Saturday, September 20, 2008

Shield Men From Folly: Fill The World With Fools

Many politicians and pundits claim that the credit crunch and high mortgage foreclosure rate is an example of market failure and want government to step in to bail out creditors and borrowers at the expense of taxpayers who prudently managed their affairs. These financial problems are not market failures but government failure.

The Community Reinvestment Act of 1977 is a federal law that intimidated lenders into offering credit throughout their entire market and discouraged them from restricting their credit services to low-risk markets, a practice sometimes called redlining. The Federal Reserve Bank, keeping interest rates artificially low, gave buyers and builders incentive to buy and build, thereby producing the housing bubble. Lenders were willing to make creative interest-only loans, often high-risk "no doc" and "liar loans," in order to allow people to buy more housing than they could afford. Of course, with the expectation that housing prices will continue to rise, it was no problem for lenders and borrowers but housing prices began to fall, leaving some people with negative home equity and banks in trouble.

The credit crunch and foreclosure problems are failures of government policy. In fact, what we see now is a market correction to foolhardy government policy. Congress' move to bailout lenders and borrowers who made poor decisions will simply create incentives for people to make unwise decisions in the future. English philosopher Herbert Spencer said, "The ultimate result of shielding men from the effects of folly is to fill the world with fools."

~Walter Williams

MP: Or if you make the world safe for idiots (and reckless borrowers, investors and executives), you’ll create a world full of idiots (reckless borrowers, investors and executives).

13 Comments:

At 9/20/2008 9:49 AM, Anonymous BARKLEY said...

I have a numbers question.
Today they are talking about a 700 billion dollar plan to stem the mortgage crisis.
I estimate that amount of money would be enough to outright purchase 3.5 million median priced homes.

Why are the numbers so big?
Why are the losses so big?

For me the numbers don't really make sense.

Right now there are around a million mortgages in foreclosure.

700 billion plus all the other lost billions we have been hearing about just dosn't add up for me.

 
At 9/20/2008 11:26 AM, Anonymous QT said...

The housing slump and sub-prime defaults are only one aspect of the credit crisis problem. They were just the touch paper.

The credit crunch/liquidity problems go far beyond the relatively small percentage of bad mortgages to a system built on leverage

The way it worked was that a bank would issue a mortgage, bundle a group of mortgages into a security which is sold, the bank used the proceeds to create more mortgages which in turn were bundled together and sold as securities....and on it went until interest rates went up, borrowers started to default, demand for homes declined, prices slumped and suddenly people started to wonder how secure these securities really were. Overnight, the market for securitized mortgages evaporated and now, banks had to bring the mortgages back onto the balance sheet and set aside capital to guarantee them or write them down to market (ie. zero).

There are 3 things worth reading to get your head around this problem:

1. David Wessell on changes to Basell II rules
2. Why the credit crunch will go on by David Roche
3. Maybe the Banks are Just Counting Wrong by John Berlau

Unfortunately, this situation is a very difficult one with no easy answers. We do have some very good people at the Treasury and the FED and we will get through it.

It is certainly worrisome but we have gotten through serious crises before like the S&L crisis, 1970s stagflation & oil crisis, and the Asian monetary meltdown.

If this is the first major economic crisis that you are living through, it helps to read Commanding Heights by Pulitzer prize winning author, Daniel Yergin. Great book on economics delineating some of the tumultuous economic crises of the 20th century. Helps to keep things in perspective.

 
At 9/20/2008 11:52 AM, Anonymous BARKLEY said...

OK
I took a look at those articles.
John Berlau talks about Financial Accounting Standard 157.
That is the "mark-to-market" rule put into effect November 2007.
Sounds like that is the main problem.
I don't like to be rude
but it sounds asinine to me.

I have noticed Steve Forbes calling for a change back on that rule.

That rule looks like it has caused a lot of damage.

I like the "rule of unintended consequences."

Or maybe someone did intend to destroy those companies?

 
At 9/20/2008 11:59 AM, Anonymous BARKLEY said...

Another point to ponder...

Homeowners do not get margin calls.

As long as they make the payments,
it doesn't matter if the house is worth less than the loan.

 
At 9/20/2008 12:31 PM, Anonymous QT said...

Barkley,

True.

The time the homeowner walks is if they have no principle on the line...ie. no downpayment (something politicians thought was just fine when homeownership was the social goal). Essentially, they are just leasing a house.

Those of us who have been in the situtation of a housing downturn just had to wait the 10 years for the prices to come back.

A wise businessman once told me that going into a recession you want to be in a strong cash position. In the last several years, strong cash positions have tended to be the norm. Many companies are in good shape to weather a recession.

One thing that we do know now is why long term interest rates remained low even as interest rates were raised and where all the money was coming from that was sloshing around in the global economy. Even Greenspan did not understand why this was happening. It would seem to have been excessive leveraging. On the upside, this leveraging effect has fed global economic growth although we are now dealing with the fall-out.

I guess there really isn't a free lunch.

 
At 9/20/2008 1:47 PM, Blogger bobble said...

LOL, mark perry is making another shameless attempt to pin this trainwreck on government.

it couldn't possibly be the result of massive greed and even more massive LEVERAGE, unchecked by any regulation. no, it's government's fault that the bets went bad!

it's sure a mess, but i'm glad it got plopped in bush's lap. he's certainly the poster boy for deregulation, and deserves some of the blame (along with "the messtro" greenspan).

imagine if this implosion had occurred a few months from now on obama's watch, and he took the same actions bush is now forced to take. people on this blog would be calling him a the "new" new deal marxist, and worse.

i guess there is some justice.

