||[Oct. 16th, 2008|11:05 am]
It sure seems like it's very difficult any more to get any sort of real, reasonable discussion going on how the government should do its job, or even about what its job should be. A case in point from today's New York Times: "...[McCain] served up the same-old trickle-down theories and a government-is-wrong, markets-are-right fervor that helped create this economic disaster."|
I sort of agree with that description of McCain's ideas, but it doesn't describe the problem in a way that actually helps anyone. It seems to me that the Liberal Media misses the point every bit as the Conservative Media -- (Fox, Limbaugh, Scarborough, Malkin). Simplistic indictments do no good.
The problem in this particular case is that free markets are right. The current freefall that financial market are in accurately represents the horrible mess we're in. What the market crash and bank failures accurately represent is this: The human race is living in a way that is unsustainable. Everything was fine when investors and markets had faith in the status quo. Now that faith is gone. Consequently, everyone who bought into the status quo is being hurt.
This current situation -- speaking specifically of the housing bust and credit crisis -- could have been avoided if certain things that used to be the case were still in place. Which is to say, the bank that loaned you the money for your house actually held the debt in house. Banks are required to maintain cash reserves to cover their obligations. This provides a ceiling on the amount of money available for lending. That ceiling keeps housing bubbles from getting out of hand -- you cant sell a $100K house for $500K if no one will lend anyone $500K to buy it.
An innovation that came into being in mortgage lending in the last 30 years was the mortgage resale business. Banks make loans, and then 'sell' the loan to bigger banks. The originator (i.e. your bank) won't make as much money from your mortgage as they would if they kept the loan in house. Instead, they get a much smaller amount, and they clear your mortgage from their books. This means that they can turn around and originate another mortgage to someone else, because your mortgage is no longer part of the formula that determines their legally required cash reserves. The bank has made the calculation that they'll end up with more money in the long run by making loans and then flipping them to someone else.
This doesn't create a problem if the bank that ends up holding your mortgage is also required to maintain a certain mortgage-to-reserves ratio. They're just a bigger bank, with larger reserves, so they can hold more mortgages, and over the lifetime of those mortgages, they will collect enough interest to make even more money.
The problem came when those big banks started selling mortgage-backed securities. If you bought one of these securities, you were becoming proxy holders of that mortgage debt, and your eventual return on investment came from the interest paid over the life of the loan. If people stop paying their mortgage, then you're stuck -- the value of the security approaches zero! You lose your money.
On an individual basis, it sucks to be you. But since you work for a living, you can just make more money by working. But the banks were also buying those securities -- and then counting them as dollar-valued assets, meaning that they could borrow against them to invest in other stuff. As soon as people ran into trouble paying their mortgages, the value of those securities went to zero. The banks could no longer them as assets, and they went 'underwater' -- their liabilities exceeded their assets, and they could no longer borrow or lend money. They're bankrupt, and that means everyone who owned THEIR stock loses their money. Since banks hold stock in other banks as assets, THEY don't have enough assets all of a sudden, and they go underwater.
What we have now as a result is a recursive chain reaction of suck. All of this could have been avoided if the chain of debt support hadn't been broken. In other words, banks shouldn't be able to count mortgages bought from other banks as cash assets. Cash reserves should be held in actual cash, or at least there should be some standards as to the safety of assets held by banks as reserves.
There's a downside to this -- it means there's less money available for loans. The upside is that housing bubbles happen because there's too much free money chasing too little property. A return to a saner system of balancing reserves against mortgages will keep future bubbles from occuring.
Of course that's no consolation to people who can't pay their mortgages now, or are watching their mortgages go underwater. But it doesn't take a financial genius to see that an adjustable rate or zero principle mortgage is a hugely bad idea. Unfortunately, a lot of people aren't financial geniuses. They share some blame for their predicament, but the lion's share of the blame goes to the lenders, because they had (or should have had) the responsibility to make sure they are making loans that customers can actually pay back. And the reason they didn't honor that responsibility is that they didn't have to hold that debt in house.
So there's a clear, bright line that should have been drawn -- a line that used to be there. That's a point where people much smarter than me should write some clear, banking regulations.
At the same time I do believe, along with conservatives, that the regulations on free markets should be parsimonious. The amount of regulation should be the minimum required to prevent disasters. You can't remove risk from the system entirely, and neither would you want to. But you can keep the risk more closely held -- i.e. the person or institution taking the risk should be the one exposed to the downside of the risk.
And that's what irks people so much about the current bail out -- the perception that the people who gambled and lost are being bailed out. I feel some of that vexation myself, but we have to do something about the current problem. Whether we like it or not, we all will be hurt if we can't restore some sanity and balance to the system, and yes, a certain amount of bailing out needs to happen.
Getting back (finally!) to the original inspiration to this post: Stop oversimplifying and caricaturing. Stop making a catch phrase stand in for a complex thing. It isn't necessary for everyone to understand everything about everything, but dammit, stop acting like there isn't anything worth taking the time to understand!