It was rather amusing to read this over the weekend from Bloomberg's editorial department:

How would all the mortgages for these apartments and houses be funded? Lenders simply followed the people. For decades, urban investors had bought stakes in farm mortgage bonds. With the agricultural economy in such straits and the urban economy booming, groups such as the Farm Mortgage Bankers Association of America (which later dropped the "Farm" from its name) reoriented their sights on the cities, looking for ways to lend to these new urban dwellers, bringing their experience in turning mortgages into bonds.

....

Banks loved the new invention because it allowed them to skirt regulations. Although the Federal Reserve regulated the proportion of savings that could be lent as mortgages (half of savings deposits) there were no restrictions on mortgages funded by bonds. These bonds, however, had a maximum length of five years, forcing the mortgage debt to be refunded, at minimum, every five years. But since the balloon mortgage, so popular in the 1920s, was refinanced every three to five years, there shouldn't have been a problem as long as more investors could be found.

Did you detect the elements of a Ponzi Scheme in there?  You should have.

In point of fact the reason this collapsed is the same as the reason it collapsed this time around -- the "values" lent against were nothing but hot air and when the next sucker failed to appear to buy at a higher price the scheme collapsed.  Since the borrower was never able to perform to maturity on the original terms it was mathematically impossible to avoid the collapse; we were simply arguing over when, not whether, the collapse would occur.

The same thing happend this time around.  And just like the in 1930s the government this time bowed to political pressure and refused to force those who made bad loans -- knowing full well that they could not be performed on their original terms, and that the collateral was not worth the amount lent -- to eat their own cooking and collapse.

Having pemitted regulations to be "skirted" (a convenient word for counterfeiting) there were in fact only two options -- lock everyone up who engaged in these frauds, starting with the CEOs of the financial institutions involved, clawing back every nickel they had in the process, or attempt to transfer the debt to the taxpayer in some fashion.

The government did the worst of all of it.  FDR not only allowed the depositors of the institutions involved to get hosed he also didn't lock the banksters up and he transferred the losses to the citizens -- even those who had not been a part of the scams -- through currency devaluation.

In short he did basically what we've done this time and the result was the destruction of our economy for more than a decade, ending only when we entered WWII.

There is no answer to these dilemmas once the government turns a blind eye or worse, becomes explicitly involved in public frauds of this sort.  The choices are only to prosecute and force those who committed the evil acts to eat them or to force everyone in the economy to eat them and protect the politically powerful who committed the crimes.

The simple fact of the matter is that at the root of this crisis, as it was in the 1930s, is counterfeiting by the lending institutions involved.  The lending of money against nothing but hot air depresses the value of the currency which drives the price of assets and the real income of earners in opposite directions.  This is inherently a fraud upon the public in each and every instance, committed with license and therefore given "legality" by the government in question as that which is counterfeited is the nation's currency. 

There is no solution that can be found to this problem until it is faced head-on and stopped. 

Simply put so long as banksters are allowed to counterfeit the currency we are arguing over whether we'd like to be financially raped a bit, some or deeply and long rather than whether we're going to suffer this ignoble act at all. 

It becomes even worse when, as has happened this time around, the counterfeiting becomes part and parcel of how government funds itself.  Government borrowing is inherent vice -- a perhaps-necessary vice in a handful of circumstances (e.g. declared war) but nonetheless it is inherent vice, as government never borrows against value, it borrows against the promise that you will get up and go work tomorrow to pay taxes -- the very definition of "hot air" unless enforced at gunpoint (at which point we call it what it is -- slavery.)

There is nothing wrong with borrowing against actual market value of an asset -- that is, liquifying that asset for the purpose of commerce.  That sort of lending is essential to modern commercial flows; without letters of credit, for example, international trade would be nearly impossible at any rational level of risk. 

But as soon as you allow someone to lend money unbacked by anything -- that is, not backed by the actual liquidation value of the asset nor actual capital put forward by an investor or equity holder then you have committed a public fraud.  You have allowed the lending institution to counterfeit the currency in question by increasing its quantity in the market simply on whim.

This is exactly identical, in mathematical and economic terms, to the lending institution running off stacks of $100 bills on the office copier.  That act, when performed, is universally recognized as a serious felony worthy of prosecution and incarceration.

It is no different in economic and mathematical impact when a bank creates credit money out of thin air, backed by nothing other than a promise to get out of bed and go to work tomorrow, irrespective of whether that credit money is created by The Fed or a commercial bank.

We will never solve our economic problems until we face the mathematical reality of what has been done and thus why these acts must, in each and every instance, fail and lead to economic ruin.