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All around the world, other countries were adopting the U.S. model. Now markets are plunging together all around the globe. To a very large degree, moral hazard is the reason. Once investors and investment professionals believed governments could and would hold up markets, lunatic decision-making proliferated. And led to the crashes that the government could not stop.

After the bursting of the tech-stock bubble in 2000–2002, the Federal Reserve needed another bubble. It lowered interest rates to the floor. In previous years, Congress had made many steps to encourage home ownership: tax breaks, creation of Fannie Mae and Freddie Mac to buy mortgages and sell them to investors. Politicians hyped home ownership of low-income families by encouraging issuance of subprime mortgages and peddling of them to investors. The country set itself up for a nuclear explosion: lenders didn’t care whether a borrower could afford a mortgage; after all, it would be sold to Wall Street and then to investors. The paper was peddled in the form of highly and deliberately complicated derivatives containing those mortgages.

San Diego, which had always had high home prices and moderate incomes, was on the leading edge — of the precipice. Citizens snapped up mortgages with teaser rates that would later balloon. San Diego became the capital of exotic mortgages. Foreclosures cascaded. Prices have plunged more than 40 percent since their 2005 peak — one of the biggest declines in the nation.

Now San Diegans’ stocks and home values are down 40 percent or more. And the government intends to prop up both. You may think that’s good news, but it’s bad news for long-term stability and sanity. Moral hazard makes it so.

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Comments

SurfPuppy619 April 8, 2009 @ 12:49 p.m.

On April 28, 2004, the Securities and Exchange Commission blithely decided to let major investment banks raise their debt levels to, say, 33 to 1: for every dollar of equity, a Wall Street firm could have a staggering $33 of debt or more — far, far more than was permitted under old net capital rules.

There is also another major reason the 5 major investment banks ran a 35-1 leverage ratio-they no longer had their own money at stake. They could take all the risks using stock holder cash.

In the old days all the IB's were private partnerships-much like law firms. But they all eventually went public in IPO's. They all eventually went public-with Godlman Sachs being the last IB holdout, caving in the mid/late 90's.

By using other people's money (the stock holders-"OPM") instead of their own personal money the IB's were happy to leverage at 35-1 because of the "moral hazard" and OPM. Take away the sharehold money for risk and make IB's use their own $$$ and there would be no 35-1 leverage.

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Don Bauder April 8, 2009 @ 1:22 p.m.

Response to post #1: Yes, if the old big investment banks -- now categorized simply as banks -- had been using totally their own money instead of partly investors' money, they probably would have been less reckless. Best, Don Bauder

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Don Bauder April 11, 2009 @ 5:06 p.m.

Response to post #3: Great. Stock market chartists always talk about head and shoulders patterns. I know what this one can be called but I am not going to print it. Put it this way: it is the most titillating stock chart I have ever seen. Best, Don Bauder

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Visduh April 13, 2009 @ 8:37 a.m.

Getting back to being serious, it might be noted that governmental actions that appear to be minimal and rather weak can have a big impact on markets. I'm old enough to remember the later days of the Nixon price/wage controls in 1973. That was the stage when the challenge was to relax and eventually eliminate the controls. Every time a rumor of some easing, or whenever there was actually some easing, the stock market would dip for that day and often for a number of days. That meant that the markets had become comfortable with the controlled environment, and were scared by the prospect of additional freedom. This was just the diametric opposite of what free-market advocates would have expected and believed should have happened.

In the long term we were much better for having gotten rid of those ham-handed controls. But while it was happening, their elimination did NOT make participants in the market more confident. What happened was just the opposite. The same sorts of things will be true this time.

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Don Bauder April 13, 2009 @ 9:59 a.m.

Response to post #5: You are absolutely right. In the current crisis, stocks tend to go up when the government announces another initiative to rescue banks, or prop up some other area of the economy (say, autos), or generally pump more money into the system. But stocks tend to move down if there is any hint that the government will take its foot off the pedal. Best, Don Bauder

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Don Bauder April 15, 2009 @ 7:13 a.m.

Response to post #7: It's one of the funnier thing posted on this blog, in my mammary. Best, Don Bauder

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Duhbya April 15, 2009 @ 9:42 a.m.

You're both boobs. Or is it "Your"?

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Don Bauder April 15, 2009 @ 10:36 a.m.

Response to post #9: Grammatically, "you're" would be correct, but in a pinch, "your" might be acceptable, depending on the intended meaning, and ignoring awkward construction. Best, Don Bauder

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SurfPuppy619 April 15, 2009 @ 12:11 p.m.

I'm old enough to remember the later days of the Nixon price/wage controls in 1973.

Wow, I was just a little kid when this happened but for some reason I remember it.

