I have one more item of bad news related to the mortgage meltdown: It'll likely provide lots of ammunition for advocates of more government regulation, in the mortgage industry and everywhere else. I'm afraid we're getting what we deserve.
Three things have become clear as the mortgage/real estate debacle has unfolded: 1) Left to their own devices, millions of people (and some pretty sophisticated lenders and investment banks) will do some profoundly stupid things; 2) The effects of those stupid things spill over to affect everyone else; 3) Lots of Americans expect their government to do something about it. (Let's not pretend that it's just Democrats; the White House was pretty darn quick to roll out its bailout plan.)
One of the fundamental debates within economics concerns the degree to which individuals make fully rational decisions. Do people always act in their own best interest? Or can government help prevent them from doing things that they'll later regret?
This debate over "rational man" isn't just academic -- it lies at the heart of what government ought to do. Should government treat its citizens as informed adults or semi-rational adolescents?
This all strikes me as a load of new evidence for the "government for semi-rational adolescents" camp.
Pick a Side
But there's a second reason that we're probably not ready for Friedman's elegant small government: When people who play with matches burn their houses down, we're generally not pleased if our political leaders pull up lawn chairs and watch the flames. We expect them to do something about it. We want a plan.
Have you heard any presidential candidate from either party explain why the appropriate response to the mortgage debacle is to let the culpable parties pay the price for their mistakes? Nothing teaches you about debt like losing your home to foreclosure. I'm still waiting for that speech. (OK, Ron Paul has probably given it -- which is one reason he'll never get more than 10 percent of the vote.)
Everyone loves small government in theory. We're tired of being told that the coffee we're about to enjoy is hot. But then we burn ourselves and expect someone to show up with ice. You can't have it both ways.
There's plenty of good stuff in the body of the article.
If this whole thing really does snowball into an economic cataclysm, history shows that we can expect a fundamental reigning in of the financial sector. Securitization of debt will become illegal. Most derivatives will not be legal. Some historical examples of this: after the Tulipmania in Holland in the early 1600's, the futures market became illegal. After the South Sea Bubble in 1720, I've read somewhere that even publicly traded stock was banned for a time. There is no law of the universe that says financial markets have to work the way they currently do. Finance is supposed to be a servant of industry and enterprise, and not the whole show.