Bubble-licious

So the financial bubble is bursting. The housing bubble has supposedly already burst. But these are so intertwined that there is probably more pain coming. How did we get to this point?



As I understand it, the housing bubble was inflated, at least in part, by low interest rates and easy credit terms. Remember the days, not so long ago, when a buyer was required to have 20% of the purchase price for a down-payment on a house. The principle and interest on the mortgage loan could not exceed 25% of their gross monthly income and the buyer's total monthly payments had to be less than 33% of that income. Remember when real interest rates were positive numbers? Thanks to central banks, many interest rates today are less than the rate of inflation. That makes borrowed money cheaper than the money earned by trade or work. Add new "mortgage products" like interest-only mortgages and adjustable rate mortgages to a loosening of lending standards, i.e., the ability to repay the loan, and people can obtain more house than they can afford to pay for in actual terms. Good for low income and young buyers until the rates adjust and their payments increase faster than their wages which is the scenario over the last seven or eight years.



So now the chickens have come home to roost. These ill-conceived and improperly vetted loans have gone into default, there's a glut of over-priced McMansions on the market. Real estate prices are plummeting, probably searching for a sustainable level based on real economic data about wages, output, and productivity. And the geniuses of financial engineering have packaged all these toxic loans into "financial instruments" so devious that experts like bond and credit ratings agencies, as well as the bankers and financial traders, can't assign the risk to those to whom it belongs. So taxpayers will pay for all this with a government bail-out so the system doesn't totally stop functioning. It would be much worse if the credit markets tighten for small businesses and companies that need some credit to keep the doors open.



But let's also address the real causes of these bubbles. The lack of transparency in many "financial instruments" needs to be addressed. And the entity charged with this regulation is the federal government. The public does not need to own Fannie Mae, Freddie Mac, or AIG. These companies, as well as the others still operating in the financial sector, need to perform their function under their charters in the market according to the regulations governing what is acceptable in the markets---investing, not gambling. Proper vetting of applicants for loans. Transparency in investment solicitations.



Congress should not pass the bail out without asserting its responsibility for economic oversight and without guarantees that it will indemnify the taxpayers against a further melt-down.