Tonight I’m going to let a couple other opinions on the proposed $700 billion financial system bailout take the place of my own opinion on the subject. I’m saving that for a later post because it’s also going to tie together with my lunchtime post tomorrow.
The first opinion is from my GOP cohort Dave Parker. This was an e-mail which Republicans and others on our e-mail list received as his thoughts on the situation at hand. I actually embed the video (it’s about 10 minutes and goes quickly), he just linked to it.
“For years I have been concerned about the regulatory structure that governs Fannie Mae and Freddie Mac… and the sheer magnitude of these companies and the role they play in the housing market… If Congress does not act, American taxpayers will continue to be exposed to the enormous risk that Fannie Mae and Freddie Mac pose to the housing market, the overall financial system, and the economy as a whole.” —John McCain arguing for passage of the Federal Housing Enterprise Regulatory Reform Act (S. 190) which he co-sponsored in 2005.
While Sen. McCain is being pilloried by his opponent, Barack Hussein Obama, for asserting (correctly) last week that the fundamentals of most U.S. economic sectors are sound, clearly, Sen. McCain has understood for years that irresponsible lending practices for U.S. housing posed “enormous risk… to the housing market, the overall financial system, and the economy as a whole.”
While Obama was out politicking this week, ostensibly itching for a debate that he’d been avoiding all summer, McCain suspended his campaign to work with Republicans in Congress, outlining conditions for an agreement that would both protect the American taxpayer and thwart a meltdown of the U.S. economy. So, “Country First” is not just a campaign slogan…
The enormous risk that Sen. McCain warned of in 2005 has now become a financial crisis of staggering proportions. That crisis can trace its roots to Bill Clinton’s signature on legislation making it easier for minority constituents with bad credit to obtain mortgages. In 1995, he had his Treasury Secretary, Robert Rubin, rewrite the lending rules for the Community Reinvestment Act, opening the flood gates of mortgage lending to unqualified borrowers.
This legislation, in effect, applied affirmative action to the lending industry, which is to say that the current crisis is NOT a “free market failure” but the result of socially engineered financial policy by the central government. The financial markets welcomed their new customers with open arms, fueling a real estate boom across the board.
These so-called “subprime mortgages,” which were offered at variable interest rates, were widely perceived as good investments. Investors used the high-risk instruments to secure assets in other markets fueling profits for investment banks and mortgage lenders. The subprime market thus expanded rapidly and the mortgage instruments were used by other firms as collateral for investments in stocks, commodities and the like.
Unfortunately, no one questioned the pell-mell regulatory system of oversight for these transactions until large cracks appeared in our economy’s foundation, the first being the collapse of Countrywide, the nation’s largest subprime lender. Then banks and mortgage lenders large and small began downsizing, dumping assets and closing their doors. Bear Stearns filed for bankruptcy. Fannie Mae and Freddie Mac, holders of trillions of dollars in mortgages, were bailed out with 200 billion taxpayer dollars. Lehman Brothers filed for bankruptcy, and insurance giant AIG was given an $85-billion taxpayer prop to keep it solvent.
This morning, as Congress is debating whether to implement the Democrat-backed “bailout plan” or the Republican-backed “workout plan,” Washington Mutual Inc. has been seized by the Federal Deposit Insurance Corporation (FDIC) after collapsing under the weight of reams of bad mortgages. WaMu, listing $307 billion in assets, becomes the largest bank failure in U.S. history. The FDIC sold WaMu’s assets for $1.9 billion to JPMorgan Chase & Co., which bought Bear Stearns Cos. earlier this year.
(Congressional Republicans might also consider repeal of Sarbox, the Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002, which has maintained a choke hold on financial institutions and is high on the list of proximate causes for the failure of Countrywide and Bear Stearns.)
The serious economic calamity confronting our nation, and the world, is being labeled a “credit crisis.” But we are on the verge of a crisis of cascading confidence in the U.S. economy, which, in the absence of aggressive intervention, could, no, will result in a dramatic recession affecting every sector of the U.S. and, eventually, world economy.
