Wednesday, September 10, 2008

On the Need for Skin in the Game

First Bear Stearns, then the modifications to the discount window, then the Fannie/Freddie nationalization/bailout, now maybe Lehman Brothers. The mortgage meltdown continues. I'd like to be able to say that the end is in sight but it isn't. This is going to make the S&L crisis look like a blip.

I hate the bailouts and what they portend about future government involvement in the financial markets. I also think that they're absolutely necessary.

I'm pretty sure that the Bush administration is suffering from bad luck on this whole thing. I'd be amazed if Democrats would have had the guts and/or foresight to pull the plug on the greatest accumulation of wealth for ordinary families in US history and insist on mortgage market reform before the fact. But the fact is that this happened on Bush's watch and he's responsible. His administration didn't see it coming. Anybody who voted for the Democrats this fall, because of this sole issue, would be justified.

No doubt the regulatory proposals for the financial markets are filled with some stupendously awful ideas. I'm confident that most of them will be wrung out before they become law. However, it is blindingly obvious that the key ingredient in a properly functioning credit market is the proper balance of risk and reward. The amount of leverage must be limited to avoid the appearance of free money. Borrowers have to have some skin in the game. I don't know whether the proper loan-to-equity ratio is 5 or whether it's 10, but it sure isn't 1000 or 10,000.

But that brings up another question: Obama's tax plan results in the virtual elimination of federal taxes for almost a third of all taxpayers. Given what we've learned at such cost in the credit markets, is it really a good idea for that much of the electorate to have no skin in the game?

Our government sorta-kinda works because the voters pay for it, which makes them much more likely to pay attention limit spending and debt. Even so, spending and debt have been increasing for years and show little sign of decreasing any time soon. Will Obama's tax plan be an inconsequential increment on an already bad situation? Or will it be the point at which voter behavior becomes completely uncoupled from fiscal reality?

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