Wednesday, September 24, 2008

What a Mess

Congress is right to question the Treasury Department's proposed $700 billion bailout. However, politicians are obstructing the bill for very different reasons. Liberals see a golden opportunity to socialize a large part of our financial system and will dig in their heels in order to increase government control and limit the free market. Conservatives are concerned at the size of the government's investment, they wonder if it will work, and they fear increased regulation will do long term damage to the economy.

Most people seem to agree that something needs to be done to stabilize our banks and avoid a massive pull back of credit that would trigger a recession. Why bail them out for their poor lending decisions? For one, ignore the "Wall Street vs. Main Street" rhetoric. Wall Street includes your retirement portfolio. It includes your chances to get a loan and your company's need for investment to fuel growth. In addition, the government bears much responsibility for the sub-prime meltdown. Beginning in the Clinton Administration, banks were pressured and cajoled into giving mortages to people who were being "discriminated against" for their poor credit. To encourage this irresponsible lending, the government backed these loans. This divorced the bankers from the risk of these loans and they went a little crazy (and they made a lot of money). Other people got in, issuing the loans and then packaging and selling them. Add super low interest rates and you get a huge problem. And I'm not a politician so I can say this: the borrowers who aren't paying back their loans bear a good chunk of blame too.

Normally, Republicans are for deregulation, which is allowing Democrats to dominate the narrative of this crisis, claiming that Republican deregulation caused the problems. Their solution? You guessed it, mega-regulation. In fact, the opposite is true in this case. Recognizing that government, not free markets, was screwing up Fannie Mae and Freddie Mac, Republicans, including President Bush, pushed for more regulation. The recognized that if the government was on the hook if the loans went bad, they shouldn't have risky portfolios. Unfortunately, powerful Democrats stood in their way, including the four senators receiving the most campaign cash from Fannie and Freddie - Chris Dodd, John Kerry, Barack Obama, and Hillary Clinton. The Democrats and the media are now working overtime to rewrite history.

So what to do? Keep in mind, this isn't a give-away. The taxpayers get something for their money, and as the economy recovers, they could actually make money on this deal. Maybe. The government helped cause the problem, they should help solve it. As the Congress and the President work out a compromise, it would be nice if they considered these thoughts from Donald Luskin at NRO:

Even if you grant that this really is a 'crisis,' and that it justifies an extraordinary intervention, there can be no doubt that the $700 billion authority being sought for the purchase of distressed mortgage-related securities is far too great an amount. Of the $1.26 trillion in non-prime mortgages — that is, 'sub-prime' and 'Alt-A' mortgages — $743 billion is already either owned or guaranteed by Fannie Mae and Freddie Mac, companies that were shored up by a government rescue earlier this month. That leaves $521 billion, which means the Treasury’s $700 billion would be more than enough to buy them all. And that’s even if the Treasury paid full value. In fact, the Treasury will get a steep discount, considering that many of the mortgages in question are in delinquency or default. Does the Treasury really have to buy every single non-prime mortgage — even the healthy ones — twice over?

And if the Treasury’s authority were scaled down to something more in proportion to the size of the asset market it claims to address — say $350 billion — must that authority be granted all those dollars at once? Couldn’t we start with $100 billion and see how it goes, and go back later for more if necessary?


Rudi said...

my problem is 1/3rd with the banks, 1/3rd with the government, and 1/3rd with the people who took out loans that they can't pay.

I've heard accounts of people in the previous housing market (when "times was good") purchasing a 700,000 home on a 50,000 salary with no money down. That really ticks me off. A top CEO at a mortgage company lent money to an extremely unlikely pay-back because the government allowed them to (or even encouraged them to) and the idiot that thought that 115% of their income could go towards their monthly payments now sound as if they're going to be let off the hook... with 10,000 per American family (average).

To quote Dennis Green, "They are who we thought they were! And we let 'em off the hook!"

Jon Vander Plas said...

I think your division of blame is pretty close.

The buyer in your scenario probably thought he could flip the house and the bank figured they could package and sell the mortgage. And they could, until bubble burst.

Another quote from an equally angry man: "Our chickens are coming home, to rooost."

Kyle Hommes said...

I don't think it is just the sub-prime market that caused this, I think the proliferation of derivatives and practices such as short-selling helped as well. As far as the democrats urging for lenders to loan money to low income families, I don't see that as the problem. 65% of the sub-prime loans awarded were given to people who qualified for prime loans. The banks wanted to put people into the loans because it meant they could jack up the interest after the fixed arms expired.

However, when Bush asked for more regulation in 2003 (Obama not in office yet) the democrats should not have voted it down. They thought more regulation would keep lending to low-income families from getting loans, which it may have, but it also would have ushered in more accountability. Despite that request, though, the Bush administration and its appointees to oversight positions seemed to let things slide as the housing crisis got worse. I don't think one political party can be blamed. In fact, I think blame needs to be more on the banks and possibly on the borrowers (if they knew what they were getting into).

The argument over regulation or deregulation seems somewhat mute to me. The government doesn't have and can't afford the resources to police Wall Street. The fact is that Wall Street needs to do a better job of policing itself. Yes, more regulations may be needed, but I think companies need to start doing what is best for the masses instead of what is best for the bottom line. It seems that whenever the goal is to make money at all costs, things go poorly for more people than they go well for.

Either way, we are all screwed.

Jon Vander Plas said...

You can bet that Wall Street has learned a lesson or two from all this. The banks clearly made mistakes that weren't in the best interests of anybody - not the people who couldn't afford the loans and certainly not the banks left holding the bag.

Good point about derivatives and short selling, no doubt that contributed as well.

I disagree, though that regulation doesn't matter. Over-regulation stifles growth and chases capital overseas and that's bad for America.

Kyle Hommes said...

What exactly would over-regulation look like?

Jon Vander Plas said...

Great question!

As we consider this question, keep in mind that capital can and does move to wherever it can find the best return. If our government creates an regulatory environment that is hostile to the financial industry, capital will flee to other countries costing us jobs and economic growth. We need these trillions of dollars to be invested here.

An appropriate amount of regulation in the financial industry attracts capital and is necessary to protect everyone from monopolies, fraud, and anti-competitive behavior. Over-regulation might be defined as regulation that drives away capital. In addition, the costs of these regulations are passed on to consumers, which lowers our standard of living.

Here's an example of what it looks like: Sarbanes-Oxley. The bill was a major overreaction to Enron, as if fraud wasn't already illegal. The bill has increased accounting costs dramatically, costing companies (and us) billions. This bill is widely cited as the main reason for the massive shift of IPOs to foreign markets. Over regulation has made the U.S. less attractive places to sell your stock, so people go to Europe or Asia instead, costing us thousands of jobs. Another example - limiting CEO pay would drive the best CEO's abroad, robbing us of the best and brightest.

Kyle Hommes said...

So, theoretically, anti-trust regulations would be good for the economy on account of the fact that they would increase competition, a scenario in which consumers benefit. But, do companies benefit from increased competition? That is what I don't understand, people say competition is good for industry, but doesn't it just drive down prices, which is good for consumers, but bad for industries?

Jon Vander Plas said...

Competition is hurts companies' profits, sure. A monopoly allows firms to charge far higher prices by restricting supply, increasing their profits. Competition is a fundamental part of the free market. More competition drives down prices and drives up wages.

Kyle Hommes said...

So it would hurt profits to break up monopolies, but overall it would be good because it allows more businesses into the economy and makes companies perform better.