2008-09-07

Laissez-"fair"?

Anyone else feel like they've been sucker punched in the groin by Adam Smith's "invisible hand" lately? The fall of Fannie and Freddie this weekend was the last straw. I was righteously indignant when my taxes were spent on artery clogging government pork, but I'm unconsolably incensed when they are spent to rescue profit mongering shareholders, home flippers, and people with irresponsibly large mortgages.

The thing that irritates me most of all is that I have to admit to myself that the government MUST step in. They have no choice. We can't let the two mortgage giants twist in the wind as they rightfully should, because there are lots and lots of honest, hard-working people who want that part of the American dream that is home ownership, and they need Mac and Mae to help them with their loans.

How did we get in this mess? I think it goes back to Adam Smith. Like many American industries of the late 80s and 90s, the banking industry experienced a fair amount of deregulation. Then, in the mid 90s, the economy picked up steam, and everyone was doing well. It seemed like deregulation was the way to go. Soon, the number of investment firms ballooned and everyone was getting into stocks and securities. It seemed like easy money. The problem was that companies were now beholden to very fickle shareholders who primarily wanted a higher stock price regardless of what it meant to the company. Executives were replaced, CEO salaries skyrocketed, and the temptation to satiate shareholders was so great that many companies start to post paper profits.

This all ended when the dot com bubble burst and Enron et al collapsed. At this point, the government had to step in like it had in the past. Sure, the market was free with deregulation, but too many people were too greedy. The markets and the companies that traded on them simply HAD to be more closely monitored. After all, a lot of honest hardworking people were hurt when their pensions and 401k burst along with the dot com bubble. In the end, it was the regular folk that were most hurt. The venture capitalists/investor types were only shaken up. And since there would be no more lucrative IPOs and acquisitions, they needed a new place to make their money. Unfortunately, they settled on the mortgage market.

Soon, the mortgage market heated up along with the real estate market. Interest rates were low, and everybody was getting into real estate. People starting flipping homes. Home ownership became a short term investment vehicle rather than a means to a permanent domicile. Investors loved it. Banks loved it too because they could sign people up for terrible variable rate mortgages which they could then sell to investors, who actually expected to see that 10 or 12% interest after the two years were up on the ARM. With deregulation, banks could be more aggresive in marketing mortgages to consumers, relaxing lending requirements, and could become very creative in how they bundled up the mortgages to sell to investors. Suddenly, "second mortgages" somehow became "home equity loans" and people could afford the cabin/boat/RV that they always wanted. It seemed like everyone was winning.

It was inevitable, though, that prices would fall. The market was saturated by real estate gurus, flippers, and investors clamoring for share price -- which had all speculatively inflated the market. Meanwhile, interest rates had been too low for too long. This had weakening the dollar, making US investments look bad in general, and causing general instability in the markets. When those investing in mortgages started to realize that there really is no such thing as a free lunch, they jumped ship, just like the home flippers and the family earning 100k a year and living in a half million dollar home on the bench.

The companies did their best the massage the numbers, hoping to hold out until the market rebounded. Mortgages were fundamentally sound, risk-free investments, right? Well, it turns out the Freddie and Fannie were counting some mortgages as capital assets, as if it was an absolutely sure thing that they would be repaid at the full interest rate. Well, who in their right mind is going to pay a 12% interest on a mortgage that is now upside-down? No one, that's who. The people buying the mortgages should have known it, too, as should the people trying to profit off of the hot market. Why people were willing to take such risks with something as important as a family's home, or millions of homes across America, I will never know.

So, are you mad yet? I hope so. Our tax dollars are going to be used to keep these companies afloat. In our efforts to be more laissez-faire, we end up being tens times less so, and exactly because we have to protect ourselves from all the capitalist asshats that assured us that a more market freedom would be better for us all.