Submitted by frlarry on Sun, 05/28/2017 - 20:00

What is the fundamental cause of the subprime mortgage crisis and the crash of 2007/2008? If you don't know the answer to this, you haven't been paying attention. The fundamental cause was that lending institutions were forced, by government mandate, to take on high risk mortgage lending. Lending institutions, for there part, attempted to spread the risk by marketing various instruments, such as mortgage backed securities (MBS), credit default swaps (CDS) and collateralized debt obligations (CDO). These instruments attempted, unsuccessfully, to mask the original problem, namely that high risk mortgages were prevented from being properly priced (in terms of interest rates) to account for risk. At the same time, mortgages were sold with varying interest rates, beginning with low teaser rates that would grow over time. All of this was instigated by a political goal, to bring people into the housing market who could not otherwise afford to enter it. It was only a matter of time before this system would collapse.

The fundamental analysis is not difficult to grasp, although the details remain obscured by technical language and political spin.

Ultimately, any time the government tries to step in to alter the fundamentals of risk management, bad things happen. They happen for two fundamental reasons: (1) the efforts the government makes in the direction of risk management do not adequately account for the magnitude of the risk or its cost, and this is the case because it is the only way such proposals can be sold to the public, and, as a result, these costs are always "kicked down the road" until they become unmanageable; and (2) such changes to the marketplace always have lasting negative impacts in the form of unrealistic public expectations, hidden costs, investment distortions and a variety of other problems that can be summarized under the technical term "moral hazard."

The same thing is happening all over again in the student loan program and in the government managed medical insurance industry. The fundamental risks the government is trying to manage (or is trying to market itself to the public as trying to manage) are not being properly valued. Risky student loans to students going for degree programs with limited or no marketable result (because the world doesn't need people with such degrees, at least not that many of them) are granted a low interest rates to encourage students with vain ambitions to apply for loans. The resulting distortions in investments in the universities only adds to the fundamental problem. Ultimately, the loan program will collapse and the federal government, and, in the end, the tax payers, will be left holding the bag.

The fundamental risk taken on by the government in the healthcare program is people with preexisting conditions. That term covers a broad variety of risks, obviously, since the costs associated with "conditions" are not all the same since the "conditions" are not all the same. Some preexisting conditions can involve enormous expense. The PPACA took on that problem and added additional burdens that were politically motivated. The result has been ballooning costs, young people dropping out of the market because their insurance is too expensive for what they need, more people out of the market who enter the market only when they discover they have a condition they can't manage without government assistance, distortions in the tracking system, investments and a variety of other areas, which, again, can be summarized, fundamentally, as moral hazard.

Why haven't we learned from the lending crisis? Because people who vote have been conditioned to expect government to solve problems that government fundamentally cannot solve.

How so, you ask? The New Deal was sold as a solution to the collapse of the stock market, beginning in 1929 and lasting through the 30s and a good part of the 40s. That collapse happened because stocks were sold at low margins, meaning people only paid for a fraction of the cost of the stock, with the intention of paying the remainder when they sold the stock. With so many stocks being sold at margin, much of the market became overvalued. During the boom of the 20s, that risk remained hidden, until increasingly highly leveraged investors began to default. At that point, the collapse became inevitable. The government tried various market intervention schemes to delay, prevent or reverse the damage, but they only made the situation worse.

We saw much the same thing happening in the governments attempts to mitigate the financial crisis of 2007/2009. We are living with the legacy of those schemes, today. They included bailouts of badly managed institutions, artificially low interest rates (thanks to interventions by the Federal Reserve System), quantitative easing (again, thanks to the Fed), government stimulus programs (popular enough that a big one is being proposed in the latest federal budget), and ballooning entitlement programs to compensate for unemployment and other distortions in the job market. The result is, for the first time since the end of World War II, government debt substantially exceeds the gross domestic product. Of course, at the end of WW2, the government was not saddled with enormous, and entirely unprecedented, debt obligations like it is today.

In spite of all this history, the average voter considers the government to be a savior.

On a side note, the Social Security Program, begun during the depression to aid elderly people who were reduced to extreme poverty, has also been considered by millions of people to be a great success. That is so because, again, people fail to grasp the fundamentals. Social Security is, and was from the beginning, fundamentally a pyramid scheme. That is because the benefits paid out exceed the taxes paid into the program on an individual basis. In theory, if the same money paid in taxes were invested in profitable investments, the same payouts could result without adding burdens to the system. The government, however, is prevented from entering the market in this way. (That's actually a good thing, because the government can't be relied upon to make sound investments, and its presence in the market would inevitably involve distortions - moral hazard again.) As long as the population, and, thus, the base of taxpayers, was growing at a suitable rate, the debt obligations could be covered. Alas, government has, in another scheme, aimed at reducing population growth, so that now the low population base of gen-Xers, millennials, etc. is saddled with covering the cost of SSA payouts to retiring baby-boomers (full disclosure: of which I am one, or, more precisely, soon will be — I'm less than a year and half from age 70).

It seems, then, that our ravenous chickens are coming home to roost. The collapse is inevitable, though no one can predict its onset, magnitude or duration, at least not without quite extraordinary inside knowledge. Its inevitable, in part, because the voter believe in government intervention as a solution to problems. Another way to say this is the average voter believes the government is Santa Claus. And if you are retired and dependent on SSA checks for your survival, that's entirely understandable. If you're a young person whose skull is being filled with mush in our educational system, that entirely understandable. If you have confidence in the news media, in academia or in government, and haven't noticed major inconsistencies, that's entirely understandable. Alas, that won't shield you from the inevitable pain. On the contrary, it's likely to make it far worse.

Why, you ask, has government taken us down this path? In part, because politicians are largely shielded from the consequences of bad policy decisions. That is the case because the average voter has almost no grasp of the fundamentals. In part because selling government programs, and the spending that goes with it, is popular. There are, of course, many politicians who recognize that many policies are fundamentally bad (involve enormous hidden costs, etc.) but are motivated by greed, popularity or power to vote for them and/or to protect them. In the vast majority of cases, none of that will shield either voters or politicians from the inevitable pains that result from collapse. We will all suffer in some way from our folly.

As delusional as these believers in government largess are, they are not as delusional as our Cloward-Piven progressives. There are those, however, who believe in the Cloward-Piven strategy of engineering collapse, not because they are delusional (in a material sense), but because they see advantage to themselves in the attainment of raw power. These people are the eagles gathered around the carcass, i.e., the folks mentioned in Matthew 24:28.

But, let's put this in perspective. It will be infinitely better to pay the piper in this life than to pay the devil in the next.