Re: OT: Mortgage industry bail-out

Ed Jay <edMbj@xxxxxxxxxxxx> writes:

[ Analysis of S&L failures, Enron scandal, and credit crisis; redirect to:
http://www.dailykos.com/story/2008/9/21/9322/74248?detail=f
]

A not so succinct, but lengthy and comprehensive historical review was
posted today. I recognize it was published on a well know progressive blog
(Daily Kos), but it speaks to the actions and behavior of individuals, not
to partisan politics. That the individuals are Republicans shouldn't matter.
It's very long, but also very informative and revealing.

Yes, it's long, too long. I quickly scanned it. It describes one factor
and ignores another.

In two of the crises -- S&L and credit -- two factors, which ought to go
together, did not. Let me list them:

1. Deregulate a market.
2. Let the market participants bear the risk.

This works. Companies will succeed or fail, but the taxpayers don't bear
the burden of bailing them out.

What really happened with S&Ls and the current credit crisis was:

1. Deregulate a market.
2. Make the taxpayers assume the risk.

This doesn't work. The result is predictable: If the taxpayers bear the
risk, the taxpayers will, of course, pay.

In the S&L case, the taxpayers assumed the risk because, even though the
S&Ls could make riskier investments, the government still insured
deposits, and charged below-market premium for this insurance. The
govenment gave the S&Ls the proverbial inch, and they took the
proverbial mile. They had nothing to lose -- the risk due to their risky
investments was now on the shoulders of the taxpayers, via low-cost
deposit insurance.

Did the depositors, attracted by a higher interest rate, care to check
if their S&L was making risky investments? Not at all -- their deposits
were guaranteed by the government, so why bother investigating?

The same in the credit crisis -- the taxpayers assumed the risk. Fannie
Mae and Freedie Mac were guaranteed below-market low-interest credit,
and almost guaranteed a bail-out. They ran with it. Their CEOs had a
duty to the company to take full advantage of all these benefits for the
sake of the company, and they did.

Imagine what would happen if you could buy stocks with the assurance
that the government would pay you for losses. Would you care any more if
you bought risky stock? Obviously not. Does this mean that the
government should regulate the market such that you could no longer
buy risky stock? Of course not -- so long as you bear the
full risk of buying risky stock, you should be able to buy it.

But in the S&L crisis and the credit crisis -- the government created in
effect a stock market, but promised to pay for all losses.

This is no way to deregulate a market.

So Ed, you are right in one sense. Markets should be kept regulated, if
the deregulation would be only partial, such that the market
participants get the benefits but the taxpayers pay the cost. The right
way to deregulate a market is to never, ever have the government bail
out the losers. If they know this, they will consider the risks more
carefully. If they know a bail-out is available, they will plan to use
it.

The Enron scandal is harder to analyze, because Enron was secretly
manipulating the system. California did not fully deregulate the market,
though - it deregulated only parts of it. I'm not sure this fits in the
same model as the S&L crisis and the credit crisis. That Enron is being
analyzed in the same breath as S&L and credit crises suggests that the
article is more interested in simply criticizing McCain and deregulation
than in doing a full and correct analysis.
--
Rahul
http://rahul.rahul.net/
.

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