Howzit Howard

Are our schools overfunded?

If you didn't read Loren Moreno's article in the Sunday edition of the Honolulu Advertiser, "Spending on schools outgrowing results," go back and read it (all of it -- most newspaper readers don't go past the "jump," where a story is continued on another page, but that's usually where the interesting bits are) in your capacity as parent and/or taxpayer. But be careful to keep the numbers straight. They are just complicated enough that one can get bogged down in arguing over what one is arguing about. And a key fact was omitted, but I'll mention it in this post. In 10 years the net enrollment in Hawaii public schools has declined, but the operating budget for the school system has more than doubled. Some test scores have improved while others have gone down (hence the headline). Here are some factors to bear in mind:

• The consumer price index has risen 27% over the years considered, almost a third of the budget increase can be explained by this. (And the consumer price index is but one way of measuring inflation. Running and maintaining a school system involves more of some spending and less of other spending than would be the case for the average household that the CPI is meant to measure.)
• A quarter of the whole budget is special ed spending, mostly imposed on the school system by court orders and federal regulations as near as I can tell.
• Teacher salaries have gone way up in those 10 years; they were really low before.

The key factor left out of the article is the number of buildings that the school system maintains, or ought to. Despite that declining enrollment, the number of buildings is up by half. Educators and elected officials lack the will to close aging schools because it will enrage the parents of the small number of children who are still sent to those decrepit schools. (In the business community it has been suggested that selling off those old schools, which usually sit on really valuable property, would pay for sweeping renovations to the schools that remain.) I leave it to others to decide if the status quo is acceptable, but you should bear in mind that this is what the statuo quo is. Here's something else to bear in mind. It's a niggling point but for some reason it bugs me. School officials, lobbying for still more money, like to compare Hawaii funding with some mainland school system. They always act like they're bringing one up at random, but it's always the same one: Fairfax County, Virginia. Which I happen to know about because my kids went to Fairfax County, Virginia, public schools. It's one of the richest communities in the nation and has one of the highest percentages of parents with advanced college degrees -- one of the most important actuarial determinants of child education progress is how much education Mommy and Daddy have. In other words, we don't have the money to come up with that level of school funding, and if we did it wouldn't work, because we're not them. You may notice that some of the points I've stressed strengthen the arguments of school officials while others do not; I'm just trying to sort out some things here. One more point: I speak in our public schools fairly regularly and am always impressed with the teachers and students alike. I have suspected for some time that our public schools are better than we think, perhaps better than our test scores, and may be close to a breakthrough if we can hold onto enough of the current teachers.

Run for your lives! (Not)

