Sunday, September 21, 2008

Is the Bailout a Blunder?

Help me out here.  

The government is about to spend $700 billion of our tax dollars to bail out the finance companies and the people who took out no-qualification loans to hide their credit-unworthiness.

The rationale for this largest bailout in U.S. history? That it will stimulate banks to lend again, thereby boosting our economy.

But isn't that just going to reward those borrowers and lenders for their greed and dishonesty and make them more likely to revert back to their irresponsible behavior?

Sure, the bailout will be a short-term boost to the economy, but it will be like a heroin shot: it feels good briefly but soon, you're much worse off. 

An economy should not be based on liberal lending. It should be based on people and businesses buying for cash, and only when truly necessary, on credit when both the investment and the borrower are truly credit-worthy.  Of course, such conservative financial practices will lead to a slower-growing economy, but it will be an economy build on a foundation of bricks, not a house of cards. 

Maybe what's needed is not government bailouts that prop up that house of cards, but the old-fashioned self-discipline needed to build a sturdy home.

What am I not understanding?


Anonymous said...

What you haven't brought up is that most of Americans are not accustomed to a slower-growing economy that very likely would be better off in the long term. We are accustomed to instant gratification. We all want what we want when we want it.

You haven't brought up that because the government is largely a liberal-controlled one, the prevailing view is that the bigger government is a better one. The more they can bail out, the more the people will be dependent on them. As you said, it's like the heroin shot, but you forgot one part there, too: soon you need and want more. Then we will be where a liberal government wants us.

You haven't brought up something I've heard several times, but have yet to verify: the government may have forced banks to make these bad loans through something called the Community Reinvestment Act. The government screwed up, and now they want to fix it. Sounds like a bad idea to me.

Your idea is a good one. And it probably will never happen.

Charles said...

I believe the hubris of the current administration is a major factor. They don't want to leave office with the embarrassment of a ruined economy added to their already miserable legacy.

From one of my previous comments: According to The Economist, 'By 2007 financial services were making 40% of America's corporate profits—while employing only 5% of its private-sector workers.'

You can bet that they used every loophole available to them to avoid paying taxes on those profits. Even when their companies tank, the CEOs walk away with tens of millions.

Why should we, the taxpayers, bail them out?

What happened to all of that free market blather about the 'invisible hand' and the markets taking care of themselves?

I say let them fail, even if it means another depression. As Ben Franklin observed, “The things which hurt, instruct.”

Anonymous said...


You are exactly right. Govt bailouts are known as "moral hazard" by Economists. It encourages and supports foolish behavior.

Like downing some alcohol to medicate a hangover, it increases the liklihood of greater problems in the long-term.

As usual, the world would be better off if the Govt just butted out.

Dr. Michael R. Edelstein

Christien said...

We had this discussion in my MBA Global Strategies Class on Saturday. It was quite interesting to hear from someone who studies this stuff for a living.

Without getting into the politics of it, the people that were involved with derivatives are going in danger of facing serious prosecution. The tax dollars are being used to buy (instead of bail) out these companies. Point is that the return will be a nice one when it rebounds.

What is most annoying to me is that had this just been real estate, then it would be fine; it's all the other industries that got blanketed underneath mortgages and HELOCs that really get to me. It's companies feeding off ignorance; but it's also consumers not taking responsibility for themselves.

Anonymous said...

The bailout itself might or might not be okay. As of now, the borrowers it protects are not the individuals holding mortgages with rates reset to high levels, by the way. It protects businesses who used bundles of those mortgages as security for other loans - both those who extended and received the loans based on the ever-increasing numbers of mortgages.

When you talk about 'liberal lending' I get the impression that you're talking about lending to individuals. What's remarkable is that the business to business lending, which is the really important lending, has been crippled by what are actually low rates of default.
Historically high, but it's not like 10% of all mortgages are off the books now.
(one source says it's about 3%. Of course, as rates reset if refinancing is unavailable, that number will jump.)
No one knows what the bonds full of US mortgages are looking like. People are afraid of them now, and no longer willing to lend against them at all.

The real risk in doing nothing is that as of now large amounts of US capital comes from overseas. If we do nothing, foreign investors are more or less forced to quickly liquidate at least parts of their holdings and invest them in strong economies.

A fast or public drawdown would have a huge impact.

The important lending for growth (Bay Area real estate market excepted) isn't banks to consumers, but business to business.

One option to address the mortgage issue would be to make a condition of the bailout that the ARM mortgages are all to be reset as 30 year fixed notes at the initial payment rate.

Most of the end customers could keep making those payments. Many were promised they could refinance and keep those low payments to entice them into taking on the debt. If the loans were profitable enough to make to begin with, then you would have your lower profit, lower growth future. If the loans were loss leaders, well, there would be your fiscal punishment to the folks who originated the loans.

What really ticked me off yesterday morning was Paulson's answer to an obvious question: if the taxpayers are asked to foot this money to stabilize banking, and banking stabilizes and rebounds, will they share in the profits?

The answer - I kid you not - was to treat such a suggestion as making the bailout a punitive action.

That peeves me a great deal. It should not be seen as a bailout - a giveway, a handout - but as public investment in the sector, with an expectation of public return from the sector.

Not indirect, trickle-down return, like Tang from the space program. Real return, with accountants paying attention and all the tools that wall street has at its disposal to ensure investors are paid.

To have these folks able to call profit sharing as a precondition for public investment "punitive" is arrogance at a level that amazes me.,2933,425712,00.html

It is unfortunate that Chris Wallace conflated two questions:
- limit executive salaries
- public share in rebounding profits

in his question; the 'punitive' response may have been a defensive response to the idea of looking again at pay for CEOs in the sector. I read the conflation in the answer as deliberate and ruling out profit sharing as well as salary controls.

Paulson is now Secretary of the Treasury, but he spent most of his professional life at Goldman Sachs.

Marty Nemko said...

Short-term, of course, international investors will keep their investments in the U.S. if the government props the finance companies up, but, again, that's a short-term fix.

The real solution is to allow the companies that made or bought bad loans to go under. The remaining companies, made even more vigilant about maintaining reasonable lending and mortgage-buying criteria, will be more attractive to international investors than they were before this debacle.

Anonymous said...

As conceived, this is plan fails the smell test. It creates a powerful new agency in the executive branch subject by statute to NO oversight by anyone.

This is the language in play yesterday; I don't know if it's still in play. I hope people will try to get Feinstein and Boxer and their Congressional rep to at a minimum strike this language.

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Anonymous said...

It looks like the latest incarnation of the bailout just failed in the House. And the stock markets are not happy about that. They were falling even before the House votes, anticipating failure.

I have a feeling that Washington will not give up on this until they get their way.

I know you're not in favor of this bailout, Mr. Nemko, but I'd like you to assume for a minute that you support it. What do you think would have to happen for the public to get behind the bailout?

Marty Nemko said...

I think if the public got "stock" for their $700 billion, they MIGHT get behind it.

I do believe, however, that ultimately the short-term pain of not bailing the financial industry out will be outweighed by the benefits derived from showing all the other companies and individuals that they need to behave responsibly or suffer the consequences.