Krugman's solution is, of course, to strong-arm mortgage originators into more vigorously screening applicants--compelling them to deny mortgages to the riskiest borrowers in order to protect the rest of us. And I must say, I don't necessarily disagree with this:
If the government is going to stand behind financial institutions, those institutions had better be carefully regulated — because otherwise the game of heads I win, tails you lose will be played more furiously than ever, at taxpayers’ expense.
If the government is going to be taking on billions of dollars in mortgage liability, of course it should force financial institutions to limit the amount of risk that they're exposed to. The issue is why the federal government is bailing out large investment banks like Bear Stearns with tax payer dollars in the first place. Aren't we setting an awfully scary precedent by doing this?
I can understand ensuring the liquidity of large government-sponsored enterprises like Fanny Mae and Freddy Mac (which are already intensely regulated by the Office of Federal Housing Enterprise Oversight), but why is the Federal Reserve now letting private investment firms off the hook for bad decisions?
I'm certainly not an expert on the mortgage industry, and I can't imagine how hard it must be for all of those families facing foreclosure, but it seems to me that if our goal is a little more humility from large financial institutions, it's probably a bad idea to tell them that they're basically too important to fail--no matter how badly they screw things up.