Friday, September 19, 2008

Thoughts On the Credit Crisis

Here are a couple of good articles on the subprime mortgage crisis that is unfolding.

AIG
Bad Accounting Rules Helped Sink AIG
by Zachary Karabell at WSJ

"The current meltdown isn't the result of too much regulation or too little. The root cause is bad regulation ...

The collapse of Enron in 2002 triggered a wave of regulations, most notably Sarbanes-Oxley. Less noticed but ultimately more consequential for today were accounting rules that forced financial service companies to change the way they report the value of their assets (or liabilities) ...

Beginning last year, financial companies exposed to the mortgage market began to mark down their assets, quickly and steeply. That created a chain reaction, as losses that were reported on balance sheets led to declining stock prices and lower credit ratings, forcing these companies to put aside ever larger reserves (also dictated by banking regulations) to cover those losses."


I've read a few other articles suggesting that FAS 157 (the accounting change discussed above) is in part to blame for the crisis.

Fannie Mae and Freddie Mac
Are Fannie and Freddie Too Big to Fail?
by Frank Shostak at Mises

"The key to FF operations is the buying of home loans from mortgage originators such as banks ...

Due to an implied government guarantee, the FF were able to raise funds relatively cheaply by selling their debt to investors. This in turn enabled them to pay higher prices to the originators of mortgages than potential competitors could pay ...

As a result, the FF have become the dominant force in the housing market."


Would Fannie Mae and Freddie Mac have needed bailing out if the Federal Reserve hadn't always stood ready to guarantee their debts? There has never been an explicit guarantee, but the market has always believed that the Fed would never allow Fannie Mae or Freddie Mac to fail.

Why is everyone shocked when the Fed bails out large corporations? That's what we gave it the power to do.

Of course, the answer is there shouldn't have been a Federal National Mortgage Association or a Federal Home Loan Mortgage Corporation. There shouldn't be a Government National Mortgage Association or a Student Loan Marketing Association. There shouldn't be a Federal Deposit Insurance Corporation. There shouldn't be a Federal Reserve System. There shouldn't be fractional-reserve banking.

For more information about our nation's monetary system, watch Money, Banking and the Federal Reserve, a short video by the Ludwig von Mises Institute.

1 comment:

Philip said...

I completely agree. Everyone needs to watch that video on the Fed. It is truly an amazing and shocking story.