The Big Crisis

One of the most disturbing things about the massive bailout under discussion this week is that we in the general public have no way of checking whether it is necessary. We have the word of demonstrably other than fully trustworthy people on Wall Street and in Washington, unaccompanied by data or explanations that would allow real consideration of the question. We have endorsements from generally reliable people such as Warren Buffet and Jack Welch, but we do not have the facts. I realize the situation is complex, but the facts could still be laid out plainly in reference material and then summarized in documents of varying levels of depth and sophistication. There is a tool called the internet that is a fine device for communications of that sort. Instead we are getting dire warnings and grim-faced politicians and panicky media twits trying to create a stampede. That is worrisome. This thing is clearly being log rolled. Generally, when you are sure of your facts and have evidence to back you up, you don’t need to log roll. (President Roosevelt could let the facts speak for themselves after Pearl Harbor. President Johnson needed to manufacture urgency over the Gulf of Tonkin.) I hope the bailout does some good, but the way it is being sold surely makes me wonder.

There has been a great deal of odd commentary on the events in financial markets in the last three weeks. I think the most absurd are the statements from leftists and some left-leaning “business” web sites that the recent difficulties are a failure of capitalism and the free market brought on by a laissez faire market in mortgages. Whatever else Fannie Mae and Freddie Mac, the two biggest players in the mortgage world, might have been, they were not free market organizations . Fannie and Freddie were quasi-governmental companies created by the federal government to deal in mortgages and mortgage securities. Their separate legal status and Washington’s only “implicit” guaranteeing of their obligations allowed the federal government to hide some of its actual liabilities in off the books entities – a practice sometimes considered criminal when engaged in by private corporations. (There must be a former Enron executive or two sitting in a jailhouse somewhere and appreciating the irony of all this.) Lately of course we have seen that when push came to shove, the guarantee was quickly made explicit with taxpayers right on the hook. Fannie and Freddie were always political organizations, reacting more to political pressure from Congress, local politicians, home builders, realtors, community organizers, developers, and others than to the requirements of prudent business. Whenever Fannie or Freddie said something, you could bet that somewhere a politician’s lips were moving. The screwed up world of mortgage securities and investing was nothing like a free market, and its present troubles are not a failure of capitalism or a reason for a more strangling government.

However, contrary to the opinions of some conservatives who blame only the politicians, there is certainly failure of a bunch of capitalists. Fannie and Freddie were not the only players in the mortgage industry, and there were plenty of others out there buying and trading securities backed by mortgages made to God knows who under almost nonexistent underwriting standards. It seems as though they thought that, given that the price of houses was going up by double digit percentages every year for a while, the quality of the collateral made the quality of the borrower immaterial. It makes you wonders whether anyone at the elite business schools bothers to teach their MBA s that linear regressions based on a handful of data points do not infallibly predict the future. (It even makes you wonder if MBAs have ever heard the old adages about nothing going up forever and no ladder reaching the sky.)

In a rational world, people and institutions that made these purchases and trades would be left to sink or swim with them, and the rest of us would go about our business, puzzled by it all perhaps, but largely unharmed. However, the world of international finance seems to be far from rational, and through various spaghetti bowls of intertwined bunny trails, these problems are said eventually to have become threats to money market funds and the entire banking system. So the government says it finds it necessary to step in and unload the bad paper on the only sap dumb and docile enough to take it and keep plugging ahead – the American taxpayer. This is of course morally distasteful, even if the threat to the financial system makes it necessary. People who behaved badly will be rewarded, and people who behaved well will be punished. Irresponsible former executives of failed financial outfits will continue to live well on the bonuses they made from puffing up earnings by putting their firms at risk. Deadbeats who put nothing down and are not making the payments on “their” houses will get a few more months of free rent during foreclosure and forbearance (or maybe even government subsidies to avoid foreclosure.) Gamblers , scoundrels, and reckless goofballs who made bad bets on mortgage securities will avoid tar and feathers and be made at least partially whole. Prudent, honest, debt-honoring, bill-paying taxpayers will get hosed – through inflation and opportunity cost and credit dislocations even if the bailouts ultimately fund themselves. In the current cliché, Wall Street will be dumping its garbage onto Main Street. The rubes may have to cut back on their trips to the Red Lobster or the local steak joint for a while, but the better restaurants in Georgetown and Manhattan should continue to see brisk business.

As to the future, one thing seems clear. We don’t want to do this again. The government should draw a clear, explicit, and publicly stated line on what it is guaranteeing and what it is not and stick to it. It should exercise a reasonable and thorough oversight over the entities and objects it guarantees, just as any prudent person guaranteeing someone else’s obligations would be expected to do. It should place a huge caveat emptor on those things it does not guarantee. People investing in money market funds should be told they are on their own as far as federal bailouts are concerned, so that their fear and diligence will impose conservative practices on those managing the funds. The same should be true for the customers of brokers and insurance companies. We need to stop socializing losses and subsidizing risk. Then if some guy on Wall Street wants to over-leverage securities based on loans to winos collateralized by empty bottles of muscatel, let him.