Here's a front page headline in the Saturday edition of the Honolulu Advertiser: "Recession Could Tip into One of the Worst in Decades" It might as well read: "You Could Die Horribly Tomorrow!" Without criticizing the headline writer -- in a moment I'll explain why I don't -- I want to advise you, in your capacity as the-person-I-just-selected-to-represent-all-consumers, not to buy into this Panicky Guy stuff, even though there is a possibility that we will indeed get a deep recession, just as there is a possibility that you'll step in front of Roberts motorcoach tomorrow. First, here's the story behind the headline. On Wall Street -- where they're so smart they managed to persuade themselves they could invest in packages of mortgages sold to people with bad credit -- the impact of spiking mortgage default was not appreciated until it had gone for months and major financial houses had to do bad debt writedowns in the tens of billions of dollars. Even then, most of them thought there would be no recession. Later, when most of them had decided that maybe there would be a recession after all -- for some of them, I'm thinking getting laid off from their Wall Street jobs might have been a clue -- they figured the recession would be mild. In fact, most of them still think so, and on this particular point they may even be right. Though seldom is heard a discouraging word, a couple of name brand economists are now saying the recession might be bad after all. The gloomiest of these Gusses are Standard & Poor's economist David Wyss (pro. "Weese"), who thinks the tax rebates will produce a summer of small growth and then we'll slip back into recession; and former Federal Reserve head Alan Greenspan, who has been relishing his freedom to make sound bitable comments now that he's retired, and says this could be "the most wrenching" economic crisis since the end of World War II, which sounds dire but could refer only to the turmoil in the financial community rather than the economy at large. But the fact remains that all these guys are doing is guessing at the future, saying it might be bad. The reason I don't blame the headline writer at the Advertiser is that it's only human to try to make a story look as important as possible. But as a consumer and investor it's your job not to panic. Panic has concrete, measurable effects on markets and the economy. If we're going to panic, let's panic when we're short of cash, not when we read a scary newspaper story. We tend to think of a dollar as one discrete physical object. But the role played by a dollar could range from a bit part, if it's sitting in a wallet for eight days (two bits is a quarter so one bit is an eighth of a dollar, get it?) before it's used, to a starring role, if it's pulled out by various owners for half a dozen transactions over a day or two. A dollar can be many dollars. Most dollars are. How many, depends on how much spending consumers do. And two thirds of all U.S. economic activity is consumer spending. The Fed can pump $100 billion dollars into the economy -- it has done exactly that in a pair of loan auctions alone, never mind the effects of its interest rate cuts -- but it can't make you or the business you work for spend money. The old saying that you can lead a horse to water but you can't make it drink is not altered by a change in the number or depth of local watering holes. Some spending is driven by real events. If you've been laid off by the imminent closure of the Weyerhauser packaging plants and you haven't got your next job yet, you're going to curtail your spending and you're right to do so. If you work for Aloha Airlines and you expect to keep your job but figure it won't do any harm to spend more cautiously until the future of the airline is sorted out, that's a cautious but altogether defensible approach. But consider for a moment the consumer who has a perfectly safe income but curtails spending because of vague fears of recession gleaned from reading scary newspaper articles or interviews on MSNBC with Wall Streets who are way more likely to get laid off than you are. Spreading fear to people in secure circumstances can actually precipitate a deeper recession.  The Advertiser story, from the Associated Press, raises the question of how Bear Stearns could go so quickly from a market value of $3.5 billion on a Friday to a market value of $236 million two days later. Easy: its CEO said there was nothing wrong, when there was plenty wrong. Spreading misleading information is as bad as spreading fear. If he had been more forthcoming the stock would still have plunged, but not as much. But that's advice for CEOs, and I'm talking to you here. We're at a possible tipping point here -- a crisis that mostly affects huge investment houses and people with bad credit is having some effect on small, conservative banks and financially secure people who spend carefully, but the effect could become greater if we scare ourselves into an economic bunker mentality. It will do no harm to remain calm and be mindful of the difference between what actually happens in the economy and what might happen. I'm not recommending blissful ignorance -- look both ways for Roberts motorcoaches before you cross -- but confine your concern to real risks. As far as what might happen, you can cross that street when you get there.

Economy cooling, not freezing

The title is more blunt than most economic reports."Hawaii Annual Forecast," it reads. "Economy Grinds to a Halt." The forecast from the University of Hawaii Economic Research Organization, or UHERO, documents something you already knew was going on, the slow and limited cooling of Hawaii's economy, a gentler event than what the mainland is going through. I know some people who were scared by the report because, instead of reading it, they read the headline, which contains a semantic mistake. I'm not qualified to correct economists on economics, but on words I am: the economy is not grinding to a halt; what the economists meant was that they thought GROWTH was grinding to a halt, which, again, is better than what our brethren on the West Coast are going through right now. Looking at the national picture, the forecast reduces expected U.S. real GDP growth rate for 2008 from 2.2% to 1.2%. "We believe that the U.S. economy is now in recession," the economists write, adding that they do not expect even modest growth until the second half of the year. The new expectation is for a limited recession followed by limited growth nationwide. For Hawaii, UHERO now predicts net slippage in visitor arrivals, changing its forecast from 0.3% more visitors to 1.9% fewer, citing weaker economic conditions and two of our ships no longer coming in. UHERO sees lower visitor arrivals not only this year but next year as well. Visitor spending may rise 0.2% but after factoring in inflation that's equal to 3.9% lower spending in real dollars. Japanese visitor traffic could be affected by continued slow growth in the Japanese economy. Hawaii real income growth, which UHERO previously thought would grow 1.9% this year, it now sees as grinding almost to a halt, 0.3%. Inflation, which fell from 5.8% in 2006 to 4.9% in 2007, will fall to 4.3% this year, UHERO predicts. The organization forecasts zero growth for payroll jobs and a 0.4% contraction in overall employment. UHERO predicts a 3.5% jobless rate by year's end, rising in 2009 to 3.9%. All the major segments of the work force are looking a little sickly except for, coincidentally, health care. But construction looks okay, with only limited shrinkage compared to the mainland. (A separate report by other forecasters recently predicted that there will actually be a small increase this year in construction employment.) So this is your takeaway: economic growth is coming to a standstill if UHERO is right. But the economy is cooling, not freezing. Commerce will continue, and indeed will be only a little slower than it was.

