Wednesday, September 24, 2008

Time for Plain Truths, Serious Questions, and Careful Consideration

In his address to the nation about its financial crisis, the President avoided mentioning that the crisis was created largely -- and probably primarily -- by the government itself.

That is important because the $700 billion plus bailout proposal is seriously and probably fatally flawed in that it would rely on the same entity that created the problem to solve it.

Those interested in the details of the governmental ineptitude and corruption that has led the nation to the brink of a real financial abyss can find pretty good and relatively brief accounts of the relevant policies and events here and at this other location. For present purposes though, one needs only to understand certain basic underlying facts:

* First, the Community Reinvestment Act, a creation of the Carter Administration, and its enforcement by financial regulators compelled financial institutions to make mortgage loans on terms that ignored sound bank practices developed over centuries, to make such loans to individuals who were not credit worth, and on properties that often were worth less or little more than the amounts of the loans they purportedly secured. The Clinton Administration subsequently increased the pressures on the financial institutions to conduct business in this way

* Second, the financial institutions acceded to these pressures because Fannie Mae and Freddie Mac could be counted on to take the resulting subprime loans off their books. Home ownership for everyone -- irrespective of whether they had the ability or responsibility to pay for them -- was the mission of these "government sponsored enterprises."

* Third, the unexpressed mission of Fannie and Freddie was to distribute large amounts of what has turned out to be taxpayer money to members of the nation's political elites and their favorite causes, friends, and supporters. The details of this largesse and of the millions of dollars that the political insiders who ran Fannie and Freddie got is a story for another day, but it explains why the many warnings of the unsound business and financial practices and the dangers that they posed were unheeded and swept under the political rug.

These, in a nutshell, turned the housing and mortgage businesses into a government sponsored Ponzi scheme. The inevitable bursting of the bubble has now occurred with devastating results. By now it also should be clear to all but the most ideologically committed statists that the crisis was created not by too little regulation by government but by its subversion of well established sound banking business practices.

The politicians are terrified that a financial collapse will lead to public focus on how and why they caused it. Therefore they are scurrying to use taxpayer dollars for a bailout that they say -- and perhaps even hope -- will "solve" the problem. It won't. At best it will do only what politicians always seek to do when a problem arises -- kick it down the road, into the future when they no longer will be held to account for it and another generation will have to figure out what to do.

Before we get stampeded into going along with this, we ought to insist on getting answers to a few serious questions:

1. From where is the money to fund the proposed bailout going to come? The government doesn't have it so its going to have to be either borrowed or just printed. Either course involves expenses that are going to increase the total bailout cost to something well in excess of a trillion dollars.

2. How are the bailout funds to be spent? The funds are to be used to buy the mortgage loans from financial institutions that are being dragged down by having the loans on their books. But at what price are these transactions to take place? The loans are not marketable so they have no ascertainable value. The prices are going to have to be determined arbitrarily in negotiations between the parties. One of the negotiators at each table will be the individual financial institution seeking the highest price it can get. The other negotiating party will be a government entity charged not with getting the lowest possible price but, instead, with propping up the financial institution. Nobody representing the taxpayers will be at the table.

3. If, as the foregoing suggests is likely to be the case, the government pays more for the loans than they would be worth in a transaction between ready, willing and able buyers, how do the government and the taxpayers come out whole in light of the costs of the whole thing -- the aggregate of the loan purchase prices, the costs mentioned in the foregoing paragraph, and the governmental entity's operating expenses that are not going to be insignificant?

The savings and loan debacle two decades ago should have taught us that any asset loses between 10% and 25% of its value when it comes into the hands of a financial institution through foreclosure, and up to 50% of if and when a governmental entity is involved. So the prospects of the government and the taxpayers coming out unscathed are pretty bleak no matter what proponents of the bailout are saying.

Recoveries from unhindered financial failures normally take place as quickly as the failures occur. When failures are artificially avoided, the troubled entities may be kept alive for extended periods but their lingering existences ultimately will reach nadirs equivalent to the failures, and recovery periods normally will be commensurately extended.

This time, however, the circumstances are not normal. The abyss is truly terrifying. It could economically devastate and impoverish the nation. I don't pretend to have an immediate answer or even a good suggestion as to how to proceed. Finding an answer will require careful thought . . . more than has been devoted to it by our "leaders" to date. We probably have very little time to reach and implement a decision . . . unless, of course, the decision is that doing nothing is the wisest course.

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