MORAL HAZARD IN HOME EQUITY CONVERSION: Basic Measurement Issues 2

We suspect that this basis risk, properly measured, is small Why, after all, should home prices vary very much beyond the control of the homeowner due to factors beyond the measurable ones of location, size, age, etc.? Still, further work might be done to try to learn something about the basis risk before launching contract forms. Research can also be done developing finely defined price indices, for homes of specific characteristics, to serve as the basis of settlement of home equity conversion contracts.

The actual moral hazard risk we will experience with home equity conversion forms is, despite our modeling efforts, hard to measure. We have assumed in our model that individuals always behave optimally in their own self interest with full knowledge. While the model is a useful start, we should not always assume that individual homeowners are accurately described by it. One issue not addressed in our model is the process of learning. We think that the ultimate moral hazard is likely to build with time after the contracts become commonplace. The homeowner’s ability to exploit weaknesses in the contract definition may tend to grow over the years, as these weaknesses become more apparent.

There is likely to be a process of social learning after large sums are committed to these contracts, when homeowners with such contracts will have a great deal of incentive and time to communicate with each other and with their lawyers about the best methods to beat the system. While creators of new home equity conversion forms may tend to view past experience with experimental home equity conversion forms as a good guide to the future, perhaps future research should instead consider carefully some blend of the evidence from past experience and the evidence from models like that we have presented here.