In Wake of Katrina, Moral Hazards Abound

Wednesday, September 28th, 2005 3:26 pm by cyclops

There are so many reasons why this country should adopt a flat tax or a consumption tax (fairness, transparency, and competitiveness, just to name a few), but to me, one of the most compelling reasons is so that I would never have to be witness to sophisticated businessmen groveling at the feet of politicians in the most infantile and undignified manner possible. A column in todays Washington Post entitled Lobbies Line Up for Relief Riches describes only some of the fat cats and their highly paid lobbyists begging for money like a kid in Wal-Mart begs for a toy.

And columnist Steve Pearlstein, in his piece entitled Don’t Let Industry Win With Disaster Bailouts does an excellent job of describing how these federal bailouts could ultimately kill industries and will definitely create moral hazards. He writes

Hold on to your wallets, Mr. and Mrs. America. Congress is in session, Katrina relief is on the agenda and special interests are drumming up schemes to help themselves under the guise of helping others.

Let’s start with an ingenious proposal to extend, retroactively, federal flood insurance to all those owners of damaged homes along the Gulf Coast who didn’t have it.

At first blush, it sounds reasonable. After all, if we want people who have lost everything to return home and rebuild, they’ll need a little capital to get started.

But the hidden winner in this arrangement would be the mortgage industry, which otherwise would have to write off billions of dollars in loans when owners stop making monthly payments for homes that are beyond repair. That explains why the idea is being championed by the Consumer Mortgage Coalition, representing large companies that originate, service and guarantee home mortgages.
That is the same Consumer Mortgage Coalition that for years has been trying to shut down Fannie Mae and Freddie Mac. Its complaint has been that the government’s implied guarantee to bail out Fannie and Freddie if something goes really wrong encourages them to boost profit by taking on too much financial risk — an example of what economists call “moral hazard.”

But you’d be hard-pressed to name a clearer example of moral hazard than allowing people to purchase flood insurance after the flood. It’s bad enough that premiums are so low that the federal flood insurance program will have to borrow about $15 billion to cover payments to those unlucky homeowners who had the foresight to buy insurance. But if you were to set the precedent of providing retroactive insurance, you would guarantee that in the future, only fools would ever buy insurance in advance, thereby destroying the market completely.

So, business as usual in our nation’s capitol. Please write your Congressman in support of a new tax code!

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