Yeah, right . . . The Time Inconsistency Problem
By David Henderson
Yesterday, Shaun Donovan, the secretary of the Department of Housing and Urban Development, was on Face the Nation to defend President Obama’s bailout program for mortgage holders. The questioner, CBS’s Bob Schieffer, asked some good questions.
One of his best questions (at the 6:40 point):
Isn’t that [letting bankruptcy judges rewrite mortgage loans] going to discourage lenders from making new loans?
Donovan sidestepped the issue to make a point about fairness. He pointed out that if you have a second home, you can get the terms modified in bankruptcy, but not if you have one home. It’s only fair, he said, to let owners of one home have the same option. But this ignores the point that lenders, if they wanted to know, knew this difference in rules in advance and that now, if the legislation is passed, the rules will be changed after the fact. Donovan did, though, circle back and answer the question. Here’s his answer:
We also have to do it right to make sure that we don’t hurt the mortgage market. What we’ve proposed, and we’re working with Congress on, is a modification of loans in existence now, the ones that have caused all the trouble [those pesky loans–I thought it was people who caused trouble]. We’re not talking about applying this to loans going forward. We think doing that means that it’s not going to affect, in any significant way, mortgages in the future, that it won’t hurt the mortgage market in the future.
How naive does Donovan think lenders are? Are they really going to say to themselves:
I’ll be just as willing to lend in the future as I otherwise would have been because I have absolute confidence that a government that gives judges the power to rewrite mortgages after the fact is never going to try to use that power on future mortgages.
Economists’ fancy term for what I call the Lucy/Charlie Brown football problem (where Lucy promises yet again not to pull back the football before Charlie Brown tries to kick it) is the “time inconsistency problem.”
An interesting instance of governments “pulling back the football” is the New York city rent controllers. In his article, “Rent Control,” Walter Block writes:
Although many rent-control ordinances specifically exempt new rental units from coverage, investors are too cautious (perhaps too smart) to put their faith in rental housing. In numerous cases housing units supposedly exempt forever from controls were nevertheless brought under the provisions of this law due to some “emergency” or other. New York City’s government, for example, has three times broken its promise to exempt new or vacant units from control. So prevalent is this practice of rent-control authorities that a new term has been invented to describe it: “recapture.”
Schieffer’s worst moment was his last:
Mr. Secretary, I want to wish you the very best. I think everyone hopes that you’ll succeed on this.
I don’t. I hope the legislation fails. And the reason has to do, not just with ethics, and not just that propping up housing prices hurts potential buyers on the sidelines, but also with the “time inconsistency problem.”