The catastrophe looming just over the horizon is indeed that big, and we must all hope that the solution is big enough to interrupt the domino effect already underway.
The question that must be asked, however, is whether the people’s confidence in their government is sufficient to thwart this cascading effect. Far more often than not, in the inimitable words of Ronald Reagan, “Government is not the solution to our problem. Government is the problem.” Of course, the only institution big enough to address a problem of this magnitude is the government.
Perception v. Reality
Essentially, perception defines value, and the shared confidence in our perception of the value of one major sector of our economy, the housing market, has eroded dramatically.
To understand the notion of perceived value, consider all that paper we call currency. If I walk into a store and pull out one of these pieces of paper with Ben Franklin’s picture handsomely printed upon it, the store proprietor will accept that paper in trade for some of his products or services because he believes it to have intrinsic value (which it once did, when it was backed by hard assets—gold and silver). But make no mistake: The value of that piece of paper is nothing more than it is perceived to be. Thus, if the proprietor’s confidence in that perception becomes diminished, he may begin to think such a piece of paper is worth only half its face value, or perhaps nothing at all.
And if my paper is perceived to have no value, I will not be able to do commerce in this or any other store.
For two decades, our confidence in the perceived value of pieces of paper called mortgages has been growing rapidly, and because the prevailing perception has been that a house will be worth more tomorrow than it is today, financial institutions have aggressively enabled buyers to assume mortgages to purchase houses. (Actually, mortgages are now traded electronically as binary data—value that!)
However, in recent years, confidence in the perceived value of real estate has outpaced reality, as mortgage defaults have trended upward. That realization has resulted in what now has become a precipitous erosion of confidence in the value of real estate, and consequently, housing market values have collapsed in many areas of the country where they were unduly inflated.
While perception can be shaped and molded, reality is finite. The reality, in this case, is that a house and its outstanding mortgage are worth not a nickel more than a buyer is willing to and capable of paying for it.
Thus, the devaluation of mortgages has had an enormous financial impact on institutions that trade in “packaged mortgages,” and consequently, on other institutions that trade with them, and, well you get the picture. The dominos have begun to fall.
Moreover, in an effort to keep their domino standing, because of the potential that any new lending would result in additional foreclosure exposure if the housing market continues to decline, banks have tightened lending in order to preserve the capital necessary to cover the cost of a growing number of foreclosures. This constriction of the money supply extends far beyond the housing markets, as loans for business development and expansion are also drying up.
This combination of events creates the perfect economic storm, and it has dire consequences for all Americans.
Consequences of cascading confidence
Confidence in the perceived value of financial instruments, which are the foundation of our economy, is calculated minute by minute by indices such as Dow Jones, Standard and Poor’s, and other measures of financial markets. These measurements amount to investor confidence indices, polls of investor perception about the strength and stability of the economy. The stability and direction of these indices are a good indication of investor confidence.
If the indices indicate significant instability of investor confidence, that instability can cause the financial markets to collapse in a single day. (See: “Great Depression.”)
Here, it’s important to note that the vast majority of Americans are among the “investor class.” This isn’t just about “the rich.” Whether you trade millions of dollars in securities daily or like cream in your coffee, you are a shareholder in our economy.
Thus, the plan proposed by President George W. Bush and Treasury Secretary Henry Paulson—waiting for majorities in Congress to determine the details—is an effort to stabilize investor confidence by authorizing up to $700 billion in guarantees for institutions holding mortgages. In effect, this will relieve lenders of liability for mortgages considered to be at risk of default—about five percent of all mortgages.
It is hoped that Republicans can succeed in crafting legislation that is more workout than bailout, the former requiring much more market accountability, as proposed by Sen. McCain and former House Speaker Newt Gingrich.
