Q2C-ME said:
even simpler... u can make it twofold:
- banks lending to average joes, with poor skills and lack of gurantee during periods of growth
- a lack of regulation in many facets of the economy...e.g (foreclosure on an individual level and short selling on a bankish level)
Id like to say something about regulation. This crisis was not caused by a lack of regulation; but rather poorly defined property rights; and in particular the ownership of risk.
Many commentators have taken the opportunity to say this is a case of market failure that needs some kind of government intervention or regulatory response, but I believe this to be false. At this early stage a complete diagnosis is forthcoming, but one of two things has happened. Either those investing in securitized mortgages have not appropriately assessed the risks of their investments, or they had the appetite for high risk / high return investments. In reality it is likely a combination of the two consolidated by the sustained availability of cheap credit which created a housing bubble in the US.
If they did not assess the risks appropriately; then this will be a lesson learned. It is in the own interests of investment institutions to apply a greater degree of risk assessment and and any regulation applied by governments is unlikely to be an improvement on this. For example when it was diagnosed the collapse of Enron was caused by a lack of process risk assessment, US legislators came up with the obtrusive Sarbanes Oxley act. The act merely formalises and complicates a business proceedure that would continue exist without such regulation.
If investment banks had an appetite for these securities, then they must 'face the music'. Risk and return are two positively correlated variables which must be obeyed. To do otherwise is to send the wrong signals to markets; and to provide an open incentive to invest in risky assets at the mercy of a government bailout if all things go wrong. The bailout package proposed will hopefully achieve its short term goals of increased liquidity and market stabilisation, but there are always long ter, ramification for these issues. The bailout is effective insofar as it restores confidence. Given the political instability in the US, its effect is already dampened from the resulting uncertainty. Aside from this, the bailout reflects a cost of approximately $2500 for every American for a crisis for which they had no control over. Whilst Australians will rightly welcome the bailout, Americans are right to be sceptical.
The bailout brings us full circle. If the government is going to put its hand up and save the day; the government is right to have some say in how the market operates. In this case some regulation would be optimal to prevent the perils of moral hazard and cowboy investments. But moral to the story isn't increased regulation, but rather increased accountability.
