When Bette Davis declared “Buckle Up, It's Going To Be A Bumpy Night” she wasn’t referring to our current financial crisis and the government’s proposed bailout of major business failures. Although, she could have been had she lived in these troubled times. Consider the lineup of distressed firms: WaMu, Countrywide, Merrill Lynch, Bear Stearns, Lehman Brothers and AIG! That’s just for today; we don’t know yet who will be next!
One of the biggest problems we face is when the government seeks to intervene on our behalf. What follows are always unintended consequences. Consider Fannie Mae and Freddie Mac: Their objective was to make home ownership for people easier even if their financial status was shaky at best. Banks were accused of redlining, i.e., denying loans to minorities and people with less than good credit. The government stuck its hand in the equation and set up these two secondary-market monsters and told them not to worry about failing because the government will rescue you if you do. In the late 1990’s Freddie Mac borrowed $125 million in the bond markets at 6.99% and then turned around and purchased corporate bonds issued by Phillip Morris at 7.68%. This was clearly taxpayer subsidization of corporate arbitrage and totally out of line with the government’s objective of advancing home ownership. So what do Freddie and Fannie then do? They loosen the credit requirements for getting a home loan. Thus was born “liar loads.” No longer were you required to supply the lender with copies of your paychecks and w2’s but you could state as your income any number you wanted. “Just pick out a number from the hat,” said the lender lady. “I see you listed your annual income at $140,000 and listed your occupation as order taker at McDonald’s Corporation. Ooh, they’re a fortune 500 company. Here’s your home loan for $600,000.”
During the Enron investigation we learned that companies were disguising their balance sheets and hiding debt. The government, in its infinite wisdom sought to rectify the situation by instituting “mark – to -market- accounting. Again its intention was good. Make the balance sheets of corporations clearer.
The unforeseen consequence in this case was the domino effect. When one bank sells a mortgage-backed loan at a distressed price – other banks will have to take a paper loss as well. Even if they’re performing well. This is the same as in your own neighborhood. You have one home that fell to the bank. The bank, desperate to get rid of the home and off its books, reduces the price until it sells. Your home and other comps in the area are all affected by that one sale and as a consequence your home and others are worth less as well. Even if you have a steady job and have lived in the home for a long time with a deep cushion of equity in the house. Try getting a descent appraisal with several foreclosures or short sales in your neighborhood!
Years ago, regulations and restrictions were placed on banks as a way to deal with the effects from the great depression. Bank runs, insolvencies etc. Again, the government’s intention was good but unintended consequences reared its ugly little head again. Because the banks have to have adequate regulatory capital on hand it must change this ratio otherwise risk technical “insolvency.” A worst case scenario. So, in order to avoid technical “insolvency” it sells financial assets as quickly and cheaply as possible just to get it off their balance sheet which frees it to make more loans.
The Federal Reserve Bank and the Bush Administration are warning that if we don’t bailout Fannie and friends we will have a dire economic problems. More so than if we allow the troubled firms to fail.
Credit will dry up, loans will disappear, job losses will mount etc. Have you ever seen government come in at the time of crisis and actually did something good? Without unintended consequences? I can’t remember one instance. We need to let these firms fail. Will it hurt? Yes. Hell, Yes! But we will recover more quickly than we will with government intervention that artificially attempts to stabilize prices and assets.
Here’s what else is wrong with the proposed bailout:
A new congressional panel would have oversight power and the treasury secretary would report regularly to the lawmakers. The original premise was to give complete oversight to one person but members of Congress balked at giving unbridled power to one person. We could have had one person held accountable but instead we muck and mire each step of the process to a committee that is prone to disagree on every aspect thus drawing out the pain.
American taxpayers are on the hook to bailout Wall Street greed and malfeasance and those who sought to gamble on the housing situation. We’re sacrificing Main Street for Wall Street; rewarding the bad guys and punishing the good guys – the taxpayers.
This hastily crafted bailout plan was subject to intense political pressure from both the democrats and the republicans. By the way, Senator Obama took credit for the democrats and Senator McCain took credit for the republicans. Need further proof we’re in trouble?
The Federal Reserve Bank hopes that by gobbling up toxic assets the banks will be all cheery again and carry on like nothing ever happened. When in fact, they’ll be even more cautious and even more fearful. In effect – paralyzed. Not forever, mind you but long enough to hurt.
This proposed bailout doesn’t address homeowner’s who are in trouble. Home values will still decrease and we will be adding one trillion dollars to our already bloated debt situation. Think that won’t affect our credit ratings abroad and here at home?
Let the market forces work things out. Let the market forces weed out the weak and allow the strongest to survive. The void they leave behind will be quickly filled in by those ready financially to grow and absorb the asset. Think Bank of America buying Countrywide and later Merrill Lynch. We can’t avoid the pain whether we bail out or not. The hope of the Federal Reserve and Bush Administration is to ameliorate our pain and suffering but unintended consequences are sure to follow. By allowing government intervention it only delays and distorts the natural market forces response. Consider this: During the height of the housing bubble my friend sold his home at an artificially high and ballooned price. He had attractive offers from several potential buyers but accepted the one who gave him a cash bonus of $5,000. Of course, with his house sold he had to buy another home. And yes he paid an artificially high price for his new home. Both the buyer of his home and himself are now upside down.
The natural market forces in place caused the bubble to burst – a good thing because it helped bring back into balance prices by lowering the price of homes. During the height of the housing bubble I told my brother that I would not qualify to buy my own house. The price was artificially inflated and out of balance with rational expectations. By allowing the government to artificially inflate and delay the inevitable pain we must suffer it ensures greater financial instability into the market. Don’t interfere with natural market forces. We will be subjected to less intense suffering and for a shorter time period if we allow the market forces to straighten out this mess. Keep in mind that we are still fixing the fixes we instituted back during the great depression nearly 75 years ago! You know what? I have an eerie thought – what if the plan doesn’t work?
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