Why bankruptcy can be a good thing

More than 3,000 people work for Aloha Airlines and many of them will be worried about their employer filing for protection from creditors under Chapter 11 of federal bankruptcy law for the second time in four years. But the ones who remember the last Chapter 11 will know that bankruptcy can be, in some respects, a tranquil time. When a company is short of cash but NOT in Chapter 11, its vendors can hold up deliveries, demanding cash up front. I'm talking about anyone from the company that supplies the jet fuel to the company that services the copiers. Every day has the potential to be a fresh travail as some other supplier decides not to service the company any more without cash on the barrelhead. In bankruptcy, control of the company passes to a federal judge, who has broad powers to make things happen that the regular management could never do. The judge can order Office Depot to keep supplying Magic Markers and he can order California airport authorities not to lock Aloha out of its gates for non-payment of rent. (I'm making up these examples; Aloha has many computers and uses comparatively few Magic Markers.) Aloha's 50-page bankruptcy petition says it has more than a thousand creditors, assets of more than $100 million, and liabilities in the same range. It estimates that funds will be available for distribution to unsecured creditors. Unsecured creditors are the ones at the back of the line when there isn't enough cash for everybody. The front of the line in any bankruptcy is the lawyers handling the case and the taxman, followed by secured creditors, like bankers and companies that lease aircraft. Bankruptcy judges always try to save a company whole before they even consider downsizing or dividing a business, and tend to protect jobs if they can. Even now, Aloha Airlines could be an attractive investment if kept whole, and the judge knows that. It has a loyal customer base, a lower pay structure than Hawaiian, and a more experienced management team than one might expect of a regional carrier in the middle of the ocean. So what happened to force Aloha back into Chapter 11? Aloha blames Mesa Air, parent of go!, for waging an interisland fare war that has ensured deficit operations for itself, Hawaiian and Aloha. While go! is the smallest of the three carriers in Hawaii, its parent company is much larger and has deeper pockets than either of the local carriers. Hawaiian, which last year won a substantial financial judgment against Mesa for misuse of proprietary information, found a Mesa memo outlining a plan to use money-losing fares to drain the legacy carriers of their cash and make it a two-carrier market with go! one of the survivors. Since Aloha had less cash than Hawaiian -- something Mesa management knew, having come forward as a prospective buyer of both Hawaiian and Aloha during their respective bankruptcies, seeing their books -- both Aloha and Hawaiian assume Mesa meant to drive Aloha out of business. Aloha has a court date in the spring for its own lawsuit against Mesa. Aloha did lose a lot of cash to the fare war, and more recently it has lost a lot of cash to spiraling jet fuel bills, made worse by the fact that its fleet, older than Hawaiian's, is not especially fuel efficient. Aloha pilots have even been cutting corners on taxiways, literally, to save a few drops here and there. What does this mean for Hawaii? It means stable flight operations for months or years while the bankruptcy runs its course, because the judge has so much more power. At the end of the bankruptcy, the most likely outcome is a reorganization in which fresh cash is provided by investors who want control of the airline. (The last time, the Ching family shifted to a minority stake while investors from California pumped in a lot of money.) One key thing to watch is whether there is an attempt by a mainland airline to acquire Aloha. Aloha's 3,500 employees are mostly based in Hawaii, because it has its headquarters here. If Phoenix-based Mesa or any other mainland carrier succeeded in acquiring Aloha, there would be job loss because the buyer would have its own back office someplace else.

What was and is in a name?

