Let Them Fail

I was watching Fox News last night when a breaking news icon came on and indicated that the Federal Government had agreed to bailout AIG with an $85 billion dollar loan. My jaw dropped. First Fannie Mae, then Freddie Mac and now AIG have received federal handouts to save them from the horrible business decisions that each made. As a result of these bailout the U.S. Government now holds over 50% of mortgages in America and also owns a 79.99% stake in the largest insurance company in the world.

I anticipate that the response from the majority of the politicians will be that our economy needs more regulation and that it was the greed of Wall Street that caused the sub-prime mortgage crisis and ongoing financial meltdown. Fannie and Freddie are quasi-governmental agencies and are some of the most regulated financial companies in the world. The call for more regulation to “curb Wall Street greed” is nothing more than politically popular hot air.

The real reason for the collapse on the mortgage giants was a bit more complex. First, Fannie and Freddie who were originally created to allow for great liquidity in the mortgage market lost their way. Both companies began hanging onto mortgages they bought from other lenders instead of pooling them for resale, and while this resulted in increased profits it also created greater liability if people began defaulting on their loans.

Second, Congress altered the lending laws for Fannie and Freddie in an effort to finance more lower income individuals. This resulted in the low/moderate incomes accounting for 56% of loans and very low incomes accounting for 27% of loans of both institutions in 2008. When low and very low income individuals began defaulting on their mortgages the bottom fell out of Fannie and Freddie.

In my view the market did not fail but rather bad regulations caused the failure. The cold hard fact is that not everyone who wants to own a home can own a home. That sounds harsh, but it was not the low or very low income individuals who caused the crisis, it was Liberal guilt. Democrats believed that owning a home was not a privilege but a right and this resulted in lax lending standards. Hopefully these standards will be tightened and Congress will learn that trying to manage the mortgage market results in failure.

As for AIG, I would not have intervened and would instead have allowed the company to file Chapter 11 bankruptcy.  AIG made some bad business decisions and should have to pay the consequences as the management of risk is a key ingredient of capitalism. The market would have purchased those assets that were profitable and allowed those that were not to fail. In the coming weeks and months I hope that confidence in the free market will overtake current calls for increased regulation and the view that the government can solve all our economic ills.