Here, in a few paragraphs, Jeff Miron lays out why we're in the mess we're in and why more government isn't the answer:
The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.
Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.
This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.
Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.
The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.
In reality I could put all of the paragraphs in bold. What you're not seeing in any bill or alternative offered to this point is any governmental reckoning for what it did to get us into this mess. And you've certainly not seen a thing which reforms the way Congress did business over the decades through Freddie Mac and Fannie Mae.
I can't say this enough times - it is critical that aspect of this debacle be addressed and corrected. The government has no business risking our nation's financial stability on some party's failed social policy. Unless and until that glaring omission is included in any bill, I'd continue to vote against it.
If that's not fixed and government gotten out of the business of providing perverse incentive which encourages extreme financial risk that ends up distorting the market, this same scenario could conceivably play out once again.
Miron goes on to talk about his brand of medicine for what ails the financial industry. It's called bankruptcy:
The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.
Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.
In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.
Part of any plan to address this situation must also contain aspects that provide disincentives to those who knowingly took risks they knew were imprudent. As Miron points out, a bailout doesn't accomplish that. However, good old fashioned bankruptcy does.
But, but, but, it will be awful. Maybe. For a time. However again, we're talking pain management, because we all acknowledge there is going to be pain.
Thoughtful advocates of the bailout might concede this perspective [moral hazard -ed.], but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.
However it isn't as bad as it sounds.
Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.
Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.
I agree completely - as Dale pointed out in his post listing his reasons for opposing the bailout, one reason the credit market is frozen right now is Wall Street expects to be bailed out at a higher price than it could get for the same assets on the open market. If it was announced there would be no bailout, you better believe they'd suddenly find a market for those toxic assets, and as Miron points out someone will buy them.
Why not let those someones who will do so and not involve the government and the taxpayers?
The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.
And while we obviously can't make Congress pay, we should do everything in our power to force them to reform the law that got us into this mess and ensure they don't again try to turn an economic issue into a social one.
Isn’t the credit market frozen due to bank fears of their counterparty going out of business? How is that related to hesitancy to sell their own MBS at 15 cents on the dollar? At that number the banks may truly go bankrupt anyways, so of course they don’t want to lend to each other. Its almost self-fulfilling.
I am also very curious...are these MBS really only worth 15 cents on the dollar? Are 85% of the mortgages they are based on really failing? Seems to be rather fire sale pricing. If they weren’t constrained by capital requirements and mark to market would such a fire sale have to happen?
Also, I would be very curious to know what companies can buy such distressed assets. It sounds like a good investment in such troubled times....Any suggestions from the peanut gallery?
You mean the picture of the salamander? Oops, I mean gerrymander.
I live 100 yards north of Marsha Blackburn’s district. Her district includes the southern part of Nashville where incomes are higher.
Until 2000, all of Davidson County was in a single congressional district. But they took out the part that tended to vote Republican and stuck it onto another district that tended to vote Republican. Then they added some areas from other counties to the north that tended to vote Democratic.
The result is that two districts became less competitive. I don’t think any Republican could get elected from the 5th district unless their opponent dropped dead on election eve, and probably not even then.
Of course, neither party is really upset about this. Each gets one more district they don’t really have to spend money to defend.
So the basic story is that the two major parties, being in command of the government, have rigged the system to each other’s mutual advantage. In other words, the two parties, who are supposed to be nominal competitors, are in alliance against the citizenry to reduce their influence in the electoral process.
"lenders are not making loans, even for worthy projects, because they cannot get capital."
Well someone has a lot of money to lend, which is why treasury securities are at an extremely low yield. Those folks don’t seem to have been too worried about credit worthiness up to now. Does anyone remember the dot com bubble? Perhaps, since they have not done it for so long, they have forgotten how to determine credit worthiness.
"I am also very curious...are these MBS really only worth 15 cents on the dollar?"
I have also thought about that. From what I have read, the non-performing mortgages are less than 10% of the total and, if the folks who believe it is all due to the Community Reinvestment Act are correct, these would be mortgges on the lower end of the price distribution. My conclusion is that those who say the MBSs are worth only 15 cents/dollar are full of s***. I will bet money that if a bailout bill does pass these worthless securities will magically become much more valuable. Heck, I would invest what I can right now at the 15% price.
That is what I was thinking...15 cents on the dollar seems pretty tempting. I did some looking but there’s not a lot of groups doing this that are publicly sold (except banks where they have their own troubles too.)
I think maybe the low price could be because you cannot tell what you actually own with an MBS. Is that actually true? If so, I could see how everyone would value any old MBS with the lowest possible price, because, hey, it could be doggy doo doo.
I think that in addition to the CRA poor lending, there probably was an equally large swathe of greed lending or fraud lending, where either or both the mortgage salesman and the buyer do some hinky things. Those might not be at the low end of the numbers.
I still think this is too complicated for most simple folks (I don’t mean the Amish).
The best example for simple folks is ..
imagine that the government started to circulate counterfeit $20 bills into the economy .. years go by .. one day the news comes out that there are billions in counterfeit $20 bills in circulation. Who will take your $20 bills ? .. Now in our current situation, instead of $20 bills, it’s securities made up of some number of bad mortgages made at the beckoning of the federal government.
But what I can’t understand .. is why the federal government should get an equity stake ?
The federal government orchestrated this screw up, they should just make restitution. Until that happens, there won’t be the proper level of outrage with the parties that let this go on. The whole "bailout" meme is merely a CYA exercise by the same politicians that let/made this happen in the first place.
The current problems would not be as severe had mortgage securities not been sliced and diced and sold off in pieces that made it impossible for anyone to understand the contents of their respective portfolios.
Had this not happened, the effect of foreclosures and falling real estate prices would have been limited to those particular mortgages, which would be written down in value, and mortgages that were backed by solidly valued real estate and homeowners current on their payments would still be valued at 100 cents on the dollar.
But because nobody knows which securities are which, the public has (justifiably) shied away from them. To follow up Neo’s $20 analogy, it’s the inability to determine which securities are real and which are ’counterfeit’ that makes the public unwilling to accept any of them at face value. Give people the ability to spot the fakes and those holding real $20 bills will be able to use them again.
It is possible to determine the status of each and every mortgage involved. More importantly, it is possible to reliably compute a statistical value of each and every security. They already do it. Foreclosures have been occuring since mortgages were invented, this is nothing new, only the quantity has changed.