Recent events again confirm the wisdom of this position. Those who tried to flee the market meltdown of fall 2008 were, in general, too late. The panicked news coverage followed the worst declines. So an investor who read the coverage and then pulled out was “selling low.” That same investor, who won’t get back into the market until things look more optimistic, will at that time be “buying high.”

Do you see the pattern? “Buy high, sell low.” That’s a sure route to ruin. When all this turmoil clears, count on it: Those who do the best will be those who followed the sound advice of “buy and hold.”

And, one more thing: Suppose someone sold after the first ten percent of a market decline, and then bragged about having missed the worst of the decline after the market went down another ten or 20 percent. That bragging would turn to regret over longer periods of time, if history is any guide.

1. It starts with the old-fashioned savings and loan association, like the Bailey Building & Loan in the classic movie It’s a Wonderful Life. That savings and loan association would accept deposits from people, loan them out on mortgages, and all was well. (Stay with me; this is going to be easier than you think.)

2. That is, until people lost confidence in the savings and loan association. Then if they all tried to withdraw their deposits at once, the savings and loan wouldn’t have the money — literally. The money was tied up in mortgages. The mortgages were sound, though, and all would be well if confidence could be restored.

3. So, if there was a run by depositors, it would take an inspiring speech by a George Bailey character to restore confidence. In time, federal insurance of deposits was an even better solution. People wouldn’t have to run get their money out if they knew federal insurance was there.

4. Backed by federal insurance, the old-style savings and loan association still had two main problems: 1.) It could only draw savings from a limited area; and 2.) Its requirements for credit-worthiness left many people unable to own their own homes, especially poor and minority borrowers.

5. The answer was to open up opportunity, both by making mortgage finance national and by easing requirements for home ownership. This was accomplished largely through the packaging and sale of mortgages to investors everywhere, enabled by the Federal National Mortgage Association (”Fannie Mae”) and the Federal Home Loan Mortgage Corporation (”Freddie Mac.”)

6. In the housing boom of the early 2000s, Fannie Mae and Freddie Mac encouraged truly risky mortgage finance behavior — lending money to people who wouldn’t have qualified in the old days. It was an over-correction to the earlier practices that had restricted home ownership.

7. As long as the housing boom continued, the risks didn’t seem very big. If a homeowner with poor credit stopped making payments, then refinancing or even getting kicked out wouldn’t be much of a risk on that mortgage money. Why? Because reselling the house at an even higher price would allow the lender to get repaid.

8. But when the housing boom stopped, everyone then realized there were thousands and thousands of homeowners who owed more on their houses than the houses were worth. They were “upside down,” so to speak. Now if the owners stopped paying, the lender might lose money.

9. There’s a lot of money tied up in mortgages that are likely to go bad. And unlike the days of the old federally insured local savings and loan association, failures don’t just hurt one local institution. In fact, lots of financial institutions had made huge gambles on mortgages not going bad — not only with their own money but with borrowed money too.

10. Because of bad mortgages, we’re back in the old movie (It’s a Wonderful Life) again. People have lost confidence in the relevant financial institution, but this time it’s a huge network instead of a single savings and loan in quaint little Bedford Falls. Any solution will have to restore confidence, and it may be very expensive to get that done.

There’s the problem, in ten easy steps.

• Fannie Mae and Freddie Mac were the key players.
• Fannie and Freddie are GSE’s — that is, government-sponsored enterprises. That means they were, uh, sponsored by the government. Not only that, they were chartered and regulated by the government.
• Fannie and Freddie took huge risks with an implicit guarantee that the taxpayers would pick up the tab if they failed. That implicit guarantee has now become explicit.

There’s an easy narrative that says “We didn’t regulate.” In the case of Fannie and Freddie, that’s simply wrong.

Maybe in the future we will regulate players like Freddie and Fannie better than we did.  I hope so. Make no mistake about it though: Fannie and Freddie were government chartered and government regulated. They were not private and they were not deregulated. (Plenty of people took stupid risks with the securities that Fannie and Freddie enabled, but that’s another story.)

One more important note: This is not really a partisan point. Here, for example, is a columnist who favors Sen. Obama for president and recognizes that deregulation is not the source of the current financial troubles. And the Washington Post, hardly a bastion of conservatism, has a thoughtful piece showing how the 2008 meltdown was a failure of distorted markets, not free markets.

Like many people outside the field he assumes there’s a conservative economic theory and a liberal economic theory — overlooking the large analytical core shared by all economists. What does that core say about the role of mortgage originators in the subprime affair?

Simply this: that self-interested private firms disregard the costs they place on others. (See “externalities.”)

Therefore, if you want firms to be careful about costs, you make sure they pay the relevant costs. In the subprime mortgage affair, mortgage originators faced simple incentives to write as many mortgages as possible, short of outright fraud. They received origination fees for doing that while being relieved of liability if the owners later defaulted. Naturally, the law is complicated, but mortgage originators who simply reflected the overall market’s bad judgment — as opposed to committing fraud or misrepresentation — aren’t in much trouble.

Put yourself in the position of a mortgage officer. The housing market is hot and a ready market exists to buy up the loans you write. Are you going to inquire deeply into whether the borrower will pay it back? I didn’t think so.

It’s not a failure of economic theory, “conservative” or “liberal” or otherwise, when people respond rationally to perverse incentives. The task for reform is simple in concept: correct the incentives (as opposed to lamenting greed or making broad pronouncements about non-existent schools of thought).

