Nothing is as cheap as someone else’s money

Did your wallet suddenly feel lighter? It should have, because yesterday the Bush administration spent $2,000 of your money. That’s your share of the $700 billion that they’re going to use to buy up mortgage-related assets. $2,000 for every man, woman and child in the United States.

This whole financial crisis seems to boil down to a rush to borrow money. Certainly, many homeowners borrowed way more money than they could afford. Many didn’t put down enough of a deposit to create sufficient investment in the property such that they would fight to stop foreclosure.

All that borrowing was too easy, pushing house prices even higher. Now that prices have fallen to more realistic levels (given household income), the value of all those mortgages correctly look overpriced. Unfortunately, since liquidity seems to have frozen and banks have raised their lending standards, it is almost impossible for many to refinance.

But, let’s look further … and what we will find is more borrowing. This week short-selling has been banned for a large number of stock. Basically, this will stop much speculation (and the market signals they initiate), but it will also stop the practice of borrowing someone else’s money to make a gamble on whether the market will continue to decline. Borrowing on a bet that someone else will fail? Or failing on a bet to borrow?

The investment banks are fast going under, collapsing under the weight of their borrowings. Tonight, two of the remaining (Goldman Sachs and Morgan Stanley) have become bank holding companies. Essentially acknowledging that they must limit the amount of debt they can take on. When it collapsed, Lehman had about a 30:1 debt-to-equity ratio, meaning it had borrowed $30 for every dollar in capital it held.

We’ve been living in an era where too many people thought it was too easy to make money. The line seemed to be if you could just convince someone to lend you the money, then you could make a killing on even the flimsiest of schemes. First it was the dot-coms, burning through money until you either ran out of cash or someone bought you out. Second was the stock market, fun times in an era of irrational exuberance. And, then it was real estate. No need to worry about the tiresome business of actually making something that people wanted to buy! Just borrow the money and watch your paper balance expand.

Now, sadly, as we face the unwillingness of banks to lend, it will be very hard for otherwise healthy businesses to finance their growth and operations. Which means levels of real income and employment will fall. That, I suspect, means that the economic hangover from all that drunken borrowing is going to be long and hard.

Just pray that we don’t all expect the Fed to bail us out. We don’t need another loan. Nor another complex financing derivative dreamed up on Wall Street. We need to stop all this borrowing and get back to making money the hard way – through hard work and innovation.


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