Greg and Matt had some excellent posts yesterday on the bailout. Matt described how we got into this mess and Greg outlined the issues in dispute. Today I want to talk about where we go from here.
I do not believe that a Congressional bailout is necessary to avert a catastrophe nor do I believe that it will effectively stop the economic damage that remains to be inflicted. All that Congress is likely to do is shift the cost of the economic damage to a broader pool and hinder future growth with unwise regulations and new programs.
Despite scare-mongering to rush a bill through Congress, the reality is that the current turmoil is a normal popping of a speculative bubble fueled by Fannie and Freddie (government) guarantees on mortgages and artificially low Federal Reserve interest rates. No matter what Congress does, a fair number of people are in homes they cannot afford and a number of banks own mortgages that will never be repaid.
Shifting those bad mortgage securities from financial institutions to the government balance sheet changes nothing. Someone is going to have to eat those losses. If the bailout pays the banks above the market value for those securities, then the taxpayers will bear those losses, either in the form of raised taxes or higher inflation. If the bailout pays market value, then the banks will not have any additional capital on their books and they will be no better off. Either way, the economic damage of these bad mortgage securities on the economy will remain the same.
The only way that the government bailout could help is if the government pays above market value for the mortgages, strengthening bank balance sheets, but the amount that is paid turns out to be less than the intrinsic value of those securities, so the mortgages can later be resold without a loss to taxpayers. But there is no reason to believe that the market value of those securities is less than their intrinsic value or that the government knows what the true intrinsic value of those securities is and will pay less than that amount.
To believe the case for the bailout you would have to believe that the government is the smartest hedge fund out there. Keep in mind, there are potential buyers with capital willing to buy the bad mortgage securities, but not at a price that banks are currently willing to sell. The banks don’t want to sell for the price that buyers would buy because they would have to write down the losses and be forced to raise capital themselves, which they are currently unable to do easily. Instead, the banks are holding on, hoping that the government will pay them a higher price or that the market for these mortgages will somehow improve.
Instead of a bailout we should allow the market to work out these losses. The government cannot stop the losses; it can only move them around. And it can do some extra damage in the process, such as imposing new regulations and introducing moral hazard for future financial mistakes.
Despite elite opinion in the media and from many on Wall Street that a bailout is necessary, the passing of each day without a catastrophe demonstrates otherwise. Sure, the markets have been volatile, but short-term market movements don’t indicate the long-term wisdom of policies.
And let’s put things in perspective. The economy grew last quarter. Credit-worthy consumers can still get mortgages, car loans, and business loans. The stock market is still higher than where it was a decade ago. Things are painful but they are not catastrophic.
As Peter Robinson over at National Review’s The Corner says, “it has become impossible—simply impossible—to dismiss opponents of the bailout as mere hayseeds and (what to a lot of people amounts to the same thing) House Republicans.” And a group of 200 academic economists from all ends of the political spectrum have come out against the bailout.
The hardest thing to do in a moment of crisis is to do nothing. But in this case nothing is probably exactly what we need.
Update: Alan Reynolds has a great piece at Forbes in which he documents that consumer lending has not declined. He writes:
“On CNBC Monday, Democrat majority leader Steny Hoyer said the objective of the rescue package is to “unlock the credit” for consumers and business. And a Wall Street Journal editorial writer told CNBC, “Until we get the banks lending again, the economy will continue to contract.”
Such alarming comments never mention any facts. Why not? As Neil Cavuto recently noted on Fox Business News, the Fed reports bank loans every week.
U.S. Bank Loans (Billions of Dollars)
| Week Ending Wednesday | Business (Commercial & Industrial) | Real Estate | Consumer | Interbank (Other Than Fed Funds) |
| Aug. 13 | 1,514.5 | 3,639.4 | 841.6 | 77.6 |
| Aug. 20 | 1,509.1 | 3,653.3 | 845.6 | 75.3 |
| Aug. 27 | 1,515.1 | 3,650.6 | 848.0 | 76.3 |
| Sept. 3 | 1,514.8 | 3,631.3 | 846.8 | 77.2 |
| Sept. 10 | 1,512.0 | 3,630.3 | 850.5 | 74.0 |
| Sept. 17 | 1,531.2 | 3,625.2 | 847.1 | 72.3 |
| Year Ago: | ||||
| Aug. 2007 | 1,311.1 | 3,498.4 | 774.0 | 82.7 |
Federal Reserve Board, “Asset and Liabilities of Commercial Banks in the United States” (H.8).
In August, bank loans to consumers were 9.5% higher than they were a year earlier–the fastest increase since 2004. The year-to-year increase in consumer and industrial loans was 15.5%, down only slightly from a recent record high of 21.6% in March. Real estate loans were up 4.1% for the 12-month period ending this August–flat lately, but not down…
Contrary to many comments, consumer and industrial loans actually increased in the latest week. Troubled giant banks have cut back on lending, but smaller banks have picked up the slack. Consumer and real estate loans dipped insignificantly through Sept. 17, remaining much higher than they were a year earlier. “
Jay P. Greene's Blog 
Jay, I will assert again what I said on Matt’s post concerning FNM/FRE
FNM/FRE played a small role by not keeping enough capital on hand, but the sub-prime mess is not their game, but they were prohibited by law from extending sub-prime. More than 60% of the bad mortgages in the country were extended by virtually unregulated independent brokers. Investment banks then, on their own capitalistic free will, invested in securities about which they had no real information or understanding.
The problems at Bear Stearns, Leyman Bros,, Merrill Lynch, Countrywide, IndyBank, etc. had little or nothing to do with FNM/FRE. Additionally, the meltdown at AIG is even further from a government caused problem, having almost nothing to do with FNM/FRE.
