Breaking the Law

It’s been another week where one needs a barf bag to follow the stock market.  Perhaps the market is beginning to stabilize, and the reality may be sinking in that the party is over, and we’ll have to go back to earning a living.  I hope so, anyway.

The rightist New York Post blames the economic crisis of the past weeks on Democratic politicians who encoursged banks to make mortgage loans to people who couldn’t afford them.  Both of the Presidential candidates lay the blame with greedy Wall Streeters who profitied from financial instruments that they didn’t really understand.

And both of those are true.  Those who say that Wall Street should be hoisted on its own petard, instead of being bailed out by the government, conveniently ignore that the government does not have clean hands in this matter.  Part of what genuinely worries me about this issue is that since everyone (politicians who encouraged bad lending, irresponsible borrowers, the banks that lent the money, and the Wall Streeters who believed that they could engineer the risk out of the whole affair) got us into this mess through their bad judgement, who will have the smarts to get us out of it?

But underneath it all, with 20/20 hindsight, it seems that everyone forgot a basic rule of economics: that the value of something, over the long term, determines its price, and not the other way around.  When the price of something becomes separated from its value, bad things happen.  It led to the Dutch tulip panic of years ago, to the stock market crash of the 1920s, and to the current economoc crisis.

Yes, the politicians encouraged banks to make loans to questionable borrowers in the 1990s, in the name of civil rights.  But if that was all that had happened, it would not have resulted in the situation before us.

But these loans were available to everyone, and many people took advantage of them, driving up the price of real estate.  It’s a funny thing: when the price of a loaf of bread or a gallon of gasoline shoots up, people get upset, but when the price of houses goes up, everyone’s happier because they think they’re getting richer.

Meanwhile, the underlying value of the property hadn’t really changed: the houses didn’t grow new bedrooms.  They were the same buildings, still where they were before, in neighborhoods that hadn’t really changed.   But somehow everyone believed that the rising prices reflected rising values, and that wealth was therefore being fabricated out of thin air.

Ultimately, even bankers and businessmen with normally good judgement bought into the charade, putting up new real estate developments into an overextended market.

And then the music stopped, and prices moved back into alignment with the underlying values.  Beyond the irresponsible borrowers who couldn’t pay their mortgages, even more responsible people might simply walk away from a house with a $500,000 mortgage if the property is only worth $300,000.

And now we have to pick up the pieces….

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