Cramdown, inflation, and fairness

Reading this bit from Kevin Drum got me to thinking:

But there’s one exception [to interest rates that are sensitive to inflation expectations]: fixed-rate loans. In particular, fixed-rate home mortgage loans, of which there are still quite a few. So for existing homeowners with traditional 30-year fixed-rate mortgages, higher inflation would be great. And for the bankers and investors who hold those loans, it would suck. Inflation may not erode savings, but it does erode the value of a fixed-rate mortgage…

Lately there’s been a lot of talk how cramdown/principal modification legislation would be great for the economy, but politically is a third rail. People would be furious that their neighbors were “rewarded” with a cheaper mortgage for their irresponsible behavior of taking out a mortgage they probably couldn’t afford. So…when the government steps in to lower the value of some mortgages for the benefit of some homeowners (and to the chagrin of banks), that’s perceived as unfair. But when inflation adjusts the value of  all (fixed-rate) mortgages, helping all (fixed-rate) homeowners and royally screwing over banks, that’s just luck! And thanks to the wonder of modern central banking, inflation is largely controlled by…the government!

Right now, I don’t have anything meaningful to say about this. But it does give some interesting insight into how “commonsense,” intuitive, morally oriented thinking a) really can’t get its arms around issues that affect the economy as a whole and b) hasn’t changed much in the last 20 million years or so.

In a much-noted laboratory experiment several years ago, described in the report “Monkeys Reject Unequal Pay,” the primatologists Sarah F. Brosnan and Frans B.M. de Waal trained capuchin monkeys to perform a certain task for which they received cucumber slices. The monkeys performed just fine, until they were permitted to see others being rewarded with grapes, a higher-value payment. Previously acquiescent, many of the cucumber-receivers promptly stopped participating, sometimes even throwing those measly, unfair cucumber payments out of their cage. Aversion of that sort is well established among Homo sapiens as well—even though, at first blush, it appears irrational and, thus, paradigm-busting for economists trained in the Homo economicus model whereby people are considered to be “rational and utility-maximizing” creatures. Behavioral economists call it “inequity aversion”—the tendency to turn down a perfectly good offer if others are getting a better deal.

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