Thursday, November 29, 2007

Real Estate Bubbles, Moral Hazard, and Financial Systems

. Thursday, November 29, 2007

NPR had a nice piece on the financial impact of the deflating housing market bubble. Offers a straight forward explanation of how lenders package mortgages for sale in the secondary market.

Be sure to read the accompanying article that explores the moral hazard question prompted by the Fed's recent injection of liquidity into the market. Bottom line here is simple:

  • A federal bailout of shaky subprime lenders would amount to a "subsidy for risky behavior," says Christian Stracke, a senior credit strategist at the research firm CreditSights. "You would encourage future risky lending and borrowing by signaling that in extreme circumstances, the government … will bail out bad lenders," he says.
  • but some industries, indeed some companies, are so integral to the U.S. economy that they cannot be allowed to fail — nevermind how they got into trouble in the first place, argue others. The "too big to fail" theory came into play a decade ago, when the Federal Reserve intervened to rescue the giant hedge fund Long Term Credit Management. The fund, initially a huge success when it was founded in 1994, lost more than $4 billion in 1998. The Federal Reserve put together a bail-out by the major creditors to avoid a wider collapse in the financial markets.
Three related notes:
  • "Credit flowing to American companies is drying up at a pace not seen in decades, threatening the creation of jobs and the expansion of businesses, while intensifying worries that the economy may be headed for recession."
  • The Fed injected $8 billion into credit markets in preparation for the holiday season
  • Bernanke hinted today, in line with his deputy's hint yesterday, that the Fed is likely to cut interest rate cuts soon (again).


Real Estate Bubbles, Moral Hazard, and Financial Systems
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