The most popular boy's names in America at the moment, based on actual births in 2006, are:

1. Jacob
2. Michael
3. Joshua
4. Ethan
5. Matthew
6. Daniel
7. Christopher
8. Andrew
9. Anthony
10. William

Please note the trend toward Biblical names -- Jacob, Joshua and Daniel are hard-core Old Testament, while Matthew is apostolic, and that's not counting at least three saints on the list. And, of course, Ethan stems from Ethan Allen, famous Revolutionary War hero and furniture brand. Ethan is also the most popular boy's name in both British Columbia and Saskatchewan. But you're not interested in that -- you want to know what the most popular girl's names are. Okay:

1. Emily
2. Emma
3. Madison
4. Isabella
5. Ava
6. Abigail
7. Olivia
8. Hannah
9. Sophia
10. Samantha

I see a couple of trends here. First, the surnames-for-first-names trend seems to have run its course. Only Madison remains in the top ten, as fewer parents name their girls Ashley, Courtney, Kelly and Jordan. Second, the French trend of the 1960s is dead. Michelle, Nicole and the other jeune-filles of my school days are all grown up and anchoring the news on NPR or something. Third, there seems to be a return to old-fashioned names, as Emily (Dickinson), Abigail (Adams), Hannah (Montana) and the like proliferate. Finally, we still seem to like the first names of celebrity actors and actresses -- Matt (Dillon), Daniel (Day-Lewis), Sophia (Loren), Olivia (de Havilland) and Ava (Gabor). I found the top 10 lists here -- http://www.ssa.gov/OACT/babynames/ -- on the website of the Social Security Administration. In 1953, when I was born, the top 10 boy's names were Robert, James, Michael, John, David, William, Richard, Thomas, Charles and Gary; the top 10 girl's names were Mary, Linda, Deborah, Patricia, Susan, Barbara, Nancy, Karen, Pamela and Sandra. (Kevin and Sean and Kimberly and Jennifer came to high visibility about a decade later as I recall.) The oldest year for which I was quickly able to find a list was 1880, the year my grandfather was born (he was 39 when my dad was born and my dad was 34 when I was born, so our three generations reach pretty far back.) The male list was similar to my birth year except that Michael and Gary didn't make the top 20 and Frank was pretty popular. The female list was notable for including one currently popular name -- Emma -- and some that we don't hear about much any more, including Minnie, Ida and Bertha. Wikipedia, in an article on the regional popularity of certain names, says Nadia is one of the most popular names in Pakistan, while the third most popular name in Australia's Northern Territory is Lachlan. Luke, Lukas, Lucas or Luka, depending on where you are is one of the most popular names of Argentina, Austria, Brazil, Croatia, Denmark, Germany, Lithuania, Malta, Slovenia and Switzerland. It tops the list in four of them. Emma is the most popular girl's name in Belgium, Finland, France and Switzerland, and second in Denmark, Ireland and Scotland. It makes the top 10 in Norway, the Netherlands and Italy. Hannah is third in Denmark and seventh in Austria. In England the third, fourth and sixth, respectively, are Olivia, Emily and Sophie. Sophia is all over the place. Are we seeing globalization of naming trends?

