Marginal freedom


Government action promotes risky behavior and you get the bill

Hillary Clinton made noise over the weekend about the Federal government bailing out people who had financed their homes with high risk mortgages and could no longer make their payments.

That shows (AGAIN) what can happen when government action influences marginal behaviors.

About fifty years ago, it became a National Problem™ that there were so many inner-city (read: black) children in poverty. The National Problem™ was especially bad among unwed mothers. The "solution" evolved to the point where governments actually paid more to unwed mothers than they did to to married couples. The unintended result was more children born to single mothers and trapped in poverty.

Not so very long ago, someone in Congress thought that it was an American Shame™ that more people didn't own their own homes. After all, there was all that land near some major cities just waiting to be developed. Just because the various insurance companies wouldn't underwrite construction in a floodplain was no reason that new homes shouldn't be built. The unintended result was that 80% of flood disaster funds went continually to the same places again and again and again.

Back in the megaspending 1980s, the FedGovs decided that savings and loans should have the same options as banks, even if they weren't Federally insured. The unintended result was that many S&Ls gave risky loans WITHOUT sufficient guarantees. Overnight, an entire industry collapsed.

Are you spotting a pattern yet?

The free market does a pretty good job of assessing risk. The problem comes when government tries to protect people from the self-correcting mechanisms of the free market.

There are reasons why you might not be able to get a bank loan. It's not that banks don't want to loan money, they do, that is how they make a profit. It is that profit thing. Banks want a reasonable return on their investment. But if it is Federal money and the bank's money is protected, the standards aren't nearly as tight. The risk for the bank has gone down.

While this sounds like a good thing, there ain't no such thing as a free lunch.

Government money comes from the private sector. Spending one dollar of public money means taxing the private sector more than a dollar, because there is the cost of collecting the tax, administrating the tax, paying the government workers, distributing the tax, and monitoring the money. Government money is a hidden cost.

If the government makes loans available at a reduced rate, the cost of the reduced rate, the risks and all the associated government spending is distributed throughout the economy.

Since the consequences of the "free money" are hidden, of course there is a rising demand. And the demand is much higher than anyone planned for. Which in turn raises the costs and the risks.

In failure analysis, this is called building a cascade. When the system fails, the stress will cause the massive collapse instead of just a few points.

Oh, and did I mention that the Federal Reserve decided that they would extend credit to banks without asking for treasury bonds as collateral?

What do you think will be the effect on investment firms when they realize the FedGovs will underwrite all their risk?

If marginal behavior is rewarded, then of course there will be more marginal behavior. When the various governments are involved, that means taxpayers foot the bill and face the consequences.

— NeoWayland

Posted: Mon - August 13, 2007 at 03:31 PM  Tag


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