Boldly rushing in

A journalism student at my college asked me for some comments regarding the ongoing Waterfall of Misery in the financial markets. I'm pretty busy, and pretty lazy, so I'll just cut and paste my e-mailed response to her.
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Banks and investors had bought a lot of a new type of asset comprised of chopped-up mortages. The value of the asset was based upon the monthly payments made by the homeowners who took out the mortgages. But once it became apparent that a lot of those mortgages were higher-risk than advertised, it was clear that the value of the chopped up mortgages was really lower than had been believed. Everyone tried to sell, so the price fell to nearly nothing. That hurt the mortgage lenders, and the investment banks that had bought lots of the chopped-up mortgages, and everyday investors who had bought investment bank stocks, thinking they were safe.

As their inflows of cash from mortgage payments had fallen, and with their chopped-up mortgage assets now near-worthless stacks of paper, banks found themselves short of the cash reserves they need to keep on hand to do day-to-day business. In some cases, they became so short of cash that their customers in good standing panicked and started pulling their accounts. The classic "run on the bank" used up their remaining reserves, and several investment banks either went broke or were bought up just before they went broke.

The surviving banks responded by no longer providing money to mortgage lenders, or pretty much anyone else. Consequently, funds for investments and routine purchases, for both businesses and households, became expensive (in terms of interest rates charged) even when one was "lucky" enough to find someone willing to lend money.

This isn't a problem that is contained to Wall Street, or even to business owners. The "capital crunch" means it's harder to get a loan to buy a new car, or to fix an old one, or to pay college tuition, or to keep food on the table and a roof over one's head while one is out of work and looking for one of the very scarce jobs available.

Because the collapse is due to lenders making bad loans and finding ways to disguise their riskiness, I understand and sympathize with the popular urge to "punish" the bankers by denying them a taxpayer-funded life preserver. After hearing of the first House defeat last Monday, my first reaction was to mis-quote a song, "The roof, the roof, the roof is on fire/ We don't need no water, let the [Nutter-butters?] burn/ Burn, [Nutter-butters?], burn". But of course, there's a problem with revenge: if Wall Street burns, our businesses and offices and homes that rely on their capital will burn along with them. To complete the metaphor, we need to put out the fire, and then rebuild in a way that we don't have to go through this [mess] again.
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I was quite proud of myself for keeping the cuss words to the minimum. Depending upon my energy level on a given day, I'm either depressed or angered by the complete gutting of the governmental oversight functions necessary for the foundation of functioning markets.

A quick reminder for the Econ 101 vets out there: a competitive market for a good needs at least
-- many buyers
-- many sellers
-- similar products
-- free entry and exit
-- full information. This is the one to get a good discussion/argument started over beers at the pub. Does it just mean that prices contain full social cost information and marginal willingness to pay, or is there more to it?

I reckon it doesn't matter tonight. No one in the current administration seems interested.

What good is social science if those in position to implement sciences' discoveries actively avoid acknowledging the discoveries. A lot of economists and political science researchers can empathize with the anthropogenic global warming scientists of the 1980s and 1990s ( ... and 2000s) this month.