The Role of Moral Hazard in the Housing Boom and Bust

Abstract

The recession of 2007 to 2009 provided a textbook illustration of the ways in which government policies intended to expand credit and capital investment can engender perverse incentives and foster systematic malinvestment. This paper will examine how politically motivated efforts by government sponsored enterprises to increase homeownership combined with loose monetary policy to generate a rash of moral hazard relationships between borrowers and lenders, lenders and GSE’s, GSE’s and the American taxpayer. The first three sections of this paper will explore the extent to which government policy was responsible for cultivating moral hazard problems in those relationships. The fourth and final section will explore the extent to which the structure of those relationships has been either mitigated or perpetuated in the decade since the bust.