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Government Intervention: A Cause Masquerading as a Solution Pt. 1

There are a number of economists and “thinkers” who offer recommendations for policymakers to quell the impact of future financial crises and recessions – with just about all of them advising further government intervention in the private economy. They undoubtedly believe that policymakers need to oversee the financial markets more stringently in order to prevent or mitigate asset bubbles, excessive leverage, and the financial crises that may result from them. However, these same economists and “thinkers” fail to consider government regulation, oversight, and the Federal Reserve as causes for financial crises and misallocations of capital.

The government purports to want to prevent financial bubbles, but it seems it is a cause of them.

It seems to be implicit that financial institutions and other private companies are operating in a laissez-faire, free market, free enterprise, capitalist economy and that they are the causes for financial crises and recessions. Only Keynesian economics and greater intervention by well-educated, well-intentioned policymakers can save us from ourselves. But was the government not well-intentioned in promoting home ownership? Was the Federal Reserve not well-intentioned in lowering interest rates following the burst of the dot-com bubble in 2000 and the terrorist attacks of September 11, 2001?

Home ownership was the “American dream.” Thus, promoting it and steering people’s behavior through government policy and laws should be pursued regardless of the costs. The government seems to follow a mantra of intentions trump results when it comes to home ownership. The U.S. government promulgated the secondary mortgage market with the creation of mortgage securitization firms, Fannie Mae and Freddie Mac. As these firms were tasked with buying mortgages from banks and other mortgage lending institutions to generate more lending, a perverse incentive was created for primary lenders to originate loans to sell them. Without a secondary market, an “originate to hold” model is king; in such a model, underwriting becomes paramount and careful portfolio management is key.

Why would a bank want to issue a loan it did not have trust in being repaid? Does this same consideration apply with a government-backed secondary market? It seems like a mortgage lending institution’s incentive transforms into that of an industrial company’s – except it is not put out of business by its bad product. What if the secondary market’s genesis was more organic and truly constituted of private companies with the threat of failure? Would these companies really want to buy bad loans (raw materials) and turn out bad securities (final products)? What’s the difference if you have no downside? Something seems to be wrong here.

Many more considerations could be explored including the differing rates of home ownership among countries with and without robust secondary markets. It is not a fact that secondary markets increase home ownership; the European Union (E.U.) was not as prolific as the U.S. in this area but many European countries have equal or greater home ownership rates. Nonetheless, securitization is on the rise in the E.U.

>Part 1
>Part 2

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