Monday, November 10, 2008

Breaking up is good to do.

In software development we have a saying. Fail often and fail early. The idea is that failure is an eventual given. We are going to make mistakes. And the system you use to build your software should be designed to discover them quickly and correct quickly. This significantly reduces the cost of failure and the impact of failure.

In the Pulitzer prize winning Book, "Gun Germs and Steel" the author explores why Western Civilization had all the things it needed to become the dominant power of societies in Australia, New Zealand, Africa, North, Central and South America. Becoming the dominant culture. It came down to the two countries that had access to the grains needed to have large population centers. China and Europe. However, Europe was a set of smaller countries fighting amongst themselves for resources while China was a very large monopoly. At one time China was sailing to the Americas and had an overwhelming naval fleet. One day the emperor decided to burn this fleet and has never recovered from that mistake. If Spain had made that choice then England or France would have made them pay and Spain would have learned from their mistakes and corrected quickly. But it was hundreds of years before China learned from their mistakes.

Now lets look at our Secondary Mortgage industry. Because Fannie May and Freddie Mac were created by Gov't legislation and supported by Gov't legislation they held a monopoly on a $12 trillion dollar industry. Now all institutions, especially if they are large and a monopoly develop group think. This is where they don't have different voices telling them they are wrong. So they start making mistakes. The problem with group think is that you see the world in a very specific way so it is very hard to realize that you are making the mistake. Even when you begin suffering the results of the mistake it is hard to see the root cause. This condition is inevitable for monopolies. So when we set up our Secondary mortgage system we need to create a system that identifies errors quickly, course corrects quickly and when failure occurs it is not devastating. This is why I think we should break up Fannie Mae and Freddie Mac into 20 to 50 smaller institutions. Reduce regulatory controls and let them compete. when one makes a mistake, let it go out of business. This failure is not devastating and others can learn from it. This is the way we avoid bailing them out in the future.

Build a system that fails early and often and significantly reduces the cost of failure. This is why Capitalism and competition is superior to Socialism and monopolies. Monopolies hold out the promise of control and central control. But it's a lie. Because failure will happen and failure in a central controlled system is devastating.