Friday, July 10, 2009

Unintended consequences

"AP - Treasury Secretary Timothy Geithner is telling lawmakers the U.S. economy stumbled last year in part because the power and risks of an explosive derivatives market blindsided the government."*

That's no excuse. He's basically saying that the government failed to see the negative consequences of its push to increase home "ownership" regardless of buyers' ability to pay. It's yet another example of government's inability to accurately see problems, correctly diagnose them, determine and actually execute the best solutions. These are things best left to the market.

Freddie Mac and Fannie Mae buying everything from the banks, regardless of the stability of the underlying loans, took away the traditional incentive for banks to lend rationally. The government guaranteed the banks' profits, and assumed the risks associated with defaulting buyers.

Banks didn't suddenly become greedy because capitalism failed. Banks have always been out to make a profit. But their greed used to be tempered by risk. When you take away the risk, or as in this case, shift it to third-parties, people will do things that would otherwise be irrational.

Further, all the big banks did this, because if they didn't take advantage of the govenment sponored scheme, they were leaving billions in profits to their competitors. The derivatives market not only rewarded risky lending, but actually punished prudent lending. It was made possible, and even inevitable, by government meddling with things such as Fannie, Freddie, the CRA, and the loose monetary policy of the Federal Reserve.

I don't play roulette, but if someone gave me money to play, and let me keep my winnings, I'd probably spend a lot more rime in Vegas. Bankers are no different.

-- Post From My iPhone

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