Moral hazard, skin in the game, and jingle mail: the new good, the bad, and the ugly?

by Patrice Sarath, May 13th, 2008, 7:00 am

The slow-motion collapse of Fremont General is the latest news from the mortgage crisis front; the company has acknowledged that it is out of cash and out of time. The wounded mortgage company is selling its retail banking operations and its loan portfolio, but its shareholders will likely not see a penny, or, as is often the case with bankruptcies, even a fraction of a penny.

Cry me a river, say homeowners facing (or already in) foreclosure. An interesting report from housingwire shows that many homeowners eligible for loan workout or mitigation efforts are not receiving those services. That being the case, it means that some foreclosures could be prevented. Lenders hate foreclosures. They’d much rather be repaid. That’s why it’s in their best interests to work harder with borrowers to keep them in their homes and paying back their loans. We’ve all been hearing a lot more about “jingle mail” — that’s when borrowers walk away from their homes and simply mail the keys back to the banks. Banks hate jingle mail.

Another couple of evocative phrases we’ve been hearing a lot have been “moral hazard” and “skin in the game.” The Fed risked defanging moral hazard when it bailed out Bear Stearns — by not letting the investment bank fail, critics said, its executives were protected from their bad decisions. They no longer had “skin in the game.”

If Bear Stearns was too big to fail, then what about the vast population of homeowners facing foreclosure? Should we bail them out too? Turns out plenty of people don’t like the idea of bailing out homeowners, even though by stabilizing their loans we can stabilize the entire economy (that’s what I mean by being too big to fail). The fact is, critics say, there’s plenty of fraud on both sides of the contract, and how do we know who is morally worthy to save and who we let fail? We want to know that the perpetrators are punished and the victims are rescued.  However, with the high volume of loans, I don’t know how you would even begin to go about sorting it out.

I’ll leave the last word to the one man who can sum it up so well — Dr. Seuss:

“And this mess is so big, And so deep and so tall, We cannot pick it up. There is no way at all!”