Regulations, not financial rescues, are the answer

As every parent knows, the danger of cutting a special break for one child is that all the other children will demand the same thing. "It's not fair," goes the inevitable refrain. "You said Susie could eat ice cream and watch TV until midnight, so why can't I?" The parents start caving and family discipline is shot.

We're now in a comparable cycle of bestowing special economic favors on members of the national family who have been hurt by the credit-market crisis. "It's not fair," argue the housing interests and consumer-advocacy groups. "Bear Stearns got a financial bailout, so why shouldn't we?" And they're right, by the simplest schoolyard definition of fairness.

So the line grows of people demanding breaks on financial obligations they can't afford. The Bush administration agreed to rescue 100,000 homeowners who are at risk of foreclosure on their mortgages. Congressional Democrats promptly announced that this wasn't fair enough, and that they intended to expand the bailout to as many as 2 million distressed borrowers.

But why stop there? What about onerous commercial mortgages? And credit card debt? Student loans? Why should anyone have to pay back anything? It's not fair.

As these special breaks proliferate, we are implicitly creating a system of transfer payments that shifts money from the smart to the stupid, from the lucky to the unlucky. Well-managed banks that controlled risk levels will subsidize poorly managed ones that didn't; prudent homeowners who decided not to take the interest-only refinancing loans will subsidize imprudent ones who did. There could be so many other, better ways to spend tax dollars on housing subsidies: Make loans to poor people so they could buy homes, say, or to needy veterans coming back from Iraq or Afghanistan, or to people who've lost their jobs.

The other response to the financial crisis, in addition to the ever-widening circle of bailouts, is increased regulation. And here, too, some argue that the cure might be nearly as dangerous as the disease. But in this case, regulation is the right course -- and the plan for consolidated supervision proposed by Treasury Secretary Henry Paulson is a good start.

The International Monetary Fund has released a scary new "Global Financial Stability Report" that reckons U.S. residential mortgage losses at about $565 billion, and total credit-market losses at a stupendous $945 billion. The IMF warns against a "'rush to regulate,' especially in ways that unduly stifle innovation or that could exacerbate the effects of the current credit squeeze." But the report also includes a long list of reform measures to improve the stability and transparency of the markets.

Among the financial titans these days, what one hears sighs of relief. They've gotten their bailout from the Federal Reserve, and they're hoping the worst is over. Now come the cries for equal treatment -- the "me too," bailouts for folks on Main Street who are lucky enough to have a lobbyist. Congress will say yes -- it would be manifestly unfair to do otherwise. But after shredding the moral hazard barriers, we should understand that the next financial crisis, when it comes, is bound to be even worse.

© 2008, Washington Post Writers Group