And the Feds come marching in...

Megan McArdle of The Atlantic responds positively to a Gary Becker piece virtually absolving banks of their responsibility (moral, mostly) in the sub-prime mortgage debacle. Both the article and the response offer fairly predictable reactions to the issue, choosing to fall back on economic theory rather than investigate and refine how the issue came about in the first place. Becker thinks that even those who didn't fully understand what they signed up for would have signed up had they actually known the terms anyways. Somehow, they both translate this into a moral victory for banks. However, they may have missed the point.

The greatest flaw in macro-economic theory is its amazing reluctance to adequately address issues of decision-making that occur at the micro-economic level. What bankers did is sell people sub-prime mortgages to less adept borrowers the way that used car salesmen sell lemons, backed by the same incentive - commission - that spoils the free market assumptions of perfect information (the individual dealers have an incentive to sign people up regardless of their ability to pay, since their pay neither fluctuates with the quality of a borrower nor do they absorb any of the responsibility for their repayment). However, unlike cars, dealers can sell borrowers on mortgages stacked in 30 pages of fine print and a world of promise, and cars are regulated by the government, financial packages, however, are not.

What's even MORE interesting, however, is that neither even questions WHY people at an individual level would be willing to entangle themselves in these contracts. Becker only alludes to how little access to credit for poor and minority borrowers made the availability of sub-prime attractive. Truth is, the REASON they would be willing to accept these loans is because they do not get offered the same resources anywhere else. And, ironically, reckless and misguided speculation on Wall Street drove CDO prices (collateralized debt obligations) through the roof compared to their real risk-value. This drove banks to offer sub-prime credit more and more as the financial packages they sold to investment firms increased in value. People just had to line up and sign.

Furthermore, saying that government intervention is a bad idea completely misses the point. Wealth in this country for middle class and poor persons in the U.S. means owning property. Mortgages are write-offs - therefore subsidized by the Gov - (rent payments are not), and loans for these are backed by the federal government. If you're a lender, the government practically shoves borrowers through your door. What government has failed to do is manage financial packages the way they manage other commodities, ensuring that they comply with minimum standards of responsibility. Clearly, their profitability made the idea of government intervention a nuisance at the time. But had such an effort been made, it might have kept Wall Street from shitting itself, and kept more people in their homes.

Thing is, economics is correct in saying that people respond to incentives, but most people who use economic theory to justify alienating government from ensuring the market functions correctly fail to recognize that it has been the investors and the bankers that have unevenly benefited from the system of incentives established by the government to push the economy merrily along. Artificially low interest rates, a lack of regulation in the public borrowing sector, as well as inadequate oversight of market offerings to the public all contributed to these incentives. We're all just greedy bastards I guess.