President Bush addressed the nation Wednesday evening with a concise explanation of the current crisis:
“This is an extraordinary period for America’s economy. Over the past few weeks, many Americans have felt anxiety about their finances and their future. I understand their worry and their frustration. We’ve seen triple-digit swings in the stock market. Major financial institutions have teetered on the edge of collapse, and some have failed. As uncertainty has grown, many banks have restricted lending. Credit markets have frozen. And families and businesses have found it harder to borrow money. We’re in the midst of a serious financial crisis… So I’ve proposed that the federal government reduce the risk posed by these troubled assets, and supply urgently needed money so banks and other financial institutions can avoid collapse and resume lending. This rescue effort is not aimed at preserving any individual company or industry—it is aimed at preserving America’s overall economy. It will help American consumers and businesses get credit to meet their daily needs and create jobs. And it will help send a signal to markets around the world that America’s financial system is back on track.”
What about a free-market solution?
I concur, of course, with the principled objections from free-market advocates and hope that free-market solutions will be re-implemented in conjunction with the necessary mortgage backup. If not, the cure may be worse than the disease. After all, it was the suspension of free-market principles that got us into this mess.
But I agree with President Bush’s comments regarding the necessity of intervention: “I’m a strong believer in free enterprise. So my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course. But these are not normal circumstances. The market is not functioning properly. There’s been a widespread loss of confidence. And major sectors of America’s financial system are at risk of shutting down.”
Further, he is correct in this assessment: “More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically. And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.”
It is worth noting that $700 billion is a bargain compared to the implications for taxpayers if the economy spirals into a severe recession—or worse.
Can any of this colossal expense be recovered?
Fortunately, there are real assets backing up these mortgages—bricks and mortar, and the land upon which the foundations rest—but this is no “deal for taxpayers.”
While much of this mortgage backing may be recovered, as was the case with the savings and loan bailout of 1989, to suggest that the “taxpayers will be paid back” is ludicrous.
Congress is going to serve as the “watchdog” over the dispensing and recovery of these funds? Can you say, “fox in the henhouse”?
Even if Congress sets up a “trust fund” in order to use recovered funds to pay down the debt incurred to back financial institutions, we should consider that “lockbox” to be as safe as the Social Security Trust Fund lockbox. Every dime paid into Social Security has been spent on government programs, leaving that fund with a bunch of IOUs.
No doubt, every dime recovered from the private sector will be treated as revenue to expand government programs, and the debt will be left on the books.
To pay for the bailout, Democrats are sure to demand higher taxes from “the rich Wall Street fat cats who got us into this mess.” While this mess clearly ended on Wall Street, it didn’t start there, but, undeterred, the Democrats will always bank on this observation from George Bernard Shaw: “A government which robs Peter to pay Paul can always depend on the support of Paul.”
And, of course, if the current plan to restore economic confidence does not succeed, you know the Demos have “Plan B.” Don’t ask…
What role have politicians played?
One staple of the Democrats’ political playbook is the use of scare tactics to rally constituencies. Indeed, Obama and other Demos have been dishing out a steady stream of dire economic rhetoric in order to keep their constituents in line. Undoubtedly, all that economic hyperbole has influenced public perception of our economy and confidence in our economy. High on the list of issues President Bush discussed with candidates McCain and Obama Thursday was a request that they (read: “Obama”) cease and desist using the economic problems as political fodder.
It is our hope that the candidates will, indeed, arrive for debate in Oxford, Mississippi, this evening and begin the debate with a unified statement on economic recovery; then Sen. McCain can proceed to eviscerate Obama on foreign policy.
Footnote: There are significant, albeit unspoken, national security implications of a precipitous economic decline in the U.S. Where the our economy goes, the world economy follows, and their will be significant national security consequences. For example, if China’s economy contracts more rapidly than at present, keeping pace with U.S. economic decline, the consequences will likely be some significant internal and external “mischief” scripted by the Communist Party. As for India and Pakistan…you get the picture.
Tomorrow the House votes on the measure, and I truly hope that this doesn’t become good money after bad. Mark Alexander is correct that there are tangible assets being discussed here (95% of the 5% of houses in question have some sort of value to them, perhaps its not nearly the amount owed but there is value) but I believe he’s also correct in saying that we’re not going to see any payback to us in whatever those assets eventually are sold for.
The post I have for lunchtime tomorrow is slightly dated because of this new financial situation but the study I cite is still valid for the points I wish to make.
