Posts Tagged ‘moral hazard’

Nothing to Fear But Government Telling Us Not to Fear

Tuesday, September 9th, 2008

FDR (from whom the title of this piece is bastardized) may not have understood the natural regulatory power of fear, but for modern day politicians, there’s really no excuse.

The seizure of Fannie Mae and Freddie Mac is the flambéed cherry on history’s biggest lesson in moral hazard. Government guarantees pretty much have to die a violent death.  Not only can fear not be segregated from its milder first cousins, caution and diligence– but on occasion fear’s closest relation is to common sense.

It would be easier to stomach the incessant repetition of, “there wasn’t any other choice”, if it was followed up with “and we must make sure we never put ourselves in this position again”, but that’s not what we hear about the “rescue” of Fannie Mae and Freddie Mac.

We also hear little about who’s to blame.  Whether it’s spoken or implied, the incantation is “fix it first, and worry about the blame later.”  It has a soothing, logical ring to it, but it would only be sensible if the repeated, seemingly well-adjusted attitude was for unforeseen, unrelated problems– not for the same mistakes over and over.  (Having one credit crisis, Mr. Secretary Paulson, may be regarded as a misfortune, to have them in most decades looks like carelessness.)

“By lending at up to 90 percent of the value of a property, or by insuring such a 90 percent loan, the government was putting itself in a potentially costly position.  If house prices fell by more than 10 percent, the ‘equity’ of hundreds of thousands of home-owners would be wiped out.  ‘Under such circumstances,’ as Fortune noted in 1938, ‘the FHA might very well find itself the unwilling landlord of half a million or more houses.’”

The quote above is from a footnote in James Grant’s “Money of the Mind”, copyright 1992.  He’s describing the birth of the FHA and FNMA/Fannie, and as you see, also quotes a 1938 article from Fortune.It’s almost as if the danger was right there to be recognized seventy years ago, and we’ve spent all seventy doing nothing but piling on more risk until the whole thing exploded…

Human error and bias– this isn’t something that government predicts, mitigates or solves– this is what government creates, adds to, and joins in.  It’s in politics, more than any other endeavor, that today’s exaggerated fear will be more important than tomorrow’s real disaster.  It was there in the decisions seventy years ago when Fannie Mae was born, and it’s here today in Fannie’s death throes.

Whether we “fix” the problem, blow it up, or ignore it into submission (all while, regardless, opportunities wither and capital stalls and depreciates)– it’s fixing the blame, not fixing the problem, that’s the important piece.  The blame isn’t a side issue to deal with when things settle down.  When somebody skips right by the blame to supposedly deal with the problem, one suspects a thin analysis, an uncertain conscience, or both.

If we don’t succeed in taking a look at the cause of credit cycles (the blame), then we’ll continue to blow up the economy, if not human society in its entirety, once or twice a century.  And the prospect that someday we may be too befuddled or enervated to pick up the pieces again can’t be comfortably disproved.

By Les Lafave

Banking Reform –