Let the prices fall, let markets find their equilibrium, by gimleteye

The subprime mortgage sector is cooked to a fare-thee-well. Across the globe, hedge funds and financial institutions are blowing up on long-delay fuses as combustible toxic mortgage waste is repriced to meet redemption calls by anxious investors.

Still, it's just a start to what began unfolding in Florida at the start of 2007: the implosion of the biggest housing boom in state history.

But as pilloried as the subprime sector has been, it makes just as much sense that home buyers deemed to be credit-worthy who bought jumbo loans and far too much home than their incomes could reasonably support are next in line for default rates in excess of bond insurance (for investors in the derivatives cobbled together from the asset bubble) and that these mortgage-holders represent a far bigger problem to markets for securitized debt assembled from large pools of the giddy, the unrealistic, and delusionary.

The question now arises as to the moral responsibility of governments and financial institutions to pick up the pieces of the massive asset bubble they created in the first place. So far, not so good.

It has been difficult for the financial press and for politicians to get a handle on the extent of the economic crisis triggered by the housing boom now in cinders.

The debate about what to do is ironic in the context of the debate about the nation’s moral responsibility to continue the war in Iraq.

Strange that the nation that elected a president based on values is now possessed by a government debating its moral responsibility to rescue voters and taxpayers from its own values.

The writer James Howard Kunstler calls America “clusterfuck nation”, , and he won't get any argument from me.

The mainstream media is finally catching on that the housing market crisis will be the major issue in the 2008 election cycle.

It has finally teased from the Goldman Sachs of the world that we are only beginning to see the waves of economic casualties from the implosion of the housing boom.

“This is really just the beginning… there’s a big wave of defaults coming over the next 12 to 18 months,” said Karen Weaver, global director of securitization research for Deutsche Bank to the New York Times (“In Washington, Measuring a Lifeline”, August 28th).

The Times article goes on to describe discussions in Congress, over what shape and form a government bail-out should take and the fundamental question, “should the government ride to the rescue”.

For a better review, the economist Nouriel Roubini blogs on the same topic.

In the Financial Times, Larry Summers – former secretary of the Treasury –writes: “what is the role for public authorities in supporting the flow of credit to the housing sector? The lesson learnt during the S&L debacle was that it was catastrophic to finance home ownership through insured banking institutions that borrowed short term and then offered long-term fixed-rate home mortgages. Now a system reliant on securitisation, adjustable rate mortgages and non-insured financial institutions has broken down.

It is undeniably true that the system of securitization, or financial derivatives as they are generically called, financed the asset bubble in housing in the United States. But Summers doesn't offer any prescription.

Warren Buffet called derivatives “weapons of mass financial destruction”: was he ever right.

The financial institutions that securitize mortgages are like the Department of Transportation for growth and development: immune from any measurable criticism.

Economists—far from the battleground in communities and civic activists who tried, over the past decade, to protect their neighborhoods from greedy local developers and bankers and consulting engineers and land use attorneys—are trying to fit a round peg in a square hole by recommending expanded authority for the government sponsored entities like Fannie Mae and Freddie Mac.

If anything emerges from a regulatory response to the credit crisis, it should start with backing down those weapons of financial mass destruction. Does Congress have the guts to confront Wall Street: we'll see.