A while back there was a discussion here about legislation that would bail out homeowners who found they couldn’t afford the exotic mortgage loans they had taken after the initial teaser rate increased. I argued that the state should not bail them out, because the effect of the bail-out would really be to shield the overly aggressive lenders from the risk they had incurred and would create a moral hazard, i.e., an incentive for lenders to act badly in the future on the expectation that they would be bailed out again. I thought that perhaps greedy lenders were using sympathetic homeowners in trouble to garner support for a bail-out.
After this week’s credit crunch, the lenders and the hedge funds who invested in their securitized mortgage pools (or who invested in plain old corporate bonds but who were so leveraged that they took a beating anyway when liquidity dried up) again would like a bail-out, this time in the form of a rate decrease by the federal reserve. Resist, Ben Bernanke! Let the discipline of the market work, so we don’t plant the seeds of the next bubble!
In my view, the Fed and the other central banks have gotten it just right so far: inject lots of liquidity into the market to keep things from freezing up, but keep interests rates where they are to make sure that the hedge fund managers, and the “accredited investors” who forked over their money, feel the pain.
TedF
I think his point is if you bail out the homeowner for the most part you bail out the lender as well.
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My question is related to the hedge funds. The lenders use an ABS to in part shield themselves from loss and get there hands on more cash to loan out. The lenders aren’t helped directly by hedge fund bail out are they? Although I guess they benefit indirectly?
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Right. But I suppose I would say that even if you could bail out the homeowners without bailing out the lenders, the moral hazard problem suggests you should think long and hard before you do it, just like you should think long and hard before bailing out flood victims who didn’t buy flood insurance.
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TedF
…the central banks have to bail out the jackasses that “invest” (I’d call it gambling) with them, In 1998, it was Long Term Capital Management (LTMC) and their super-rich customers. In 1987 it was Reagan’s stock market plunge. Now, a bank in Germany is likely to go belly-up (probably along with a few banks in the US) because of what is euphemistically referred to as “sub-prime”–but what is really “high risk” lending practices in the US real estate market.
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Just how stupid can people be?
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Obviously, most of them are not stupid. The agents want commissions–which are based on sale prices–and the towns want higher and higher property valuations–which are also based on sale prices–for their property taxes. The buyers be damned; nobody cares about them. And the central banks will bail them out regardless.
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But that is except when the buyers refuse to pay their mortgages. Know who owns the houses then? Yup, the banks. And what are they going to do with them? Sell them to somebody else for ten cents on the dollar. And that’s where the banks go broke.
Bonddad is indispensable for anyone who wants to follow this financial stuff closely.