Long time reader Casey sends me this note in response to my musings on the current crisis, which I gratefully reproduce here.
I think the Wall Street crisis is a combination of 2 big factors hitting at once, the global credit crunch and the sub-prime mortgage crisis. I don't know nearly enough about global credit markets to know what causes or remedies the problem, but it is important that the issue is a global one and not limited to the US. Nor is it a case of the US sneezing and everyone else gets a cold. The warning signs have been popping up in Asia in Europe all year.
The sub-prime mess is a little easier to understand. The biggest cause of the crisis was the collapse in home prices. Lenders did not mind giving mortgages to high-risk borrowers because everyone assumed that the housing prices would continue to rise so even if a borrower took an interest-only loan the mortgage would never be worth less than the property. If the borrower had bought more house than he could afford, he could just sell it to pay off the mortgage. When housing prices fell, the lenders who borrowed too much were in trouble. Since they would then have to sell the property at a loss, it became easier to let the bank foreclose on the property than to try to find a buyer and sell the house at a loss and still default on the mortgage.
I think this whole mess was caused by easy money in the market. The Fed left the interest rates too low and the money supply went up. The banks were sitting on piles of cash and nothing to do with it so they came up with exotic mortgages for high-risk borrowers. Hopefully, this crisis will see an increase in rates which should create an incentive for people to pay off their existing debt and start saving. It will be tough going for a while, but we need to hit bottom before we can really start to recover. I agree that regulation isn't the solution. The financial sector is one of the most regulated industries in America and Fannie Mae and Freddie Mac are 2 of the most regulated companies in that sector. Increasing regulation just means more paperwork to sign and more verbiage that borrowers won't understand. I don't agree with your statement on stability. We do need to turn off the money tap and get individuals out from under their debt before they buy a house or start a business. Easy money is fine, but only in bursts. If it becomes the norm, then people don't save and take on too much debt.
But what do I know. I work at a not-for-profit, and I've been drunk since 9:30 this morning.
I have only a little to add. The financial crisis is, without a doubt, a global phenomenon. Apparently the Russian stock exchange (yes, there is such a thing), melted into rancid caviar this week. It's important to recognize that, before launching into major regulatory overhaul of our financial institutions. I think that some regulation for the sake of stability might be in order, but I certainly agree with Casey that the odds of regulation that is effective and not counterproductive are not good. I note that the view expressed above, that the money supply has been too liberal, is in agreement with my colleague, Dr. Schaff.
Finally, I hope the hangover is not too bad. Most of us schedule them for the next morning.
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