I cannot even dream of the President or Congress putting in price controls today.

Tell me, did the Nixon price and wage freezes help?? Did they stop inflation-which I think was the purpose (this was before my time).

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Don Bauder April 15, 2009 @ 1:52 p.m.

Response to post #11: Nixon's price/wage controls probably exacerbated inflation. For awhile, they seemed to hold down statistical inflation, but as soon as they were lifted, inflation roared up. The company I worked for at the time (McGraw-Hill) got around the wage controls by promoting people to a supposedly higher post -- thus justifying a higher salary. But there was no higher post; the person was doing exactly what he/she had done before -- just had a fancier title. All kinds of ways to evade those Nixon controls were used. Best, Don Bauder

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Duhbya April 15, 2009 @ 2:41 p.m.

Response to post #10: Ok, thanks. Now I've got it: Your boobs both.

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Don Bauder April 15, 2009 @ 7:05 p.m.

Response to post #13: Here's another: whose boobs? Or Who's Boobs? Best, Don Bauder

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Burwell April 15, 2009 @ 9:07 p.m.

It's a little known fact, but noted economist Arthur Laffer first conceived of the Laffer Curve while dining at Hooter's. He sketched out the curve on the back of a Hooter's napkin. The napkin is currently on display at the Reagan Library.

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Duhbya April 16, 2009 @ 4:58 a.m.

Response to post #14: boobs is (oh, no...are?)David Copley's.

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Don Bauder April 16, 2009 @ 9:49 a.m.

Response to post #15: Another case of cherchez la femme. Best, Don Bauder

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Don Bauder April 16, 2009 @ 9:51 a.m.

Response to post #16: David Copley will be so happy to be shielded from such badinage once he sells his company (or most of it) to the Hollywood contingent. Best, Don Bauder

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Duhbya April 16, 2009 @ 3:30 p.m.

Response to post #18: I'm so confused. Is this yet another case of cherchez la femme? Poor Richie Rich.

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Don Bauder April 16, 2009 @ 6:58 p.m.

Response to post #19: Now you have me confused. If what Burwell says is true, it is definitely a case of cherchez la femme. Best, Don Bauder

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Duhbya April 17, 2009 @ 6:57 a.m.

Make mine a double, then. Ok, enough. I'm making myself dizzy.

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Don Bauder April 17, 2009 @ 9:17 a.m.

Response to post #21: Double it is. Best, Don Bauder

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Fred Williams April 18, 2009 @ 12:40 a.m.

Economically speaking, I believe the nation's markets are best represented as a boob shaped curve.

While some markets internationally still have perky slopes in their charts and well rounded assets, we've become a bit saggy. This is understandable since we've recently had the financial silicone implants removed.

Economics is fascinating...

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Don Bauder April 18, 2009 @ 7:20 a.m.

Response to post #23: Our advancements in Silicon Valley have been erased by the deflation of Silicone Valley. Best, Don Bauder

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Fred Williams April 18, 2009 @ 11:18 p.m.

11% unemployment in the valley now...a 100,000 techies, nerds, geeks, recruiters and software sales-critters out looking for work.

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Don Bauder April 19, 2009 @ 6:02 a.m.

Response to post #25: San Jose unemployment hit 10 percent in February and is going up. Tech is hurting. Best, Don Bauder

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Twister May 1, 2009 @ 10:39 p.m.

Somewhere in some dusty box I think I've got a copy of your 2005 piece warning of the impending bust. Is it available on-line?

Well, "moral hazard," yes. But this is the excuse the lenders have used to hold onto toxic houses they're letting rot and their pools fester with mosquito larvae, drowned kids, dogs, cats, lizards, ad nauseam, no? Seems insane from a long-term investment point of view to me, but at least there will be some “stimulus” effect for the reconstruction industry . . .

Maybe that’s where I should invest (instead of the banks) so I can join the feast along with all the other maggots?

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ltemplet July 5, 2009 @ 3:08 p.m.

We've enjoyed 15-20 years of faux prosperity and high living. Unfortunately, we didn't earn it. To get cash for our party, we borrowed from the Chinese and Japanese and stole from most of the world in the form of taking their investment money in return for worthless "securities", all the while taking pride in our new "service economy". Now we find ourselves with huge debts and debt service, dramatically reduced wealth creation capability because so many jobs have been shipped overseas, and increasingly difficult borrowing circumstances. Our credit-card party is ending but the politicians don't want to face it and lead us into more sensible economic practices. Instead, those morons are forecasting highly unrealistic 3.5% GDP growth in the next year and 4.0% for the decade after that and using these "forecasts" to dupe us into further increases in government spending and borrowing. Where does it lead? Into the third world existence that Bauder keeps talking about.

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