Mortgages, The Market, and Mania

I'm not a big fan of regulation for regulations sake, having a fairly wide libertarian streak (blame my Texas upbringing), but there are many cases when regulation is good thing. One of the best is regulating the impulses that destroy us (I might argue that if you only destroy yourself, then regulation is unnecessary) and, particularly, when that destruction takes others along. Such is the case in the financial markets.

History shows that, over and over and over, the markets succumb to manias that enrich a lucky (usually, the early) few, and destroy everyone else involved, and often a goodly number of bystanders. The current situation is such.

We had historic real estate price growth rates and historic low interest rates. Everyone and their dog was getting involved in real estate. This necessitated a huge growth, and explosion, in the mortgage market. One fed the other which fed the first and on the bubble grew. Rational observers could see only one result, but the participants and the government gave us the old refrain: It's different, this time.

Rule Number One: It's NEVER different, this time!

So we had incredible price growth in the real estate market, we had cheap money, much of it, due to the rising prices, outside of the government parameters for loans, and the twain met and drove the market to it's inevitable doom.

At some point, the greater fool theory took hold and the underpinnings started to crumble. People who had gotten cheap mortgages, outside of federal guidelines, and sometimes out of their ability to pay, began to worry; people looking in decided to hold off for a while, which slowed the growth of real estate prices; people with money to lend became less interested in lending to what was now, obviously, a tenuous bubble economy. And then the bubble burst.

And now, the reaction is spilling over to the financial markets at large. The Dow is down more than a thousand points from it's high last month, with no real end in sight, as the problems are psychological, not fundamental. The secondary market for mortgages has collapsed to the point that the Fed is having to hold it up.

All of this because most of the activity took place outside of any regulation.

I'm not proposing that we regulate the financial markets into stasis. The people that drive the markets are risk takers, always have been. But the situation has changed, dramatically, over the last several decades. Most of the risk takers are taking risks with other people's money, not their own; this changes the dynamics of risk taking and makes seemingly insane risks seem reasonable. Particularly if the only cost to the risk taker is getting a multi-million (or in some cases near billion) dollar golden parachute. Corporations may not have enough to pay their pension obligations or provide health coverage to their workers, but they always seem to find the money to pay off execs they want gone. Go figure.

My economics is all undergrad, and as such, I'm not going to offer any significant proposals here. But, it seems to me, that if we want to restrain 'irrational exuberance', then we need to reinforce the risk side to the risk takers. I don't know if this needs to be civil or criminal penalties, or financial sanctions, or what. I just know that something needs to be done, all across the board, to 'teach' corporate management that there are costs to 'failure'.

Businesses pollute, cheat, collude, lie, etc, with virtual impunity. Legal penalties against them are ridiculously small. If Halliburton is ever convicted of fraud in Iraq, they'll pay a heavy penalty, but compared to the profits they've raked in, it will be a pittance. Where's the coercive effect? Where's the fear factor?

Penalties for serious infractions need to be made much more severe, altho perhaps variable with the size of the company. And, in my opinion, there should be offenses for which the penalties are crippling to the company, perhaps even life threatening. And management involved in the offenses should face penalty as well. I'll leave the specifics to the experts but we need to make the punishment fit the crime, to the point that potential offenders think twice about committing the crime.

We should be able to get the Repugs on board with that. Isn't that their whole position on crime in general?

(cross posted at DailyKos )