Sunday, September 28, 2008

The Big Bailout: Rewarding What Behavior?

In discussing the current financial crisis, I've been in conversations where friends ask 'how could this happen?' At the origin of much of the situation is the mortgage market. So, you say how could homeowners take on such large mortgages? Why did they keep refinancing and refinancing? Well, let's think about it - the government rewarded it, and the mortgage industry and homeowners responded to their incentives.

In the 'olden days' the tax system was set up to allow people to deduct interest paid on credit cards, car payments, and basically any other type of credit. Then the system was overhauled so that the ONLY thing that basically can be deducted is the interest paid on mortgage payments.

Consumers are smart; they took on second mortgages to pay off cars, credit cards, loans for projects, etc. The mortgage industry made money on this behavior, then they got creative and put together other packages to bring in even more people into the mortgage market.

If you reward a behavior, you get it.

So .. with the new bailout plan, just what is the government rewarding? What about the $25 billion they are giving the auto companies? It's interesting how that is now 2nd (or 3rd, 4th) page news when compared to the $700 billion for the financial industry. What new behavior will the bailouts (plural) motivate leaders to pursue?