Saturday, March 15, 2008

Heads I Win, Tails You Lose

Heads I Win, Tails You Lose
By Jerome Grossman

In a key scene in a famous movie, "The Graduate", the young Dustin Hoffman is cornered at the graduation party by an older man who whispers enigmatically, “plastics", a hot business of that decade. Ten years ago the same bore would have whispered "Real Estate." Welcome to our world of capitalism, where boom and bust often alternate, where the quickest make a killing and the slower have trouble sleeping.

Subprime lending on mortgages with little or no money down followed by securitization of debt in derivatives was born out of the illusion of permanent high demand. The housing industry was overbought and oversold and of course would never collapse - until it did.

The banks and financial institutions that invested in this "sure thing" were gambling with OPM, Other People's Money. They couldn't lose: if the market turned they were too big to fail, they would be bailed out by the government, then after a few years the gambling would begin again. Not protected were the consumers who signed the mortgages, nor the small businesses affected by the decline in trade. Only the big boys: heads they win, tails, the taxpayers lose.

Now the White House offers a plan to resolve the growing credit crisis made worse by eroding home prices. The plan relies on the same banks and mortgage brokers and Wall Street firms that are to blame for the current crisis. Yet there is no plan to prevent a recurrence in the future. No significant regulation is provided and the federal government has only a limited role in the regulation. The plan is to leave regulation to the states. We know how that has worked out on other issues such as taxation: the states compete with each other awarding breaks to the businesses in order to attract or keep them.

There is a larger question. If banks and financial institutions are so important to economic life that they need to be rescued repeatedly from their own mistakes, they become virtually a public utility that ought to receive a certain guaranteed profit but be barred from speculative investments. That was once the law under the Glass-Steagall Act enacted under the New Deal in 1933 after the stock market crash of 1929 but repealed in 1980. If we want to keep the bankers conservative and protect the depositors, perhaps Glass-Steagall should be reenacted to limit our worries and our losses.


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