Capitol Hill Blue Forums Political Issues Finance, the economy & Economics How will the financial crisis develop?

False dilemma. The question of legitimacy has nothing to do with with what caused the crisis. If one defines derivatives as being a wise and long-term viable activity, then I'd agree they're not legitimate. They still didn't cause the subprime credit meltdown.

The government has no business setting interest rates. Just as when the government tries to control prices, such action invariably leads to market distortions and loss of efficiency. In the case where interest rates are artificially held low - rather than rising in step with risk as they should - a bubble is invariably created. Investments begin to be judged not on their own merits, but on the irrational exuberance that the long, unbroken stream of past profits has granted.

People keep investing and investing, risk keeps growing and growing, and no one is properly worried about what happens when the music stops -- and why should they be, when the government (through Fannie Mac) is picking up most of the risk?

We knew for years the subprime mortgage market was a time bomb, and that housing was a bubble. Home prices doubling every few years in some areas? Million-dollar McMansions on every street corner? Thousands of fly-by-night banks popping up, then instantly selling all their paper, leaving the taxpayer to foot the bill? EVERYONE knew this was coming. But thanks to the Fed and Congress, no one took action.

In any free market, the interest rate on all those houses would have started to go up years earlier. The bubble never would have formed at all. The market would have cooled off, then continued to grow when sanity returned.