Cause of subprime mess Buyers, sellers, financial institutions - and government- all failed.

is associate editor of The Inquirer Editorial Board and editor of Currents

A single, startling week this month challenged anyone's delusions of the unimpeachable wisdom of free markets.

That was the week of Dec. 17-21, when the Federal Reserve and the European Central Bank scrambled to head off shock waves from the subprime-lending fiasco. That week laid bare one raw, unavoidable fact:

The subprime mess is a failure of the free market. A flat failure on all sides. Buyers. Sellers. Financial institutions. And government, which should have been watching but wasn't.

Proof - if anyone needs it - that the market is a human, not a godlike, thing, a marvel of productive, efficient prosperity when it's running right, a hungry black hole when it's not.

Here's hoping consequences aren't terrible. But the ride wasn't worth it.

The subprime mess is as American as roller sneakers. It started when middle- and working-class people with shaky credit saw a chance that once seemed unlikely: to own their own homes. Banks and other lenders offered them mortgages that started out at very low

interest rates. True, those rates would balloon later. Wouldn't that mean many folks would suddenly

not

be able to pay their monthly payments?

"Not to worry," lenders said. "The housing market is so hot that your house will be worth a lot more by then, and you can rejigger your mortgage into something easier to handle." Sounded good. The U.S. housing market was on a mad roll, stoking the world economy.

But the housing market collapsed - along with any chance, for many buyers, of meeting those mortgage payments. (Most of them, by the way,

will

work it out and meet their payments - bless 'em. But far too many won't.) Lenders were left holding many millions worth of bad loans. They shrank their businesses, fired CEOs, restructured.

Not just here. Mortgages get sold, resold, and re-resold, bundled up and auctioned off to who knows whom - including European banks. Now many of

them

are holding what one pundit calls "debt bombs." If those go off, banks might stop giving loans, and the economy could slow way down.

Central banks got busy on both sides of the pond. On Dec. 17, the Federal Reserve held the first of four special year-end auctions on short-term Treasury bills. It's a fire sale of slashed-rate loans to financial institutions.

Next day, the Fed proposed new regulations on lending practices. Response: a lot of moans. That's a sign they're needed.

Question: Why weren't such safeguards

in place already

? An editorial in the Financial Times called the proposals "a bit like taking a second job after the house has been repossessed." One of the fastest-growing Bush-era scandals is the way regulators ignored early warnings. As early as 2000, highly placed officials told Fed Chairman Alan Greenspan too many banks were selling loans to people who couldn't afford them. What happened? You bet: nothing.

Some have called the Fed proposals a "shift" toward a new "regulatory role."

New?

No: As the banking system all Americans own in common, the Fed

should

watch how money is bought and sold in this country.

In Europe, they are less leery of central tweaking. On Dec. 17, the European Central Bank stunned experts by pouring about $500 billion in low-interest loans into the European banking system. Close to 400 banks, worried about debt bombs, had asked for help.

True believers think the market can right itself. It can and should, to a point. But regardless of whether the next six months are a slough of despond or a brief gray stretch:

A made-in-the-USA financial virus exported to the world - not much there to be proud of.

We were caught with our regulations down.

What price a "free" market if it destroys homes, hopes and livelihoods?

Markets reflect the faults of the people who create them. Witness the American working- and middle-class buyers of the cut-rate mortgages. They should have been smarter, not have bought houses beyond their means. "Greed is right; greed works"? Not for them, evidently. Don't, however, saddle them with all the blame.

If buyers are culpable, sellers are more so. Sellers know more than buyers, especially in a highly technical realm such as mortgage banking. Sellers drove the deals, advertised them (often

very

sketchily), made the risky bets, accepted "no-doc" applications (imagine: in many cases, buyers

did not have to show they could afford the mortgages

) - a stupid, disastrous business practice thousands of salespeople repeated across the country.

Lenders should have watched their sales staffs.

The Fed should have watched the lenders.

Even if repercussions turn out to be moderate, come on - no more market idolatry. Like many of the best human inventions, the free market is often to be admired, never to be worshipped.