Bail out the banks?

In the wake of the collapse of the housing boom, banks and financial institutions are taking significant losses. Unfortunately, banks have not been hit with the degree of losses which they actually deserve. The Federal Reserve has been propping up the market and banking industry by lowering the interest rates. The problem is, the banks deserve the financial pain that they are in. Mortgage lenders approved loans to lots of people who couldn't really afford them, and mortgage brokers had financial incentives (provided by the lenders) to sell as many loans as possible, even when the loans were risky. Back in 2004, when I bought my house, mortgage lenders were approving loans up to four or five times the annual incomes of borrowers, as opposed to the traditional multiplier of three.

To demonstrate how totally insane the banking industry was, here is an example in practical terms. With a five to one ratio, this meant that a person with a $70K salary could get a $350K mortgage. This approximates to payments of about $2155 per month on an after-tax income of $4000 per month. Add in another $700 per month in property taxes and insurance, and the person is left with $1145 per month to pay for food ($600), utilities ($150), condo fees ($300), maintenance (???), car payments ($400), clothing, etc. In the DC area, the person would be running a major deficit. Worse, during the housing boom, $350K would only pay for a tiny condo in Arlington.

Of course, the banking industry knows how to do math, and they fully understood the risks associated with the loans that they made. They were gambling that the housing boom would continue, and in the process, made huge profits originating loans. Now, however, the consequences of their actions are coming due, and they want the American taxpayer to help bail them out. At the moment, the help is indirect, through low Fed discount rates, a Treasury-inspired "superfund", market intervention by Freddie and Fannie, and perhaps an economic "stimulus" package. But does anyone doubt that the taxpayer will be asked to bail out the financial industry if these stopgap measures fail?

Capitalism is about taking risks, and hopefully taking smart risks. Companies that make smart decisions should profit, and those that don't should lose money. We shouldn't reward the financial industry for bad behavior, and nobody should shed a tear for the financial industry as it tries to dig itself out of the mess it created.