Another Downturn Another BuyOut

Bureau of Economics

Americans love capitalism.  We love to tell the government to stay out of the business of business.  “That which governs least governs best” and all that hoo ha.  This holds true until something goes wrong.  The World Trade Center and Pentagon are attacked: let’s change our way of life.  The mortage industry fails to properly regulate itself, and now it appears that the government will come to the rescue of Fanny Mae and Freddy Mac.

Given the circumstances I don’t see any recourse but to bail out these two pseudo-corporations, but wuoldn’t it have been more cost effective to employ some amount of regulation to avert the need for the U.S. tax payer to step in – again?  Let’s recall the last fiasco in the 1980s where the savings and loan industry all but collapsed and the Resolution Trust Corporation was formed to recover the mess.

Instead of paying through the nose at the end, perhaps a little LESS liquidity would have done nicely.  For instance, debt was sold from one bank to another like candy without any notion of the risk.  What if the bank that issued the note had to hold it?  At that point the risk is the bank’s and the bank’s alone.  Perhaps this is also an argument for a higher reserve ratio for subprime mortages.  Another approach would similarly require a ration of prime to subprime loans so that there is a maximum risk portfolio.

One of the reasons this isn’t done is that people say that the market should sort itself out.  And that works up until a certain point, after which Americans who are not delinquent foot the bill.

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