Government’s realistic limits

Not everything can simply be fixed by government, and the country's financial crisis may be viewed by history as one such example of this unpleasant but indisputable fact. The possible inability of government to fix this problem - caused by irresponsible lenders, borrowers and crooks inside and outside of government - may explain why the United States House of Representatives shocked the world's financial markets Monday by rejecting a proposed $700 billion bailout.

The financial crisis involves bad loans, backed mostly by houses worth far less than the value of the loans. It's a real problem with real consequences that may involve economic pain for some time to come.

The implications of major lending institutions going broke are enormous, and reach into the pockets of nearly every citizen of the United States. Retirees and prospective retirees, for example, may see their pension plans fail. That's because the bad loans were bundled, passed around and bought up by major investment firms - firms funded by everyday investors.

Any government bailout, no matter how it gets packaged, would involve government buying the bad notes at an overvalued price. As President Bush said, the government would then sit on the bad investments until their value returns, and then sell them in the private market.

Few believe the bad investments will become good investments any time soon, if ever. If that were the case, private sector investors would be buying them. The whole crisis is based on a complex Ponzi scheme that led to senseless amounts of home construction, which led to an unprecedented surplus of homes.

The result is a massive imbalance of supply and demand. We are a country with too many homes, too little demand, and the result is a devalued real estate market. The bad loans on these properties were mostly the result of a desire to create demand by turning people into home buyers who had no business borrowing money to buy homes - especially homes that were artificially overvalued by a corrupt mortgage industry that churned out fraudulent and inflated appraisals.

This imbalance of supply and demand can be resolved only by a great economic recovery, in which the majority of Americans can genuinely afford big, pricey luxury homes, a massive influx of upper-middle-class immigrants, or the mass elimination of homes. A major baby boom would put the solution 30 to 50 years into the future.

True economic forces are to financial shysters what gravity is to a juggler. Like gravity, market forces ultimately do their job. In this case, market forces proved that borrowers who earn $50,000 a year can't pay off $300,000 loans. Market forces proved that millions of homes weren't worth what the sellers, lenders and appraisers said they were worth.

Government probably can't fix this nightmare. All it can do, by all appearances, is pretend to fix the problem with yet another artificial cure. Another surge of feel-good money to fix a problem caused by feel-good money is akin to curing an alcoholic of the delirium tremens by handing him a flask of whiskey.

The whiskey will hold the DTs at bay, but the sense of well-being is fake and destructive. Likewise, a $700 billion infusion of cash will make people feel good and it will save the hides of politicians for now.

But it's not real, and it's horrifically destructive. It sends another powerful message to the financial world that anything goes in the American economy. It eliminates the notion that bad economic decisions have nasty, unpleasant consequences. It facilitates more financial activity that pretends gravity doesn't exist.

One reason the House didn't go along with Bush's request for yet another Dr. Feelgood fix has to do with the warning of 122 economists, including two Nobel Laureates, who signed a letter explaining the danger of another phony cure. It said: "If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted."

Just as continuing to drink, or to drug, in order to avoid the pain of going straight is desperately short-sighted. The party can't continue forever, at the peril of the children and grandchildren who will be left to clean up this mess if we don't straighten up now.

We won't pretend there is an easy answer to this complex problem, but shielding decision-makers from the detrimental effects of their bad decisions will guarantee another generation will face the same situation.