Sunday, October 12, 2008

Musing on The Mortgage Crisis

With governments around the world desperately trying to save the banking industry from itself, I think it is time to consider these actions.

The current crisis we are seeing unfold is a direct result of nothing more than blind greed on the part of the banks. There can be little doubt about that. The various abstract constructs that they created to shuffle money between institutions created the illusion of safety but in fact decoupled risk and consequences of poor lending practices from the reward of profits.

With taxpayers ultimately holding the bag for this mess, the depth of the crisis speaks volumes to the consequences of the blind ideology of allowing the 'free market' to run unfettered - especially in areas where the industry is foundational to the economy itself. The claim is made - all too often - by hardline free enterprise advocates that the free market should reign supreme, without any government intervention.

While things are on an upswing, that isn't such a bad thing ... right? Well, I think such a view is both short-sighted, and deeply flawed. The consequences of allowing foundational aspects of the economy to run amok are becoming quite clear these days. Some brain boys in the US banking system came up with this neat idea called 'Asset Backed Commercial Paper' - essentially a vehicle for auctioning off mortgages in lots to investors who have no visibility on the underlying mortgage or the borrower's circumstances. This created a layer of abstraction that decoupled the bank that initially made the loan from the risk/reward equation of making that loan; and shuffling it off as part of a larger packet of loans to some investment bank. The investment bank only really sees the numbers on paper - an asset behind the debt itself, so the investment bank thinks it is on pretty solid ground.

Clearly, this is not so much the case, as we are learning.

What does the current situation tell us? That the 'free market' works only when there is a reasonable amount of balance in the market. When it gets too far out of balance in one direction, it will inevitably fall apart. The role of government is to ensure that the market remains in balance.

Free market ideologues will argue that the government has no place in the market. When the impact of that market coming unglued is as pervasive at it is with the banking industry, the cost of that imbalance lands firmly in upon the shoulders of the taxpayer. Therefore, the taxpayers have a right to insist (through their government) that the market players be regulated in such a way as to ensure that the risk and reward of the marketplace is kept in perspective.

This isn't to say that all aspects of the free market must be carefully regulated, but there are certain areas which are foundational to the basics of the free market itself, and clearly those need to be kept in balance.


VĂ©ronique said...

Excellent post!

Anonymous said...

I disagree. There should be no regulation in the market whatsoever.

That being said, people should not expect bailouts from the taxpayer when they take a risk. Sometimes when you invest you take a risk and lose and in that case the taxpayer shouldn't bear the brunt of your choice. Period.

MgS said...


Like the ideal of absolute equality and shared gains that Marx expressed, the ideal of the "utterly unfettered free market" fails on any scale larger than a small village - for largely the same reasons.