As our political leaders fumble around trying to come up with a “solution” to the present financial situation, it is hard to resist making some observations and comments. First of all, the present problem is not due to failure of markets, but due to failure of government policy. Therefore, there is a great deal of doubt as to how good a solution the government will come up with to solve a problem they caused in the first place. And that leaves in question the viability of the $700 billion bailout of Wall Street.
The first part of the problem is that the Federal Reserve has been creating too much money and credit. A second major factor is that banks have been forced to loan huge amounts of money to people who are simply not credit worthy. A third part of the problem is the creation of two government entities Freddie Mac and Fannie Mae, which have facilitated the creation of bad market investments.
Everything went along just fine as long as the market for homes was going up and the financially weak holders of mortgages were secure in the “knowledge” that at any time they could sell their real estate for more that their loan and get out from under the mortgage.
Once the bubble burst along with the stock bubble the value of houses and stocks dropped while the price of oil and things we have to buy went up. It became impossible to sell overpriced real estate except by precipitous price drops.
Note that the stock market is readjusting to the new more realistic values of the stocks, although many stocks are greatly under priced and are bargains.
Two actions that will help solve our problem include getting the amount of money and credit down to where they belong and letting the market for bad mortgages reach its free market level. Once the mortgage market reaches its proper level the bad mortgages can be sold off for what they are really worth and credit will be restored.
The big question is, ”Should the Federal Government buy out some or all of the bad mortgages to get the credit markets working again?” There is no obvious answer to this question.
It would be great if we could simply let the mortgage market readjust to the realistic values of the mortgages and let the mortgage lenders suffer the consequences of their bad judgment.
People are worried that if the government doesn’t infuse money into the credit market there is some possibility of a serious recession.
However, if the government buys out the bad mortgages it will lead to more government regulation of the credit industry, more government power, a lot of wasted money and more moral hazard.
The moral hazard comes from the fact that people will be left with the idea that they can do anything and the government will bail them out if it doesn’t work out.
The ambiguous up-down action of the stock market indicates that investors don’t have a clear consensus of what should be done.