Tuesday, March 18, 2008

The Fed Acts

It’s best to let the market sort these things out.

As the president said last week:

“The temptation is for people, in their attempt to limit the number of foreclosures, to put bad law in place,” he said. “I believe there ought to be action, but I am deeply concerned about law and regulation that make it harder for the markets to recover.”

But I guess that only applies to the little guys. When the big guys get in trouble well so much for market forces. Thus the Fed has conducted a fire sale of Bear Stearns and said the U.S. Government will take over the really bad investments made by the company. Read more about it here.

Is this a wise thing to do? Yes, probably in the long run it is. There should have been a great deal more action a lot earlier and we might not be in such a mess. But to let this company go belly up would have been a disaster to the economy.

Who’s to blame?

First off Wall Street. Plain and simple it’s greed. Bundling of very questionable mortgages and selling them as a commodity. And Wall Street firms just kept on doing it. Will Bear Stearns be the last to fall? Let’s hope it is.

I think the appropriate analogy is to think of a Wall Street as a small child. The sub-prime mortgage market as a huge tray of chocolate candy. The tray was put in front of the child. The child ate and ate and ate and ate the chocolate until it puked. The unfortunate thing is that the America tax payer gets to clean up the puke. And we all know how much fun that is.

The next question to ask is why did the child puke. Yes, the child ate too much chocolate but the child ate too much chocolate because no one was around to supervise the child. No adult was present. The adult of course, in this case, would be the Federal Reserve and the Treasury Department.

They just sat back while the child ate and ate saying there was nothing to be concerned about and that the market would correct itself. There was no need for any sort of regulations for these types of loans. They are now falling all over themselves to regulate the sub-prime market.

Remember last summer they said this would not effect the economy at all. I think the saying is the chickens have come home to roost.

The thing is that steps could have been taken that might have prevented this crisis or at least lessened its severity. The Fed could have looked long and hard to see the effect of continuing to raising the prime rate would have done to this segment of the market. The prime rate is not directly linked to the way mortgage rates are set but it does influence them.

But the Fed had to fight that great phantom menace inflation and so it continued to raise the prime rate. It disregarded the warnings that the sub-prime market could indeed impact other markets.

I remember when I was looking to buy a house six years ago these types of loans were around. My real estate agent said they were a bad idea because at some point interest rates would go up and the mortgage payment would sky rocket. That’s exactly what happened. My real estate agent could see that but the regulators couldn’t.

There's a great article from E.J. Dionne in the Post about this.

A couple of points from the article:

The Wall Street titans have turned into a bunch of welfare clients. They are desperate to be bailed out by government from their own incompetence, and from the deregulatory regime for which they lobbied so hard. They have lost “confidence” in each other, you see, because none of these oh-so-wise captains of the universe have any idea what kinds of devalued securities sit in one another’s portfolios.

The closing sums up what I’m thinking about his whole thing and I bet a great many other people as well:

So now the bailouts begin, and Wall Street usefully might feel a bit of gratitude, perhaps by being willing to have the wealthy foot some of the bill or to acknowledge that while its denizens were getting rich, a lot of Americans were losing jobs and health insurance. I’m waiting.

I think we all are waiting. My guess is will be waiting a very very long time.


Anonymous said...

This is absolutely one of your best posts ever. Lucid argument illustrated by references to bodily functions! Superb. — Ed

Jason in DC said...

Yes I thought the analogy was a very good one too. Glad you liked it. :-)