Politics & Policy

Regulation Time?

Social critics are despondent over the failure absolutely to fix blame on somebody for the terrible subprime-mortgage phenomenon. There’s the temptation to blame a phenomenon judged to be malicious, or at best thoughtless, on an institutional feature of the free-market system. Jared Bernstein of the Economic Policy Institute in Washington cites a pressing need for regulation, the invisible hand of the marketplace having failed us.

It is useful to remind ourselves that the market does not pose as, or at least ought not to pose as, an executor of justice. If John and Jim, apparently equally endowed and equally motivated, launch identical business enterprises and John succeeds while Jim fails, one can’t look to the market to weigh the two entrepreneurs by meritocratic standards. The market can’t judge what role sheer luck played in the different outcomes. Free-market theory intervenes only to say that Jim, the loser, should himself bear the costs of failure.

As opposed to what?

Well, as opposed to taxing John from his earnings sufficiently to compensate Jim for his failure. The market seeks simply to individuate the winner and the loser. Interventionists are moved by a desire to temper the judgments of the marketplace, and the way to do this is: by regulation.

Regulation in some form or other is almost everywhere licensed and, generally, applauded. If competitors run taxi companies, regulation denies to any one of them an exclusive franchise: Do not seek to eliminate the competition. And there is regulation built into progressive taxation: The winner climbs into a higher tax bracket, and is thus burdened to the advantage (in the short term) of the competitor.

The mortgage crisis came on because our free society did not think to intervene at a juncture where it could have limited the effects of cosmic thoughtlessness and insouciant greed. So that the question now arises: How does society single out the gross violators, meting out punishment to those who deserve it without harming others? Is it possible to identify the guilty parties?

This family desires a house, but cannot not afford a mortgage based on conventional factors. A friendly mortgage broker emerges. He will arrange for them to get a mortgage at an easygoing rate. The lender will agree to this because, immediately on writing the mortgage, he will sell his interest in this family and their house to yet another party, who bundles it with similar mortgages and sells slices of the package to various investors. And so a great pool of mortgages accumulates, banked away in every corner of the financial house, a bit of everybody’s portfolio who has an interest in the financial order.

What the market would do, facing that situation, is to impose punishment on the disorderly mortgage brokers and lenders. But where are they? They are almost universally out of sight. They didn’t linger over the worthless mortgages; they passed them on to buyers who have been waking up during the past six months bereft of assets they thought they had.

If we could start from scratch, we might have managed a federal regulation that forbade giving mortgages to people without an adequate credit history. But we cannot do that in retrospect, so we are in mid-quandary, with foreclosures lowering the values of all houses, not just the ones with risky mortgages. Is there a market for, say, 30 million American homes?

The politics of the matter are at least this clear. The federal government being the only agent that can possibly intervene, it needs to do so, by forbidding the liquidation of mortgages until the disparity between true value and hypothetical value is pounded away by time and inflation — and a revitalization of the functions of the marketplace.



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