Economic crisis changes bank etiquette

The Federal Reserve Board doesn't simply wave a magic wand to make interest rates rise and fall. It raises or lowers one particular interest rate and counts on this action to cause bankers to make similar adjustments. And they do. On Tuesday the Fed cut the federal funds rate three quarters of a percent, and Hawaii banks sliced the same amount from their own business loan rates, cutting the prime rate from 6% to 5.25%. Time was when the Fed's mechanism for this was the discount rate. This avenue for nudging the economy fell into disuse until recent months when, facing an unprecedented crisis, the Fed began doing both. The most recent cut in at the discount window was undertaken by the Fed on Sunday, which shows you how hard the Fed is working. It doesn't ordinarily undertake anything on Sunday. (Sunday is Monday in Asia so I'm guessing the Fed was trying to prevent Asia stock markets from plummeting hundreds of points on Friday's leftover bad news. Markets fell anyway.) Raising or lowering the discount rate has been ineffectual in recent years because for a bank to visit the discount window is considering bad etiquette, something a bank would never do unless it was in financial peril. No bank likes to be seen as being in financial peril, ergo, no one went to the discount window. Until  now. Lehman Brothers is going to the discount window. Why not? It's already in peril and everybody knows it. It's being acquired by J.P. Morgan with back-up from the Fed, so both the problem and the solution are common knowledge. Stock that was worth $10 a share last Friday will fetch $2 a share when Morgan does the takeover. What can Wall Street possibly do to Lehman to punish it for visiting the discount window, TP its offices? More interestingly, however, Goldman Sachs, which isn't in nearly as much trouble as Lehman Brothers, says it has decided to "test" the discount window. What it will test is whether it can access the cheap cash without adverse effect on its stock. The answer might be yes. It's a new world, a world of crisis in which owning up to problems and taking action to solve them is respected, no loss of face. Here's another sign of a new world. Morgan Stanley posted one third lower profit on 17% low revenue -- and its stock went up. Because Wall Street was relieved that things weren't worse. Did you know that a simple announcement that a company will do nothing can make another company's stock fall? Societe Generale, second largest bank in France and the one that lost a lot of its assets to the inept trades of one employee, saw its stock decline Thursday because the top French bank, First Hawaiian parent BNP Paribas, is no longer interested in acquiring it. This leaves Societe as a standalone bank desperately trying to persuade the world that its rogue trader (a) acted alone, and (b) was a mastermind, which allows the bank to pretend that its security systems aren't too bad. If an accomplice surfaces, or if, as is already indicated, we come to realize that the trader was a moron who simply got in too deep and tried to gamble his way out, then the bank's systems and management look incompetent. If you see anyone at the Fed's discount window wearing a beret, call security.

Rates down, Dow up

Should you hide under the mattress, stuff money into the mattress, or jump on the mattress? The mattress question, which I introduced on the air Thursday morning, is just another way of raising the more serious question of which economic developments, of the many we're hearing about these days, are truly worrisome and which can be safely dismissed. On the air I dodged the issue by facetiously concluding that you should compromise and vacuum under the mattress. Implicit in the joke, though, is the idea that you might want to hide down there eventually, just not yet. The Dow rose more than 200 points Tuesday morning on the expectation that the Fed governors, teleconferencing at that time, would cut interest rates again. The meaning to be deduced from this: investors are more worried about a further plunge in U.S. stocks and constipated lending than they are by the falling dollar and soaring oil prices. Lehman Brothers may have moved the market, too, by announcing profits down by half, which the market actually regarded as good news, having expected even worse, proving that on Wall Street all things are relative, including the Lehman Brothers. Also in the news background Tuesday:

• Delta is offering buyouts to 30,000 employees hoping to lose 2,000 jobs while trimming domestic capacity 10%, twice what it said before.
• Northwest joined Continental, which joined United, which followed Hawaiian and Aloha, in hiking roundtrip fares $50 to try to cover soaring jet fuel costs a bit.
• Oil traded around $108 a barrel and gold traded around $1,009 an ounce, as investors who unloaded stocks buy commodities.
• The yen traded around 98, the euro bought $1.58 and the Canadian dollar remained near parity with the U.S. dollar.
• The producer price index is up 0.3% in the latest monthly report.
• Housing starts fell less than expected but permit applications plummeted nearly 8%.

What would Commissioner Gordon do?

