The Bear Stearns collapse

Banks are collapsing, here and in the UK, because they decided a play a reverse lottery. (A reverse lottery, for people who don't know that term, is when you have near-assured tiny gains, with a tiny risk of catastrophic failure. Like the lottery, but swapping winning and losing.)

The banks basically started a 'risk distribution' scheme that ensured everyone was holding a piece, so they'd all go down together, and required housing prices to keep going up. As those prices were absurdly artificially inflated, the highest relative to earnings in the entire history of mankind, this behavior was extremely stupid, or it would have if the executives doing it had actually been attempting to run their businesses instead of making as much money they could and sprint out the door.

A sane government would have clamped down on house prices at the start of all this, making the collapse not happen, or at least a good deal softer. Sadly, we were stuck with people who wanted the economy to look good, and it looked like crap, so they faked it with house prices.

A good deal of economic growth over the last 6 years was fictional. Artificially inflating houses prices is not 'growth'. It certainly helped cover up the decrease in production, though, and the fact that wages were not increasing. And, with loans for everyone, people weren't even homeless! It all worked perfectly, our magical fairy economy where no one can afford houses because they aren't making any money, but they still have a house because of pixie dust mortgages, so no one's on the street.

And occasionally, banks will ask themselves 'Why did we lead to a bunch of people with no money whose only asset, their house, has decreased in value to less than the amount of the loan?', aka, look downward, and plummet straight down, Wile E Coyote style.

Posted by: DavidTC | March 16, 2008 10:40 AM

Rod, KUDOS for raising an important, worthwhile issue!

Kevin Phillips notes that the downturn for the last three world powers (Dutch, Spanish, British) coincided with a major rise in speculation by the very wealthy. Now we're seeing what specualtive exuberence has wrought on the stock market and the housing market and the damage is spreading to main street via financial markets.

Watching this over the past few years has led me to make up this rule: Great wealth is fine. Many people being wealthy is fine. But too many people having too much wealth is not healthy for a nation's economy.

And remember that Bear Stearns is not a commercial bank. Instead, it fell into the class of investment that was to risky to fall under normal banking regulation. Maybe that was not a good idea?

Look, I'm no economist, but if there's one place that ideological conservatives seem to have erred it's in maintaining that a market with no meaningful regulation is self-correcting and that government should stay out (except to provide the legal basis for commerce and finance, of course).

Anyway, I think that too many having too much to speculate with requires someone to watch out for the many who suffer serious life changing hurt while those who speculated -- well, they're not going to be homeless anytime soon, are they?

Posted by: ChuckDFW | March 16, 2008 5:12 PM

Rod,

I wish that you would talk more about the economic problems that the entire world is facing due to the real estate bubble that our very own Alan Greenspan caused.
There is some great info at "Dr. Housing Bubble," and also "Patrick's bubble blog."

At this time, the FED is bailing out Wall St. by lowering interest rates(causing inflation and a dollar devaluation).
In addition, our government is taking on bad Wall St. mortgage paper, both by the FED directly, as well as shoving some of the toxic loans onto Fannie Mae and Freddie Mac, which means that taxpayers will be paying for the mess in the end.

If you really look into this, it will make your blood boil! This is the single BIGGEST story that is not getting the coverage it deserves.

Posted by: Jerry Witt | March 16, 2008 9:25 PM