 
At 9/21/2008 10:54 AM, Blogger OBloodyHell said...

Been saying it for years:




Too Much Tiger Food,

Not Enough Tigers.


.

 
At 9/21/2008 11:00 AM, Blogger OBloodyHell said...

> LOL, mark perry is making another shameless attempt to pin this trainwreck on government.

Bobby, get your head out of your ass.

Fannie and Freddie, the central component of this problem, are GOVERNMENT institutions.

Yeah, they're "Government Corporations" -- if you imagine that makes them even vaguely like REAL corporations, then you need to lay off the drugs -- they're making you stupid.

This trainwreck is not only caused by the government, they laid out the tracks and scheduled the trains on them.

You can argue over which laws and which regulations screwed the pooch the most, sure. But it was the government -- corporation, law, and regs -- in one form or another -- that cornholed this bitch.

 
At 9/21/2008 11:15 AM, Blogger OBloodyHell said...

> it's sure a mess, but i'm glad it got plopped in bush's lap.

Only by ignorant fools.

Bush tried to deal with the problems leading up to this five years ago.

Note that that's the NYTimes reporting it.

Also: Guess which political party told him to f-off?

Also: Note that the developing issue is hardly coming out of nowhere -- it's been talked about for almost two years now leading up to this.

*Which* political party has been in power in that time frame?

*Which* political party has been ignoring repeated treatises to tackle the problem early, when cheap, rather than late, when expensive?

That would be the same idiot group that's been trying to tell you to ignore the evil tyrant behind the desert curtain -- because he was never any threat.

Wonderful powers of prognistication they have, eh, what?


Sorry, bobbie, to burst your little warm and fuzzy "government-is-good" and "Bush-is-eeeeeeeevil" bubbles.

I'm sure you'll ignore the fact that they got popped and continue believing whatever assinine BS you want to, though.

 
At 9/21/2008 11:17 AM, Blogger OBloodyHell said...

> it helps to read Commanding Heights by Pulitzer prize winning author, Daniel Yergin.

And if you're feeling lazy, there's also the PBS series based on it.

 
At 9/21/2008 11:22 PM, Blogger bobble said...

OBH:
"get your head out of your ass"
"you need to lay off the drugs -- they're making you stupid."
"assinine BS"

LOL, you forgot "libtard".

seriously tho, i don't agree that the GSEs are the central cause of the problem. like you, i'm not in favor of having GSEs, but i don't let that cloud my judgement.

i think a more central cause was that bush weakened and neglected financal regulations.

just as one example, in 2004 the bush SEC changed the capital ratio rules for companies like Merrill, Goldman, Lehman, Bear, and Morgan Stanley so that they were allowed to increase leverage from 12X to over 30X.

SEC regulation

 
At 9/22/2008 2:47 AM, Blogger juandos said...

Nice of bobble to ignore reality: "it couldn't possibly be the result of massive greed and even more massive LEVERAGE, unchecked by any regulation. no, it's government's fault that the bets went bad!"...

Lee Pickard offered up HIS opinion about the problem...

Why should the government have written the, "net capital rule" in the first place? Its NOT their job...

OBH's question is valid: "*Which* political party has been ignoring repeated treatises to tackle the problem early, when cheap, rather than late, when expensive?"

Maybe you should read Paul Gigot's The Fannie Mae Gang

I think Walter Williams has a commentary that describes your condition bobble: Stubborn Ignorance

All that being said I don't think its the federal government's job to bail these outfits out either: Why Bailouts Scare Stocks by Alan Reynolds

 
At 9/22/2008 4:12 AM, Blogger OBloodyHell said...

> LOL, you forgot "libtard".

Your statements suggest that, but I don't explicitly recall any facts in evidence to indicate your political, as opposed to economic, stance.

Libtard=Socialist. It's not symmetrical -- Not all socialists are libtards. You may well fall into the latter category.

> i think a more central cause was that bush weakened and neglected financial regulations.

No he did not. That was Congress. As my link showed, Bush CLEARLY was attempting to rein them in long before this was an evident problem, by adding more direct oversight and stronger limitations.

There were also multiple entreatises from the Bush admin to the Dem-controlled Congress in the last two years to get a better view of where things were at. As with the 2003 matter, "F*** Bush!" was the SOP.

So instead, the economy takes it in the...

I don't think that you can even begin to make the argument that the GSEs are not at the heart of this. The others -- the banks, AIG, etc., are all contributory. But it takes the credit crap to start the whole shebang rolling like the proverbial snowball down the hill, building and building.

> All that being said I don't think its the federal government's job to bail these outfits out either

I don't, either, but I do somewhat agree with Walt that there is a point where you sort of may need to step in and "fix" things so as to prevent cascade problems. I also very much concur with Frank Martin's analysis, over on VariFrank (included on another thread's comments but I'll repeat it here, in full) --

As a taxpayer, I'm just asking, as a capitalist, I'm appalled, as a shareholder, I'm furious

Now, I say this as a complete capitalist, but if a business gets so large that its failure would collapse the market(Like AIG is purported to be), then is it fair to say that the business should be broken up by the government to keep that from happening?

"Too big to fail" should not be "Taxpayers pick up the tab". If you are too big to fail, maybe we need to make you a little smaller.

That goes for you too GM...


I concur. Any business which we step in to save should be required to divest itself into not less than three independently incorporated and market-listed parts, with assets and functions suitably divided

 

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