I think the Wall Street crisis has gotten to the point where Commissioner Gordon would turn on the beacon to summon Batman. The most serious part of the crisis, though, is that it is sufficiently new that no one really knows for sure what to do about it. President Bush doesn't actually have the option of summoning Batman and Robin, so instead he had a Monday meeting at the White House with Fed head Ben Bernanke, SEC Chairman Christopher Cox, and Treasury Secretary Henry Paulson. He isn't going to be a lot of help from them. They don't even have cool outfits. Cox and his predecessors could have foreseen the subprime mortgage debable, which started all this, and they could have used their bully pulpits to lobby for sane regulations on mortgage lending. They didn't. I don't know what Cox could do now except investigate lenders, and that won't bright resolution, through it might bring vengeance, if that's your idea of a good time. Paulson has been advocating changes in the way the lending game is played, but he only started making this point a few days ago. Cab drivers were making the point before he did. The administration was conspicuously disinterested in the whole matter for months, although this may have been due in part to a fear that anything the White House said would fuel the sense of crisis and stampede traders into selling. Which they did anyway, but still. Bernanke has done plenty. Bernanke has shed his former persona as the college professor who didn't believe in ad hoc strategies to invent entirely new mechanisms on the fly to inject the economy with billions of extra dollars -- not just cutting the federal funds rate (as the Fed is expected to do again Tuesday) but also cutting the discount rate that used to be its main mechanism of movement (the Fed cut the discount rate to 4.25% on Sunday) and lending tens of billions in cash at auctions. On Friday, when the giant financial services house Bear Stearns was on the edge of collapse (after the head of the company said earlier in the week that Bear was nowhere close to this pass), the Fed offered to help rescue Bear by letting it borrow money with fake collateral -- mortgage bundles that no one wanted to buy. It wasn't enough, though. By Sunday the bailout had turned into a buyout, and the company, whose stock had been worth $10 a share Friday, agreed to a $2 per share stock swap to be acquired by J.P. Morgan. In a way, nothing the Fed has done has been enough. Pumping all those extra billions into the economy sent the dollar down against other currencies. The yen rose to parity and beyond. The euro moved to an all-time high, almost 1.6 to the dollar. Stocks, meanwhile, plummeted. This made commodities more valuable than stocks, so major institutional investors sold their stocks -- the Nikkei fell 454 points Monday and most markets worldwide fell at least 3% -- and bought commodities instead. Silver rose to a 26-year high. Gold at one point hit $1,030 an ounce Monday. Oil touched $110 a barrel and is up. The price is currently driven by demand for oil futures contracts, no demand for oil. The global economy has never before been so connected, and stock markets are entwined more than ever. Can any government affect it alone?

Gold price glitters; S & P eases jitters

In what the New York Times called "a historic day for a historic metal," the price of gold hit $1,000 an ounce Thursday. Investing in gold has been a refuge in uncertain times since defense contractors specialized in archery, so this'll give you an idea how nervous Wall Street traders are. Gold went to $1,005 before subsiding to just under $999 at the New York Mercantile Exchange close, and eased a few bucks further in overnight Asia trade. As you know from watching that movie about robbing the Federal Reserve Bank in New York, they keep a basement full of gold there in convenient bullion form. It's worth $242 billion, $75 billion more than a year ago.   One of the things that made markets nervous -- the Hang Seng index in Hong Kong fell more than 1,000 points Thursday because of it -- is the $16 billion default and imminent seizure of all assets of the Carlyle Group's mortgage fund affiliate. The Wall Street Journal suggested a moral: connections only go so far. Carlyle has in the past employed President Bush the Elder and former British Prime Minister John Major. It currently employs former SEC chief Arthur Levitt and its top executive ran IBM before ascending to the big time. All the king's horses and all the king's men, however, were not able to buy more time when the fund was hit by margin calls, and the mortgage fund fell 87% on Thursday alone. O how the mighty, etc. Levitt told Bloomberg News this would "not affect" the main Carlyle enterprise. I assume he meant, not that there would be no effect, but merely that Carlyle would not be sucked into its affiliate's screaming vortex of oblivion. Levitt made a point of saying that others would follow Carlyle down this road. That's scary on two levels. Level one is that he's willing to scare the markets just to make people feel better about Carlyle. Level two is the implication that nobody did anything stupid or wrong, nobody failed to think things through, nobody got stampeded by the rest of the market, nobody got greedy, there is nothing to be learned from the debacle, and they were merely blindsided by a Cole Porter storm ("It Was Just One of Those Things.") To be fair, not everyone thinks there is plenty more mortgage crisis to come. The Standard & Poor's credit rating agency said the end of it is "now in sight." Though I've got to say S&P must have better distance vision than I do, it was still a glimmer of hope (and another song title, "Three Little Words") sufficient to lift the U.S. dollar from its record low against the euro, though Hawaii tourism executives will be encouraged to hear the yen remained stronger than it has been in a dozen years. Treasury Secretary Henry Paulsen signaled an end to administration opposition to rewriting the rules of mortgage lending, and that may have helped, too. BusinessWeek dismissed it as all prevention and no cure, but prevention is to some extent the business of Congress and the White House, while cure is more in the kuleana of the Federal Reserve Board and the markets themselves. Other economic and business news...

