The current financial crisis is a big example of how nature will always equalize a system. When the consequences of an action are eliminated the rate of the action will increase. Eliminate the hangovers and people will drink more. I would at least.
All things in nature will eventually equalize themselves, because a system imbalance cannot exist for long. For instance if you eliminate the wolves; the deer will eventually over populate the area and start committing suicide by jumping in front of your car. I think they miss the wolves too much. So the system self equalizes.
Another example of risk and reward system we should all me familiar with is our sex lives. What do you think would happen if a bunch of 20 something’s were kept on college campus but were told that pregnancy could not happen and STDs could not be caught? In three months half the campus would be pregnant and the other half would be scratching themselves wondering what is wrong with their pubes. I am not condemning them. I would have taken part in such an experiment too (I would have been a whore but nobody wanted to be a whore with me). So much for memories, either way you should have gotten my point.
The current crisis can be tracked to who ever let Fannie Mae and Freddie Mac to buy very crappy mortgages. The rest of the funny financials like collateralized debt securities and derivatives were simply the mold that grew from the cesspool of Fannie and Freddie taking risks no one in their right mind would take. Normally when a private corporation would take unneeded risk it would burn out and die or outside investors would refuse to underwrite the endeavor. What made Fannie and Freddie different was that they were tacitly guaranteed by the government. This means that the underwriters had less risk of failure because if worst came to worst the government would take care of everything. These underwriters, investors or gamblers saw rewards that were better than the risks of underwriting the companies.
For period of time the imbalance of the system was balanced periodically without crashing the system because the gains and leverage were not great enough to cause the system to collapse. Housing prices went up and went down for all of eternity. What made this different was the timing. Stocks were tanking after the dot bomb debacle (another example people not using their heads) and the Fed was trying to get the economy moving again. The Fed lowered interest rates making money very cheap. In any boom and bust cycle there are still winners. These winners began investing in real-estate.
Shortly before this time Herb Moses an executive a Fannie Mae was playing hide the salami with Barney Frank. Barney Frank at this time was in charge of making sure Fannie Mae was doing good business. He opposed the transferring of Fannie and Freddie oversight from the Department of Urban and Housing development to the Treasury Department. Granted either one is still a government run. It seems that a government department whose job is to get people into housing would have a conflict of interest with a company who provides financing for homes. So if said company will provide additional financing for the department’s projects they would overlook the horrible risks they were taking. I have no proof that this is what happened. But it is not too much of stretch to think this is what was going on. Especially since the ramifications became so clear a few years later.
Without anyone to watch over Fannie and Freddie and many investors willing to take extra risks because the government would back any risks these organizations ran rampant. The CEO’s of the companies and the attendant executives began writing bonus rules that had nothing to do with long term viability of the organization. So the bonuses that were given were for the amount of assets in management (or mortgages owned). There bonus had nothing to do with the quality of the assets. Who here can see what is about to happen next? Raise your hand.
Fannie began taking all the mortgages they could get from the private companies in the market. These were sold as all kinds of securities and what not. Investors not knowing what fannie was doing but believing the government would come to the rescue were willing to write checks to fannie. The private companies realized that they would not hold the mortgage more than a few months to a year would sell the mortgages to Fannie. The risk was off the private company but they still had the reward of the first year’s mortgage payments and other service fees.
The price of homes began to sky rocket. Soon few people could afford a home with traditional methods. But the private company could make up crazy mortgages that started off with smaller payments. The buyer could afford these teaser rates in the beginning but by the time the real rates came the mortgage would be owned by another company (usually Fannie or Freddie). These artificial buyers could only maintain this growth for so long. Soon the market collapsed.
In this game of hot potato Fannie and Freddie were left holding the potato. Which means that the we the American tax payer was actually holding the hot potato.