Tuesday, September 23, 2008

Why a Bailout?

Now I’m not an economist or a financial wiz. I don’t have some “inside” story or scoop on the current financial situation. I’m only a concerned citizen-taxpayer watching the market, the mortgage “crisis,” and the failure of large investment companies. And I’m wondering why? Why has there been a failure in the mortgage industry? Why are these large investment banks failing? But most of all, why is it the responsibility of the American taxpayer to bail them out? Potentially to the tune of $700 Billion!

Before we decide how to resolve the crisis, isn’t it important to know what contributed to it? In this election year, there’s bound to be a lot of partisan finger-pointing; and it looks like there’s sufficient blame on both sides to satisfy the most rabid political partisan. But who cares who or what is to blame. The real question is why? If we identify why this “crisis” happened and what contributed to it, we could better identify how to resolve it and, most of all, how to prevent it from happening again.

The Democrats, and those supporting an Obama presidency, claim it was deregulation of the banking and mortgage industries. For example, the New York Times said in a Saturday editorial that, “This crisis is the result of a willful and systematic failure by the government to regulate and monitor the activities of bankers, lenders, hedge funds, insurers and other market players.” Those believers in big government and bureaucratic oversight claim that the 1999 Gramm-Leach-Bliley bank deregulation bill (by the way a bill sponsored by former-Senator Phil Gramm, who was a McCain advisor) is responsible for the financial meltdown.

The Gramm-Leach-Bliley bill eliminated 60-years of government bank regulation, and allowed commercial and investment banks to consolidate by repealing the Glass-Steagall Act that prevented banks from offering other financial services, like insurance, investments, or commercial banking. The bill was necessary to allow US banks to compete on the world-market, particularly with European banks who could offer “universal banking” to their customers. It’s interesting to note that the Gramm-Leach-Bliley bill was enthusiastically endorsed by Democrats, (including Senator Biden), passed the Senate with 90 of 100 votes, and was signed into law by President Clinton. So was it the root of this financial-crisis evil, as many Democrat pundits would have us believe? Probably not.

Despite the partisan desires of “big government” advocates to point to bank deregulation and Senator Gramm as the “ground zero” of the current financial troubles, deregulation is not the major contributing factor. Bank deregulation simply allowed financial service companies, like banks, to diversify their businesses. Diversification is a good thing, isn’t it? At least that’s what they tell us small investors. In fact, without the deregulation we might have had more taxpayer bailouts of financial institutions. Under the old regulations, some of the bigger, more diversified entities would not have been able to purchase troubled companies. J.P. Morgan would not have been able to take over Bear Stearns, for example. Most of the failing firms have been non-diversified commercial banks or purely investment banks.

So deregulation, per se, isn’t necessarily the root of the problem. Instead, the major contributor (it is too simplistic to say that there is a single failure that caused this mess) seems to be the push to provide high-risk mortgages to people who would not otherwise be able to buy their own home. Now, I’m all for home ownership, and I like the idea of affordable housing. Someone who has a stake in the community, in the form of a home, is more likely to be a responsible citizen. But, it looks to me like advocates for affordable housing lost track with reality.

The Community Reinvestment Act, a piece of legislation heavily backed by Democrats, permitted community organizers (like ACORN) to pressure banks to make more mortgage dollars available to folks that didn’t have the assets or credit to otherwise qualify for a home loan. The Community Reinvestment Act permits the FDIC and other banking regulators to punish banks who don’t lend money to low-income and minorities. For example, community organizers who didn’t like the level at which a bank was providing loans, or didn’t like the bank’s response to political demands, could block mergers and acquisitions that would help the bank’s assets grow. Subprime mortgages are the result; money lent to people who do not have the credit, assets, income, or down payment to qualify for a normal mortgage. Of course, banks got on the bandwagon and found that subprime mortgages were a money-maker, as long as the real estate market was hot. After all, if the borrower couldn’t pay on the mortgage, the home could be sold and the mortgage money recouped. But when the market slowed, the bubble burst and banks were left holding lots of bad paper.

Added to the problem created by the Community Reinvestment Act and the explosion of subprime mortgages, there was a political component involved in creating the credit-friendly environment that contributed to the current financial mess. Politics created Fannie Mae and Freddie Mac. Politics allowed them to dominate the mortgage market. Politics allowed these two entities to shift the risk of subprime mortgages to the US taxpayer. In 2005, Democrats opposed, on a party-line vote, a bill to more strictly regulate Fannie Mae and Freddie Mac to prevent their more questionable loans to “underserved” populations (a code-term for low-income or no-asset borrowers). It’s interesting to note that the two mortgage corporations were managed by Democrat power-brokers, like Jamie Gorelick who made multi-millions of dollars when she left for bigger and better things; like advising Senator Obama.

Now, on principle I don’t like big government or over-regulation. There are things that government does well, like protect us from threats, but government shouldn’t be in the business of running businesses. Although I don’t like government intrusion into the free market, some oversight may be necessary. It’s interesting that Senator McCain saw a potential problem as early as 2006. He said, “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.” Investment is risk. Businesses that invest do so by taking calculated risks. The key to government oversight is identifying just how much regulation is necessary to permit investment, and risk-taking, without either over-regulating and stifling business or under-regulating and permitting the possibility of financial collapse. Like everything else in life, balance is essential here.

So where does that leave the proposed bail-out plan? Good question. I’m concerned over the “need for speed.” Why do we need to move so fact that the details of the plan are not readily transparent to anyone without a Ph.D. in economics? Why are we putting Billions of dollars in the hands of one man and telling him to “fix it.” Why do we need to accede to the Democrat’s demands that we include a plan to permit judges to restructure individual mortgages for bankrupt homeowners, or worse subsidize them with taxpayer money? Why do we need to add other “toxic assets” to the plan, like bad credit card debt? I say we should slow down a bit, analyze the problem, and fix it; not put a band-aid on it and hope it will heal.


James said...

Actually, President Bush was warning about overextension at Fannie Mae and Freddie Mac as early as 2001.

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