At the beginning of this year there was great hand wringing over the sub-prime mess and the havoc it was (and still is) creating. Pundits have called our current financial crisis the biggest crisis since the Great Depression. There was great demand for Congress to “do something”, thus Congress kicked into gear (for example, limits were temporarily raised on FHA loans to make them available to high priced places like California).

But some ideas being floated around Congress are generating intense philosophical debate, namely the concept of “moral hazard”. Moral hazard is an insurance term, used to describe how people possibly may behave under certain circumstances.

Wikipedia defines “Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.”

Millions of people bought homes in 2005 and 2006 that have now lost a substantial amount of equity, but they’re still meeting their financial commitments (ie, paying the mortgage) . We also know vast numbers of individuals also bought a home they simply couldn’t afford, but lax (or no) underwriting got them in, and now the chickens are coming home to roost.

Should those people be helped by Congress? Or should they feel the pain of their poor financial decision making? The big Wall Street firms that financed that easy credit have already taken their painful medicine (billions of dollars of investor money lost, the former CEO of Bear Sterns went from being a billionaire to just being merely rich ($67 million), etc).

What a difference a few months makes. Congress was ready to provide $300 billion worth of assistance to the real estate debacle, but the concept of moral hazard now has a strong voice against it.

It’s so very easy to separate the macro from the micro. What’s good public policy? Should we be accountable for our own behavior, or always have “mommy or daddy” in the background to pick us up, dust us off and get us off and running again after we’ve made a poor decision? It’s very easy to find numerous hardship stories of people who were lied to, duped or whatever, that are truly in a hardship situation because they bought a house they simply (in normal times, with traditional “normal” underwriting) couldn’t afford and now they’re losing their home.

Moral of the story for first time buyers: 1) stick with a traditional, 30 year fixed mortgage. If you can’t afford that payment, you can’t afford that house. 2) consider NOT getting the most expensive home you might possibly be able to buy. Remember, just because a lender is willing to push you to a 45% – 50% back end ratio doesn’t mean that’s a wise decision for you.

So – who’s right? Who’s wrong in the great “moral hazard” debate?