Saturday, September 20, 2008

Why the government intervened

I really don't like what the government has done by taking over Freddie Mac, Fannie Mae, AIG, and funding various other major transactions because what they are doing is setting the stage for another similar problem just as the savings and loan bailout set the stage for later problems, but I understand why they intervened. Almost all of our major companies borrow money for day-to-day operations. This is because even if they make tons of money, they don't make it in a steady flow throughout the year to guarantee that they can pay for any specific day's cost of business. What the government saw was a run by investors away from banks which would eliminate enough money from being available for companies to pay for their day-to-day operations which would effectively stop the economy. Our economy runs on the trust of investors in the banks, and when too many investors flee to cash, the banks don't have the money to lend to the companies. What the government saw was another depression occurring. This wasn't because the economy wasn't fundamentally sound from a short term perspective but because the dip in available money for lending was far too low causing too much of a shock for the economy to ride out without significant damage which would take a long time to recoup. However, the root of the current problems causing investors to flee is because the government intervened in previous problems and causing investors to ignore valid risks in the future which eventually build up causing yet another big mess. What the government needs to do is extricate itself from this death cycle by interfering as little as possible even to the point where the economy may go down slightly because removing short term fear by investors shouldn't lead to them ignoring the riskiness of their investments too much as happened when bad mortgages were repackaged as investment vehicles leading to the sub-prime mortgage mess.