Trying to Address Moral Hazard in Lending

One of the contributing factors to the housing bubble was a moral hazard problem between mortgage brokers and lenders with independent brokers selling "bad" loans to lenders. The problem was that with the increasing ability to securitize these loans and sell them to third parties, the lenders had no incentive to try to solve the moral hazard problem.

A proposal working its way through Congress tries to address this problem by requiring lenders to keep a portion of the loans they write. Two concerns with the proposal: (i) how much do you need to force the lenders to keep to give them an incentive to fix the problem? One early draft suggested requiring lenders to keep 5% of loans they write, but this may not create a large enough incentive. (ii) forcing lenders to keep part of these loans requires them to keep more capital on hand, reducing funds available for lending.