June 02, 2010

You Say To-may-to, I say To-mah-to

Excerpts from real, live, actual email conversation with my brother-in-law:

RECIPE FOR THE BANKING CRISIS: Have lawmakers insist that banks make mortgage loans to people who can't afford them. Allow banks to sell 'floating rate' mortgages that have interest fixed only for a short term, ballooning to big numbers after just 5 years with a wink and a nod that they will be able to refinance before that happens...
Yeah but you don't address the "multiplier effect" of these huge derivative bets that housing would never go down in price. Granted Fannie & Freddie were disasters, but the reason much of the private market for mortgages was so screwy was because banks were selling them to other banks and so had no skin in the game. They didn't care if you had any income because they knew they were going to turn around and sell it. I think for the free market to have truly worked, we would've had to let those banks fail.
In order for the free market to work, the Gov't should not have been requiring banks to loan money to satisfy demographic profiles that granted loans to people who couldn't afford them -- even with the Feds holding the bag. That's really where the whole thing went south.

FM&FM jumped in the game too, buying and selling these things just like they were there to turn a profit like a real company rather than service mortgages as an agent of the Gov't.

There was no free market to start with -- banks were failing because they were setup to fail by Lawmakers in Congress who passed regulations that upset the free market for home mortgages.

Letting those banks fail would've been a much larger disaster, IMHO, with even more companies gone and less jobs. Of course, I'm not sure we've hit bottom yet either.
But the banks were failing not because of bad loans - Lord knows they can absorb a huge rate of defaults - but because they avoided government regulation and placed bets that those homes wouldn't default. It's like if I were a bank, and I made a loan to somebody of $1,000, and then I bet $1,000,000 that whoever borrowed that money would not default. I can deal with the $1,000 loss, but not the $1M loss.
Those loans you were betting on were on mortgages using property as collateral, property whose value was inflated because the Feds had spurred a housing bubble by 1) requiring banks to loan money to people who were likely to default, and 2) allowing banks to make money on the origination of these loans, then trade these loans on the stock market immediately.

The whole bank-failure-process was started as a result of over-priced mortgages being made to people who could not afford them -- something regulated by Congress to make homes affordable to everyone, even those who couldn't afford them.

And the whole thing seems to me a lesson in the terrible unintended consequences of the Gov't regulatory interference in any market.
The classic "bad mortgages versus bad bets" argument.


Robert said...


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Rev. Robert Wright

William Luse said...

Seems to me that both of you have good points. Keep in mind that's coming from an economic illiterate.