

Ask news.yc:  Should the gov't let the current crisis self-correct? - aswanson

Offhand, it seems to me that the current liquidity crisis is the result of government market interference (artificially cheap credit) and the attempt to fix it is based on creating more cheap money.  Shouldn't market forces be allowed to clean out and correct?
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anamax
> The unregulated market had a big part to play in causing the current sub-
> prime mess in the first place.

And bailing them out will have what effect?

If you shield people from the consequences of doing dumb things, they'll keep
doing them.

People who invested in subprime-mortgage-backed bonds SHOULD lose money.

Besides, they were going to keep the profit, so why shouldn't they take the
loss?

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vitaminj
The unregulated market had a big part to play in causing the current sub-prime
mess in the first place.

Check out the BBC's explanation of how the sub-prime lending model worked:
<http://news.bbc.co.uk/2/hi/business/7073131.stm?src=rss>

In a nutshell, banks used to lend people money with their own assets. Because
it was their own money, they made people jump through hoops to make sure they
could pay. But in the new model, banks packaged up mortgages and sold them to
investors as mortgage bonds. The investors had no idea about the ability of
individual homebuyers to pony up for repayments, but they were making a good
return. Now that the banks didn't stand to lose, they loosened the standards
on their normal checks and balances so that unemployed hobos could buy $500k
homes (since there were no regulatory requirements). Ahhh the free market at
work.

(The reason why so many banks lost money was because they themselves were big
investors in the mortgage bond market)

The free market does solve problems and self-correct, but it can also cause a
bit of damage along the way. The point of common sense regulation and
government intervention isn't to stifle the market, but to prod it in the
right direction and minimise the pain. Economists call it smoothing out the
business cycle. Granted the highs aren't so high, but neither are the lows.

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Prrometheus
Cheap credit was at the heart of the mortgage bubble. It fueled an
unprecedented rise in housing prices. If housing prices rise at a historic
rate for 5 years in a row, who cares about credit quality? Foreclose on a home
and you own an asset worth 25% more than the mortgage you made! Don't lower
your lending standards and you will make 0 loans in a competitive market where
everybody else is giving mortgages away.

I worked with subprime mortgage companies. After the bubble started to pop
everybody blamed it on stupidity and greed. These qualities were surely
involved. What goes up, after all, must come down - but try to time the pop!
In the end, the bubble was market-driven and the market was Fed-manipulated.

We had a soft recession in 2001 because of cheap credit. We get another
recession in 2008 because of that same cheap credit. End of story.

~~~
vitaminj
Yeah I agree, though my point wasn't so much about the bubble than about the
crash. The crash was precipitated by a critical mass of foreclosures, which
was attributed mainly to sub-prime borrowers. A softer landing could have been
achieved if there were stricter lending regulations, and the bubble wouldn't
have been as high either.

I wanted to respond to the assertion by the poster that this was all a result
of government interference. Yes, the government (via budget deficits) and the
Fed (via monetary expansion) were meddling with the market, but the nature of
the free market itself was a contributor. The market isn't perfect and neither
are regulations, but it's not an all or nothing proposition... there needs to
be balance.

~~~
Prrometheus
The bubble was unprecedented. Hopefully, lenders remember that credit quality
matters the next time the fed decides to dump 1% credit on us.

~~~
anamax
No, it wasn't unprecedented. In fact, this bubble was exactly like every other
bubble.

EVERY bubble is driven by folks who say "it's different this time". They're
wrong every time.

As they say "pigs get fat, hogs get slaughtered".

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trevelyan
Keynes pretty much demonstrated that the feast/famine metaphor doesn't apply
to economics.

imho, the real mess is going to happen when the American public realizes that
social security is possibly the least insolvent government program, but that
its ongoing surpluses have been handed out in tax cuts and war profiteering.

I'm still stunned Gore lost.

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mattmaroon
What strikes me is the number of people who predicted this whole mess in the
first place. Even during the bubble, there were people describing, almost to
the minute, exactly what would happen. The market always has its share of
chicken littles, but the detail with which some people predicted the crash
makes me think they're a little more than that.

Rationally, it seems like it will scare institutional investors out of the
market and into PE and VC funds, so it might be a better time than ever to run
a startup.

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aswanson
I know. I remember back in '06 listening to a business week podcast where they
said "Wall Street has found a way to slice up bad debt and create grade A
debt" and thinking,"how the hell is that mathematically possible?" Turns out
it wasn't.

~~~
mattmaroon
Lol. I had only a 700 credit rating at the time, had been self-employed for
over 3 years, and was approved for a no-doc loan on a $300k condo with only
10% down. I actually could have afforded it, but there was no way for them to
know that and no reason to assume it either.

That's when I realized something was wrong.

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tomjen
If you had been self-employed for three years, then you had properly found a
way to make money by yourself (or you would have starved to death before) so
what risk is there to lend you the money?

~~~
mattmaroon
Well, you can scrape by on a lot less than the income required to pay that
mortgage when you live in Ohio. And with no documentation and a less than
stellar credit rating, plus little down, they were nuts to grant it to me.

Luckily for me I didn't purchase the condo, as the housing market there took a
nosedive, and I'd currently be unable to sell for less than I'd owe the bank.

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mixmax
Basically what you are saying is that the people that took the risk should
also take the hit, which seen from a moral standpoint is obviously right. The
problem with this approach though is that the financial markets are
notoriously non-transparent and full of feedback loops. This means that the
blow will hit a lot of people that didn't take risks, but just happen to be in
a bad spot, for instance a young family of blue collar workers that have just
bought their first house. They have not had the potential upside, but they
will get the downside.

This is why government intervenes, not to save the risk-takers.

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bayareaguy
People have been looking the other way for too long. Many borrowers have been
led to believe that lying on their loan applications is ok and brokers have
been mis-stating the actual risk to the buyers of those loans.

It was fun while it lasted but the party's over.

I don't think the government should bail out anyone. What they should do is
start regulating the entire industry better.

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Prrometheus
The government can get involved to soften the blow, but it should be careful
not to create ANOTHER bubble like it did in 2001.

~~~
aswanson
An astute individual during the dot-com bubble could have forseen the effect
of the market crashing would lead to cheap money and hence a mortgage bubble.
What does this latest bubble pop portend for the prescient investor?

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bayareaguy
If you're shrewd, you may be able to get a good deal on some property. Just
stay away from places where there will be new construction when things turn
around.

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bprater
I think the question is valid, but I really appreciate YHN because it is all
hacker related news.

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aswanson
Yeah, me too. I hesitated to post it, but figured it may spark some
interesting discussion.

