The recent nose dive of stocks, apparently driven by a crisis in the subprime mortgage markets, raises the ongoing question of when and why government should intervene in the private sector. This fits into broader questions of the proper role of government overall, and the unique responsibilities the federal government has for maintaining the economy.
Recall that the U.S. Constitution was proposed in many ways to provide for the development of a strong commercial republic. The state of the macro economy, at least since the Great Depression, has been seen as a responsibility of the federal government. Fans of the free markets like to maintain the illusion that it runs without government assistance, but in fact the government often acts as a referee ensuring that the market is free from control by either the demand or supply side. That is what makes it free.
Critics though--appropriately--point out that often regulators bias decisions in favor of the industries they regulate in order to secure their solvency.
Market transactions can create problems for society as a whole, or for the politically powerful. This creates a political incentive for intervention. Critics argue that these interventions work against the long term efficiencies that markets promise and perhaps create moral hazards by subsidizing bad behavior.
The current situation, as we know, revolves around decisions by some lenders years back to take advantage of historically low interest rates and provide mortgages for people who might not normally qualify for them due to bad credit or low income jobs. These are the sub prime loans at issue. There is certainly much to applaud in allowing these individuals the opportunity to purchase homes (the American Dream and all that). The increase in the housing sector has been the biggest financial success story of recent years, some economists argue that if not for the housing boom, we may have been stuck in a recession. But the risky nature of the loans made them, perversely, more expensive to the borrowers and more likely to put them in a financial bind. They were more vulnerable to default, and this seems to have caught up with the borrowers and by extension the businesses that lent them the money.
What's worse is the fact that when times were flush subprime mortgage companies attracted the attention of hedge funds (investment firms for the wealthy) which made them components of their portfolios. Once the mortgage firms showed signs of trouble, the hedge funds began to suffer and investors feared for the economy as a whole.
The question is whether government ought top leave all this alone and let the marketplace work through the troubles, or it should intervene. The argument for intervention is partly based on the idea that these negative factors can have spillover effects on others not directly affected by this industry and partly a result of political reality. The affected parties have political supporters who might find it in their interest to be knights in shining armor.
There are two categories of need here though--one being the hedge fund and mortgage companies, the other the people who have lost their homes. Which set of need will be given priority. In a sense we already have our answer because the Federal reserve rode in to lower interest rates which makes money cheaper to borrow so the companies can cover the losses. Benefits for the borrowers do not seem to be on the horizon however, but given that fact that we are in the thick of a presidential race do not be surprised if candidates--more likely Democrats--start floating proposals to aid these people.
If the crisis continues, expect this to benefit Democrats in the same way that 9/11 benefited Republicans. It focuses attention on the issues that the general public seems to trust the part on.
This thing has legs, so expect more on it.
