This is a Cato Special Podcast. I'm Caleb Brown. When you apply for a loan, a grant or any

substantial cash infusion, the paperwork is often voluminous when Treasury Secretary Henry Paulson came before Congress to ask for an immediate $700 billion for an attempted rescue of the financial sector.

His testimony was just a few pages.

Jim Dorn, the Cato Institute's Vice President for Academic Affairs,

and editor of Cato Journal

believes that slowing this process down

might allow cooler heads to prevail.

A pretty consistent line that I hear is that we had essentially created a financial system in which the benefits, the upside, was private,

and now we are seeing a significant downside which is being in a sense socialized.

That is the costs associated with bad decisions will be borne by people who did not make those decisions.

Well, this is the moral hazard problem that when you

misprice and underprice risk, people take more risk.

And that's exactly what happened in this case Fannie and Freddie misprice

risk basically. They could raise capital on the markets at a less than market

interest rate and then basically buy up a lot of mortgages and later

on they were asked to buy up subprime and alt a type mortgages and then repackage and sell those as mortgage-backed securities, which

they guaranteed.

So there was a market for that.

The reason there was such a large market is because of the implicit government guarantee.

So they were basically saying, okay, on the downside, the risks will be socialized, but the profits will be privatized, and a lot of people made a lot of money off this and

the big investment banks, Goldman Sachs, Bear Stearns and Lehman and others, their leverage was incredible, especially Bear Stearns and Lehman.

Their ratio of assets to net worth or capital was on the order of about 30 to 1.

...