AIG Takeover: Socialism as Remedy to Bad Regulation

My post on AIG article in the Economist:

So now socialism is the remedy to repair capitalism crippled by bad regulations?  Why not consider regulatory reform first?

The laws, regs, and policies are bad in several ways, and here are the root causes, in my layman logic:

1. Political Correctness. Lawsuit rulings against redlining becomes legal extortion that forces banks to give loans to high risk borrowers. Banks need a way to reduce risks of these loans or unload them.  The bad loans get so ridiculous because the overseeing authorities also get infected with politically correctness, and ignore obvious bad signs in borrowers.

2. Government Guarantees to Bad Loans.  GSE’s like Fannie/Freddie buy the bad loans in huge quantities, thus giving banks a way to unload the worst loans. They now are not incentivized to self-police their loan risk.

3. Intertwined banking functions.  Investment banks get into loan markets and compete with consumentr banks, except they get to bundle bad loans into massively interconnected securities like derivatives. AIG sells expensive insurance to investment banks who know that the bundled bad loans are ticking time bombs when housing prices eventually fall.  Investment banks buy up many more bad loan bundles, using their existing ones as collateral.  The whole mess is leveraged incestuously and becomes a house of cards depending on housing prices never falling again.

The reform has to be more transparent and ethno-geographically independent loan criteria, abolishing de facto housing welfare GSE’s like Fannie-Freddie, and separation of banking functions to make bundled investments intelligible.


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