Financial Fallout

Next week, Rep. Barney Frank is going to hold hearings on the feasibility and the desirability of creating a new federal agency to absorb some of the bad, mortgage-based liability that Wall Street currently finds itself under.

“The question is, and it’s just a question, is, ‘Are we at the point where the private market has made so many bad decisions and is so depressed that it can’t get out from under?’ “ said Mr. Frank, who is planning to hold a hearing next week to explore whether Congress should create an agency to help the markets dispose of hard-to-sell assets.

This gets at something that I’ve been thinking about with regards to the financial crisis. As I understand it, this whole thing stems from two things: the bursting of the housing market bubble and investment banks’ decision to create a new type of revenue stream based upon mortgages. Once the pool of solid, sanely based mortgages had been exhausted, though, the investors looked around for more people to buy houses. As their need to continue the expansion of this new revenue stream increased, their criteria for what constituted a safe bet on a mortgage declined: No down payment? No problem. Don’t want to prove that you have a job? We’ll trust you. Why would you lie about that?

All this lead to a couple of different, rather predictable in hindsight, results. People who did not really possess the means to purchase a home were getting loans of extraordinary size to buy houses that were priced way beyond what was a realistic market value. And, as long as the prices of the homes kept rising, this looked like a good deal. Even if buyers who couldn’t afford their mortgages in the long term failed, the investment banks would be left holding paper on a house worth more than what they’d underwritten it for.

Of course, when the bubble burst and suddenly everyone was trying to sell their $450,000 McMansion, the price of those homes dropped dramatically – and the banks found that all their investments were worth far less than what they’d put into. Usually not a good situation for an investor to be in.

The Times article above discusses the question I’m really curious in: who should the government try and protect? The investors who encouraged people who had no business buying homes to take the plunge? Or the homeowners who suddenly find themselves head over heels in debt with a house they can’t sell and which isn’t worth as much as they paid for it?

There is certainly plenty of blame to spread around, but one thing is true: the people who are really going to suffer from this are the homeowners. Whatever happens to the investment banks, whether they government breaks them up or they’re absorbed by another, even larger firm, the people who made the decisions that lead us here are going to turn out just fine. The homeowners were foolish to take a risk that they couldn’t afford, but that’s an understandable, personal flaw. The investors who made these decisions all along the line are at least as guilty for encouraging them and creating the means of their destruction. But they’re not going to pay anything close to the price of the average homeowner in this.

It may be that the government needs to step in and make sure that all this loose debt is consolidated in one place. They also need to make sure that this doesn’t happen again. Is there anything that can be done for the homeowners? The corporations are falling apart, but the people ran them will be fine. The same can’t be said for the homeowners

The whole thing has convinced me of one thing. If a company is too big to fail, it’s too big period. Deregulation and consolidation have brought us to an ugly point. I don’t think anyone went into this whole thing with a will to see people destroyed. However, this whole episode just proves a firm point of human nature: if people can do it, they will. If you don’t stop them from making sausages with tainted meat, they will. If you don’t stop them from putting children to work, they will. If you don’t prevent them from pouring toxins into the drinking water, they will. And if you don’t stop them from giving bad loans to people who can’t afford to repay them, they will.