate market, but it matters indirectly. I’m generally skeptical of government interference in markets, and the mortgage market is a great example of that. Bureaucrats simply cannot allocate capital as wisely as a market can. I’m not sure if the proposed IPOs would change anything, but it’s a developing story that I’ll be keeping a close eye on.

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