I will concur that the Fed kept interest rates too low for too long, but the administration supported that agenda.
This credit crunch is a result of an infinite number of bad decisions from bankers, brokers, and investors. None of them were forced into these decisions by government policy, nor inhibited by such. From the people who carry too much on their Mastercard and an unmanageable ARM to people who don’t understand derivatives investing them caused this mess.
We don’t have to agree on the extent to which FNM/FRE shared responsibility with individual lenders to agree that a bailout won’t work and isn’t necessary.
As I said in my post, I have no opinion on these matters. Here’s why.
Jay makes a powerful case that there’s no credit crunch. But then I surf over to David Warren, who says in his latest column:
The various credit crises we face are real, notwithstanding the facetiousness with which I began this column. Anyone who doubts this should look into shipping news. All over the world, ships carrying vital commodities are failing to load and sail because banks are currently too shy to extend modest, conventional credit instruments. The cumulative effect of that, and much else like that, will soon bring home the reality of failing banks even to those who keep their money in pillows.
http://www.davidwarrenonline.com/index.php?id=925
Are there cargo ships lined up around the world unable to sail? (Well, I sure hope they’re unable to “sail,” since it would be silly to put sails on a modern cargo freighter.) David Warren says so, and others whose opinion I respect have said similar things. But a lot of bigshot economists oppose the bailout and say there’s no crisis. Presumably they have access to the same data on shipping. Who’s right?
I’m glad it’s not my job to decide.
That is what I’ve been hearing…lending is still strong in the commercial and industrial sector (non housing related).
I suspect a bailout will only draw money away from these working institutions and put it back in the hands of the very people who just got destroying billions of dollars worth of wealth thanks to their risky practices.
Game…set…match! That lending data clinches the argument against the bailout.
Excuse me: “Those” lending data.
I’ve got my eye on you, Ladner.
Curses! Foiled again!
You are watching the collapse of credit markets throughout the world. After the next few months you will be singing a different song if financial institutions are left on their own to stop the bleeding.
Wall Street and Main Street are not separate worlds as some dreamers would believe. What happens on one dramatically affects the other.
You can play the blame game….. woulda, coulda, shoulda…until the cows come home. It will not solve our present problems. Without outside intervention, our economy stands an excellent chance of becoming a corpse by Christmas. That should be worth a couple of academic publications.
Cody-
Why then is there no evidence of this in the lending statistics? Why is Ditech.com still running radio ads offering subprime mortgages?
How do you like the free-fall the market is in? Investors believe intervention came too little, too late….and too tied up in red tape. And, baby, they are bailing big time. Once the DJA broke through 10,000…it’s Katie bar the door.
Take our $700 billion rescue bill (plus another billion+ of pet project spending) for example. It is so full of “oversight” that Secty. Paulson may be able to buy a Nathan’s hot dog within the next three months….maybe. After conducting suitable hearings, Congress will let him know if he can have it with or without mustard.
Uh . . . either that, or investors never believed in the bailout in the first place. How do you know which it is?
The original bill was three pages long and gave Paulson essentially unlimited power. If the second version has too much oversight (and I have no idea whether it does), maybe he should have come to the table with a more reasonable proposal and been willing to work with Congress instead of trying to bully everyone into handing him a blank check.
Mind you, I continue to have no opinion on the merits of the bailout itself. But if the continued decline of the markets has any probative value, it’s probably against the bailout rather than for it. I mean, if the normal process of legislative compromise was enough to render the bailout so ineffective that markets reacted negatively rather than positively to its passage, then the bailout was probably always too fragile to do any good.
If you are interested, here is a site that summarizes the rescue/bailout (take your pick…I like rescue) legislation… http://shrinkify.com/ef4 A copy of the legislation itself along with descriptive commentary is available on the site.
The bill grew from Secty. Paulson’s original three-page proposal to 451 pages at passage. The legislation is officially known as the Emergency Economic Stabilization Act of 2008, or EESA.
The Congress was stunned at the market’s instantaneous, extremely negative reaction to the House’s first rejection of the bill. Investors’ initial euphorea over rapid intervention by Paulson gave way to grave doubts about anything Congress would produce. When EESA passed later in the week, there was a very brief market spurt of optimism which gave way almost immediately to the start of a massive no-confidence vote we see in play now.
I think you would agree we are passed the point of wondering whether investors believed any kind of intervention…Paulson’s or Congress’s or any other institution’s…would have ever realistically worked. We have what we have, a free-falling market characterized by near-panic selling.
On the contrary, I don’t think we are past the point of wondering whether investors ever believed in any kind of intervention. When the first bill failed and the markets tanked, this was taken by some as evidence that the bailout was desperately needed to save us from a panic, by others as evidence that investors had hoped to profit from the bailout but were now facing up to the possibility that they might actually have to take the losses that their bad investment decisions had earned them. Then, when the second bill passed and the markets tanked again, this was taken by some (including yourself) as evidence that the second bill was too little too late, and by others as evidence that the bailout wasn’t restoring investor confidence because investors aren’t fooled by Washington gimmickry, and it was therefore never going to be effective in the first place.
I don’t know which storyline is true, but surely it matters which?
The law is called the “Stabilization Act,” so everything must be stabilized. It would be against the law for things not to be stabilized. And tomorrow the Congress might pass a law making everyone under 6 feet tall 6 feet tall. No one can be shorter.
There may be certain economic realities that the law cannot change. The reality is that a bunch of people are in homes they cannot afford and banks own a bunch of mortgages that will never be repaid. Someone will have to eat these losses and no law can change that reality.