If Banks Don’t Fail, How Will They Learn?

BY Paul Solman  October 3, 2011 at 1:46 PM EDT

Fannie Mae

Paul Solman answers questions from NewsHour viewers and web users on business and economic news here on his Making Sen$e page. Here’s Monday’s query:

Name: Matyas

Question: There was no real real estate crisis where I live: Texas. Why some areas were so severely affected and others not? Is this a result in difference in laws and regulations (or the lack of regulation)? There was a $100 billion bailout of Freddie-Fannie. What would have been the results of not bailing out exactly? My primitive understanding is that if a mortgagee does not pay, the bank gets the property in exchange. If the property is not worth enough, then the bank made a mistake at the time of underwriting and financial forecasting. The bank should pay for this mistake in their profits. Without letting these banks fail, what is the guarantee that they will not make the same mistake again? What is wrong with this simplistic view?

Paul Solman: How quickly we forget. We did let a bank fail — Lehman Brothers — and the world economy froze. No one trusted anyone else, so no one would lend. Without lending, a modern economy can’t operate. That’s the simplistic reality. Without the bailout of the F-twins (or F-bombs, if you prefer), there mightn’t have been another mortgage issued in the United States. Foreclosures would almost assuredly have run amok, even in Texas. Do I know this for sure? No. Do you want to take the chance that I’m wrong? I would hope not.

Photo of Fannie Mae by Flickr user futureatlas.com via a Creative Commons license.

This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions. Follow Paul on Twitter.