A great deal is being said about the latest financial market failures, brought on by the inevitable collapse of the sub-prime lending market. Should the Federal Reserve bail out the hedge funds that, until recently, were making so much money? What were any of these people thinking when they backed securities with sub-prime mortgages anyway?
But what about the people who took out the sub-prime mortgages? Sure, investors are loosing money, but these are (mostly) people who had extra money to invest anyway. They may feel the loss that they're taking now, but it's the borrowers who are losing their houses.
Which is why I was so happy to read what Paul Krugman had to say in The New York Times on Friday (Workouts, Not Bailouts; 8/17/07). He begins by pointing out the obvious - the people who promoted securities backed by sub-prime mortgages are just as bad as the ones who duped Enron's shareholders. It's the borrowers who need the help, not the lenders. So far, there have been 2 propositions floating around:
1. The Federal Reserve should buy up the the failing securities from failing hedge funds to bail them out.
2. The Federal Reserve should do nothing and let the hedge funds sink or swim as best they can.
Krugman proposes a third idea: Federal agencies could buy up the mortgages that backed those securities and renegotiate more reasonable (payable) terms with the borrowers to help them avoid foreclosure.
I'm not sure how much of a chance this proposition has - the dark side of the Protestant work ethic dictates that those who fail simply aren't trying hard enough. The funny thing is that this concept only seems to apply to the poor. The people who promoted faulty securities in the first place also failed, but they did so much more spectacularly, in a way that few of us really comprehend. That seems to shield them from much of the condemnation we'd direct at someone who, say, borrowed money when they weren't really qualified to so that they could buy a house for their family. It even seems to lend them a sort of mystique in some admiring eyes. The truth is that the stock market is the new frontier, and hedge fund managers - or pioneers, in the language of the wild west - feel that they should be free of the rule of law (financial regulation) because of the risks they're taking.
Because it's such an incredible risk, lending money at high interest rates, then passing that risk onto other people, and still others! The most ridiculous part of the whole thing is that I really thing that these people expect to be bailed out, even as they foreclose on the people foolish enough to borrow from them.
I hope that Krugman's plan gets some attention, especially with all of the furious debating the flock of presidential candidates are doing over everything else. But for god's sake, we can't seriously bail out the hedge funds. Also, read Krugman. He's worth the price of Times Select.