With the collapse of Lehman Brothers to Bankruptcy, and with Merrill Lynch being absorbed by Bank of America, our financial system is foremost on many people’s minds this week. Add to that the federal takeover of Fannie Mae and Freddy Mac last week, and the Bear Sternes collapse earlier this year, and we have a financial mess. All of this primarily has to do with the collapse of the mortgage market, as Bear Sternes, Merryll Lynch, and Lehman Brothers all had significant holdings in mortgage-backed securities that have sharply dropped in value. Both McCain and Obamaare calling for reform and increased government involvement and regulation into the financial sector. This is precisely the wrong prescription.
The problems we are seeing in the current mortgage crisis have very little to do with the free market, and more to do with government regulation. In a free-market system, there is risk and reward. It is natural that if a company is not run right, that company will fail, so there is every incentive to run the company correctly. Since Frannie Mae and Freddy Mac were government-backed, in the sense that there was always an understanding that the mortgage under-writings were backed by the U.S. government. In addition, the Federal Government, beginning with Bill Clinton and continuing with Bush, began mandating increased loans for low-income home buyers, creating the sub-prime industry that created billions of dollars in loans that people could not afford. (This is also to say nothing of the corruption and back-scratching between Fannie and Freddy and various Democrats.) It is because of this government intervention that we are in the crisis we are in. The Freddy and Fannie takeover was necessary, but as Larry Kudlow reports, it is a good thing that the government did not bail out Lehman Brothers. The concept of risk/reward has to remain in our free-market system, no matter what the short-term pain is.
We are in a financial mess — one that will take some time to resolve. It is not a crisis, depression, or recession. It will resolve itself, as the fiscal crisis’ of the past always have. The question is, are we going to make things worse with increased regulation, or are we going to reform, put sensible regulation where needed, but deregulate the mandates and allow the free market to work.