The cost of insuring the financial industry
鈥淎sk me how insurance works.鈥�
鈥淎ll right, how does insurance work?鈥�
鈥淲ell, okay, you give me your money鈥︹��
鈥淚s that all there is to it?鈥�
鈥渊别蝉.鈥�
鈥淚s that a joke?鈥�
鈥淣ot exactly鈥︹��
Fire insurance works by sharing out the risk of a fire among hundreds of homeowners. In effect, if one house burns down, the others have already put aside enough money to rebuild it.
It鈥檚 a kind of voluntary socialism鈥reely collectivizing the risk of a house fire.
But just because you have fire insurance doesn鈥檛 mean you will leave a can of gasoline on the kitchen stove. You know it would be a big pain to replace the house and its contents 鈥� even if you were made whole financially. That鈥檚 why it works, because it doesn鈥檛 change human behavior. So, actuaries can calculate the odds of a fire fairly accurately.
But suppose you could insure against losses in the stock market? Or suppose you were guaranteed health care鈥r a comfortable retirement鈥o matter what you did? Wouldn鈥檛 you at least be tempted to live a little? To take chances? To spend a bit more?
And wouldn鈥檛 the whole economy change as a result?
For the last 50 years 鈥� or more 鈥� we have been taking part in a vast experiment. What will happen as more and more risks and costs are socialized?
We already saw what happened in the mortgage market. Bankers used to take their risks one by one鈥� If they thought a man was a good credit risk, they lent him money. Sometimes they were right. Sometimes they were wrong. Being wrong from time to time was just a cost of doing business.
But then the financial industry collectivized the risk. The banker lent, earned a fee, and then sold the mortgage on to Wall Street, where it was securitized, packaged and resold. What was the consequence? Well, mortgage lenders stopped worrying about individual risks. They changed their behavior and stopped using their own judgment. All they wanted was to close the folder, collect their fees, and move the paper on. Soon, they were lending without asking questions 鈥� using low-doc, IO mortgages. House buyers changed their behavior too. Easy mortgage credit pushed up demand鈥hich pushed up prices. Pretty soon, the whole town was on fire.
But then the feds stepped in and collectivize the risk even further. Now, Fannie Mae and Freddie Mac are arms of the US Federal Government. And now we鈥檙e all partners in the insurance company! Now, when houses burn down WE ALL have to pay.
We鈥檝e seen what happened when government collectivized other parts of the financial system too. You can collect Social Security whether you saved for your retirement or not. And you could get unemployment compensation whether you saved for a rainy day or not. And you can get food stamps whether you tried to find a job or not.
And now, if you鈥檙e a major Wall Street bank, you can get a bailout from Washington whether you deserve it or not.
How about that? The feds have spread the risk around so much that everybody pays for everybody else鈥檚 mistakes.
Is that a good system, or what? Government insures everybody against everything. Only the government doesn鈥檛 have any more money鈥�
鈥o, then you give your money to government鈥�
鈥nd that鈥檚 all there is to it.
------------------------------
海角大神 has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