1. A rescue plan is passed and is effective. Then we get a minor increase in overall unemployment, two quarters of economic recession, and we’re done. Maximum unemployment is about 7 percent or so.

2. A rescue plan is passed and doesn’t work. Then we get an extended recession, possibly taking years to recover, with unemployment maxing out at about 10 percent.

3. No plan is passed. Here we get into uncertain territory. It all depends on how adaptable our economy is in getting savings converted through to make funds available for economic activity — something our system has been very good at, but that now seems shut down by the events of September 2008.

How bad is a recession in general? It’s terrible for those who lose their jobs, but in the U.S. it doesn’t mean people starve in the streets. Remember, even if unemployment hits 10 percent, 90 percent of the labor force is still working. As for making drastic changes in plans because a “recession is coming,” that’s a losing game. Example: Should someone drop out of college to save money because “a recession is coming”? Answer: No. The average recession lasts about 11 months. It’ll be over by the time you graduate.

Examples could go on and on, but you get the idea. Anything that’s a smart idea now — such as working hard and saving — will be an especially good idea is there’s a recession. Dumb ideas — such as buying a fast car you can’t afford — become even dumber if there’s a recession.

1. Nobody knows what will happen, including me. So be skeptical about anyone making predictions, including me.
2. If there really is going to be a collapse of financial institutions in the absence of government intervention, then we will have a long period of economic distress. It would have all the usual hallmarks of tough economic times: stagnant income growth and high unemployment. People would not starve in the streets, however, and it would not be another Great Depression.
3. But there’s reason for skepticism about collapse. One alleged example of collapse was that McDonald’s was having trouble getting working capital. That proved to be overblown, and beyond that: Do you really think that a business model as sound as McDonald’s couldn’t somehow get funded in its day-to-day operations, even with ready investors holding trillions of dollars of cash and looking for a return? My own opinion is that awkward makeshift institutions would begin to fill in the gaps and McDonald’s would find a way to run. It wouldn’t be as good as our current system but I think we would muddle through.
4. Politically, both sides have been guilty of brinksmanship in the proposed bailout. The Democrats have been trying to get goodies for political allies in the bailout, while the House Republicans have been trying to put in some long-hoped-for tax changes. This is not the time for any of that.
5. So, my favored solution: Do a clean, technical bailout that allows the government to buy up distressed mortgage-backed assets and establish an orderly market for their disposal. If there are eventually profits from this, apply them to reducing the national debt.
6. And when all this is done, get the government out of the business of holding mortgage debt.
7. And for the future, try to draw a sharp line between assets the government will guarantee (such as bank deposits) and those it won’t (such as hedge fund holdings). Then try to structure things so that anyone who places a bet on non-guaranteed assets is on their own. Too often we have allowed people to take giant risks, reap the giant returns, and then put the losses on the taxpayers if the gamble goes bad.

If you hold the stock of your employer, you’re taking a double chance. First, you’re taking the risk that a single stock will decline. But second, you’re taking the risk that when your company’s fortunes decline, you lose big in the stock market and lose from job-related effects.

Some employers will match your purchases of their stock. Fine. Find out the time limits and, as soon as you’re permitted, diversify out of your own employer’s stock.

There are many tales of woe from people at Enron, Merrill Lynch, Lehman Brothers and AIG that all made the same mistake — holding their own employer’s stock in large amounts. Don’t make the same mistake.

It’s not even clear that the U.S. is in a recession, as of this posting. The economy was actually growing, by 3.3 percent, in the second quarter of 2008. Yet news reports seem to have come up with a new and expansive definition of a recession.

Look at this article, in which Hilda Sanchez concludes we’re in a recession and says, “We are cutting corners in our spending. For our groceries, we are buying a lot of generic and we are eating out less.” If the definition of a “recession” is “a time when a reporter can find families cutting back on spending,” then we will forever be in a recession.

“Absolutely, we’re in a recession,” said Hilda Sanchez, 44, of Waterford, Calif.

Worse yet, those who think a recession cure will save everyone from having to watch their spending are just wrong. So let’s use the word “recession” more precisely. You can’t fight an enemy you don’t know — and if your enemy is, say, high energy prices or lack of job skills, the end of a recession won’t make those things go away.

Don’t.

There’s very little to be gained by spending a day standing in line. Remember, we have federal deposit insurance that will guarantee your deposit up to $100,000. So, just keep that deposit where it is, in the shaky bank, and continue to write checks on it as usual.

But what if you just absolutely have to get that money out? Consider the fact that if you take the money out in cash, it will then be vulnerable to loss and theft — both far bigger dangers than bank collapse.

If you just want to move that money to another bank, go to your new bank and their staff will facilitate moving your deposit over. Don’t go to your old bank and stand in line.

How about people with more than $100,000 in a single account? If you fit that category and you didn’t notice the $100,000 limit, move right away to put your funds into differently titled accounts, each with a balance under $100,000. You may spread your money across different banks or different ownership arrangements, as this FDIC fact sheet points out.

It’s extremely unlikely you’ll gain anything by standing in line to get your money out of a shaky bank. If the bank has already been taken over by Federal officials, as IndyMac has been, you’ll either get all your money (if your accounts are below the $100,000 limit) or the designated proportion. But being there in line won’t change that proportion.

Here’s a long FDIC video if you want to find out even more.