Sure, some bought houses with little or no down with risky variable rate mortgages and are now feeling the pain. But they all weren’t deliberately scamming the system, and buyers, mortgage companies, and investment banks were all part of the bubble. AngryRenter says no one should get a bailout, and maybe they shouldn’t. But what the Fed is really worried about is the counterparty risk for all those sliced and diced mortgages that have been bundled into risky securities then bought, sold, or used as collateral for more trades.

This is why the US government forced the sale of Bear Stearns, who had literally trillions of notional dollars in trades with other entities. If Bear went down, then all those trades go bad too, something which could cause a cascade of failures.

The key point here is these are private trades made within the shadow banking system. They are not insured and unlike the stock market, there is not always a buyer for every seller. If the entity on one side of a trade goes bankrupt, the firm on the other side is stuck with a now worthless trade. Then maybe they start wobbling financially too.

I expect we will eventually have massive government intervention to prop up the real estate market, to prevent areas from turning into ghost towns and to ward off systemic failures.

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