SCENARIO 1: I tell my son that if he washes the car, he can use it on the weekend. Will he be more or less likely to wash the car?
SCENARIO 2: I tell my son that he can NOT use the car unless he washes it first. He never washes it because he gets wrapped up in video games. So, I wash it for him, and then hand him the keys and tell him he can use it since it's clean. What lesson is learned there?
People respond to incentives, and people generally prefer to pass burdens on to others if they can get away with it. Why are these simple economic lessons so difficult for our thick-skulled politicians to understand?
On Wednesday, U.S. Treasury Secretary-designate Timothy Geithner suggested creating a so-called "bad bank" which would buy nonperforming loans. This bank would buy the worst loans that banks made, infusing cash into those banks (thus rewarding the financially wicked) and taking ownership of non- and under-performing real estate loans. Most estimates are certain that this will be a net cost to the taxpayers, with some estimates to the tune of $3 trillion to $4 trillion.
So, if I get this right, Banks made insane loans to non-credit-worthy people, lied about asssessed valuations, and engaged infraud; and then, sold them to other reckless banks in a grand game of hot potato. Speculators in the financial industry played the game, and many got caught with an awful lot of bad loans.
Geithner's proposed response? Let taxpayers absorb that loss, and give the banks a 'free ride.'
How is this different than Scenario 2 above?
This proposal permits banks and financial institutions to walk away from their own misdeeds, and pass the full burden on to innocent taxpayers. Instead, we should consider the OPPOSITE approach: Require banks to hold the loans that they make.
Suddenly, it will become very apparent who the prudent investors and lenders are, and who is out to play Roulette with taxpayer money. If Banks are forced to bear the burden - and enjoy the success - of their own practices, it will be a long time before we see a repeat of the current debacle.
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