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Should the Federal Government Provide a Housing Bailout?

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Maya Raichura
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Should the Federal Government Provide a Housing Bailout? - August 19th, 2012

One of the reasons that Modern Political Economy is such an enjoyable course to teach is that every term a real-life issue emerges that underscores the course’s contemporary relevance. What to do about the credit crisis that cascaded from the home mortgage debacle is the latest case in point.

Reports are circulating that Wall Street firms, led by Bank of America, are pushing a plan that would have the federal government buy up troubled mortgages at a discount, forgive debt above the current market value of the homes and then use federal loan guarantees to refinance borrowing at lower rates. In other words, bail out everybody who forgot about the concept of risk — from homeowners all the way up the food chain to financial institutions and investors.

Some people have viewed this gambit as somewhat ironic because Wall Street has successfully preached a laissez-faire policy on the part of the government that would encourage all sorts of financial innovations, but of course it isn’t ironic at all. As Adam Smith, the father of modern political economy, recognized more than two centuries ago, when the vicissitudes of the free market strike home, everybody from the poorest of the poor to the richest of the rich looks to the state for protection.

The case against state intervention is that if you bail out those who didn’t pay enough attention to risk, the same dynamic will be repeated in the future. That’s the moral hazard argument of the free-market purists, who argue that in the long run the market will correct itself and go forward with everybody a bit wiser about risk.

The case for state intervention was put succinctly by the always pragmatic Lord Keynes: “In the long run, we’re all dead,” he said to those who argued that market forces would eventually cure the Great Depression. He actually agreed with that perspective, but he favored government pump priming because he worried about the social and political instability that might result from a prolonged economic crisis.

So I asked my Modern Political Economy students to share their views on whether the federal government should intervene in the current crisis or simply let the market work its painful way out. A couple of the students will post their answers on the blog tomorrow. I’d be interested in what others think as well.

Photo credit: Sean O’Flaherty



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