• Boxed in by higher costs, Weyerhauser Company is closing its Honolulu plant, putting 85 people out of work. The corrugated packing plant has been running for 50 years.
• Hawaiian Airlines has made a straightforward announcement that it is raising roundtrip fares to the mainland by $30. It takes effect for May 1 travel onward.
• The University of Hawaii has decided to offer a four-year degree in health care administration at the West Oahu campus. Classes start in the fall.
• Gary North, the senior Matson executive in Hawaii, will retire at the end of the month and will be succeeded from a Matson executive from Guam.

Are rules of mortgage game about to change?

Sometimes things have to get worse before they get better. In the mortgage crisis, something is happening this week which may worsen the crisis enough to force officials to improve the rules of the mortgage game. If you read this blog regularly, you know that mortgage lenders don't sit on their notes, accepting your monthly payments for the next 30 years. They get rich quick by packaging their mortgage paper and selling the bundles to investors. The buying and selling of mortgage investments -- collections of mortgage notes -- was a thriving business until all those subprime mortgage borrowers started to default. What was supposed to be a pretty safe investment turned out not to be, and the flow of buying and selling halted. The new development this week is that the lack of confidence in those mortgage investments has spread to regular mortgages. There have been vague indications of this, but Thursday morning the indicator was really, really clear. The Carlyle Group used to have a reputation as a group of politically well-connected, astute investors who made piles of money with leveraged takeovers and turnarounds of distressed companies. These alleged geniuses proved their fallibility when they created Hawaiian Telcom, which so far has been a money pit for them (maybe the new leadership will rescue the owners' reputations by turning things around) and now they have shown that, far from being Einsteins, they may actually be regular people (but with a great deal more money than most regular people) whose luck ran out. They set up an affiliate called The Carlyle Fund to invest in those mortgage bundles just when stress fractures were beginning to appear in the subprime bubble. U.S. mortgage foreclosures doubled and tripled as subprime borrowers realized they had been sold loans with payments they could not possibly make. In the aftermarket, where investors buy and sell packages of mortgage notes, panic set in. Or maybe it would be better to say, they suddenly woke up and realized that the investments they were handling weren't safe after all. The market dried up. Huge investment houses took multibillion-dollar writedowns. Their stocks tumbled. Wealth evaporated. Lending braked. The Fed slashed interest rates and pumped billions into the economy but the trouble continued. The dollar weakened. Institutional investors pulled money out of stocks and bought oil futures, driving oil prices even higher. The Carlyle Fund managed to stay out of those headlines until this month, when it missed margin calls. At first we thought Carlyle would simply negotiate for more time. And it tried to. But its creditors weren't buying. The word Thursday morning was that Carlyle has defaulted on $16 billion in debt. It's going to have some assets seized. Here's the kicker: Carlyle didn't focus on subprimes. Its portfolio is Grade A prime Fannie Mae- or Freddie Mac-approved all-American regular mortgages. So now we know that investors don't even want to trade in ordinary mortgage bundles. At this point the word "panic" starts to look more apt. Ready for some silver lining? Treasury Secretary Henry Paulson says the government needs to find way, without choking off markets, to rewrite regulations to prevent this from happening again. "The objective is to get the balance right," Paulson said. "Regulation needs to catch up with innovation." What's new is that the treasury secretary is even willing to discuss fresh regulation. Until now the administration has been against that. We tend to associate regulation with socialism, and talk of market forces as if zero regulation would be a good thing. Partisan taking of sides on regulation leads to that kind of "bumper stickers for brains" digging in and can prevent workable solutions. So think of it this way instead. All markets are regulated. They are not lawless. The game has rules. The rules change now and then. There is such a thing as too much regulation, and such a thing as too little regulation, and, in theory, the right amount of regulation. For example, it might be a bad thing to forbid mortgage lenders to offer loans to households where the payments would use more than half their income. But it would do no harm, and might do a lot of good, to require that borrowers prove they have the income they say they do. (Aggressive lenders often took the borrowers' word for it, and in some cases may even have encouraged borrowers to simply write down the amount that was needed to qualify, without even bothering to figure out how far it was from their real income. In California these came to be known as "liar's loans.") Now let's see what happens.