The Moral Hazard of Regulating Sub-Prime Mortgage Lending

The term "moral hazard" is being bandied about in commentary about the sub-prime mortgage woes currently roiling our financial markets.  Columns from George Will and Irwin Stelzer among many others, warn against the interposition of government bail-outs or federal pressure on lenders to develop rescue packages for failing sub-prime borrowers.  These bail-outs fit the traditional definition of moral hazard as "an insurance problem; when the cost of a disaster is reduced with insurance, people have less incentive to avoid the disaster."Our federal flood insurance programs are a classic case in point:  those inclined to live near the ocean or gulf or in river valleys prone to flooding would be reluctant to live in these potentially dangerous areas if they had to foot the bill for the effects of floods or hurricanes.  Instead, Big Brother balances the risk on the backs of more sensible Americans, allowing a special form of insurance helping flood...(Read Full Article)

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