Tuesday, September 30, 2008

Wall Street Bailout

I don't know what to make of the meltdown in the financial industry and the government's efforts to fix it.

It seems the basic problem is that the financial industry - led apparently by the government, in particular Congressman Barney Frank, and the Wall St. investment banks - made an extraordinary number of really bad mortgage loans.

Most of the country had no idea what was going on. I heard an inkling from my sister, who sells real estate. She told me her company (at the time) was pushing new contruction houses on first-time home buyers who didn't have the money to buy a house. She said they were giving loans - many under various federal "guarantee" programs - to buyers who couldn't come up with even $100 for a down payment. It was literally "just sign here and the house is yours". She told me that they could get a mortgage for literally anyone, and were literally doing so.

At the time I thought this was odd, and a bad idea, but I had no idea of the scope of the problem. Apparently her situation was typical of the real estate market across the country, and the major investment banks were putting a huge percentage of the country's financial wealth into these transparently bad loans.

In retrospect, this whole problem (of deliberately giving mortgage loans to people who obviously couldn't pay) seems obvious, and I think it seemed obvious at the time to ordinary sane people who knew about it. Various demonstrably smart people like Warren Buffett warned against it, and were ignored.

I think perhaps the mortgage companies thought that when the homeowners couldn't pay, they would simply foreclose on property that had since appreciated, and they'd make more money. The problem with that theory was that all these dumb mortage loans created a huge real estate bubble, which meant these people who couldn't pay their loans owed a lot more money than the houses were worth.

In simple terms, the whole economy was in this artificial bubble created by banks deliberately making these bad loans. There were anecdotal warnings from others in the financial industry that the situation was unsustainable, but the warnings went unheeded by the industry leaders in both finance and housing.

There is some evidence that there was criminal collusion between the mortgage industry, the financial industry, and regulators... read the wikipedia entry on the subprime mortgage crisis for more info. Apparently the most egregious offenders making the transparently bad loans were paying off lots of government officials under the table to keep the ball rolling.

This hidden scandal has major implications for the current political season. It is probably not an accident that Fannie Mae and Freddie Mac were among Barack Obama's biggest campaign contributors. I think it gets a lot worse than it looks, and of course the MSM is in full cover-up mode as usual.

So in this environment, the President and the leaders of both parties tried to sell us on the need for a $700 billion bailout of Wall St. this week, as necessary to save the economy.

Is it? I really don't know. Maybe it is. It seems to me that there is a hell of a lot of bad debt out there, and for the government to force you and me to buy it up is not exactly a recipe for long-term success. It seems like the only thing that will work is for all the bad debt to get out of the system, as soon as possible. If that means everyone's real estate values will go down (which has already happened), that's probably unavoidable.

The sooner the economy confronts this disaster and swallows the bitter pill, the sooner we can put this situation behind us. I'm afraid that transferring all the bad debt to the taxpayers will only prolong the agony, while socializing the whole US economy forever in the process.

But maybe I'm totally wrong, and things will be worse if there isn't a bailout. I really can't tell what's going on from the shenanigans in Washington. The bailout bill yesterday really was advertised as a "done deal", and there was adequate bipartisan support to pass it. That was obviously not the case.

And weird stuff went on. Nancy Pelosi apparently made a deliberate effort to scuttle the bill, by going out of her way to piss off the Republican swing votes in the house minutes before the roll call. Why did she want the bill to fail? To benefit Barack Obama? It amazes me that the candidate most closely associated with the subprime mortgage scandal is benefiting the most from the debacle. That kind of tells me our society is completely off the tracks and our future is not a happy one.


Eric said...

I see a lot of opinion columns, including some pretty foamy ones, but a shortage of facts. The most reputable sources utilized by the foamy ones, the Wall Street Journal and the Washington Post, don't appear to offer much support for the foamier allegations they're used to support, unless I missed something.

The aphorism "cock-up before conspiracy" seems particularly apt under the circumstances: the best evidence I've seen so far is that Pelosi is an idiot, not that she's colluding to throw the election Obama's way. And while I'll freely admit to supporting Obama--perhaps I'm blind, then--all I can see in the sources you've cited is, at most, guilt by association.

I'm unclear on the "government leadership" on mortgage loans, as well: poor stewardship and lax enforcement of the few banking regulations that remained in place after, IIRC, 1999, I'll concede. Plenty of blame to go around to members of both parties for a weak and ineffectual Congress--absolutely. But I don't see government leadership as being the problem; the direct opposite, actually.

Last thought: is it a "hidden scandal" if you can look it up on Wikipedia?

John the Scientist said...

Well, government leadership encouraged bad loaning practices under the sub-prime affordable housing programs. This was used as a smokescreen for covering loans to other risky creditors, such as real estate speculators.

The regulators who want to take over this mess were in large part responsible for a housing welfare program that's now backfired, and I want Congress to stay the hell out of the financial markets, because if they don't we'll get more bipartisan vote-buying like this.

Ilya said...

I never spelled out in my arguments elsewhere that the alternative to the bailout seems to be financial-industry-wide bankruptcy. You're right that the only thing that will fix the economy is getting rid of the bad debt. The problem is - it cannot be accomplished quickly without a major governmental intervention. History suggests that crises of this magnitude take years to naturally unwind. The bankruptcies of a large number of financial institutions will perpetuate scarce credit => less business => less consumer spending vicious cycle for years to come. And it will mean much more to an average person than downward adjustment of their real estate value.

Apologies for my "broken-record" act. I figured I had to put my 2 cents to every blogger who touches the topic ;)

CW said...

I really appreciate the opinions of our more-insightful-than-the-average readers of this blog, because I really don't know what to think. I tend to think _something_ needs to be done, but I really don't trust government to do _anything_.

I have a hard time believing that saving a bunch of crooks from the consequences of their crookedness is ultimately good for the economy, and I'm not sure the _whole_ financial system is in such dire straits as is claimed, because there are plenty of banks (like all the ones I do business with) that didn't make or buy bad mortgages and are in a position to really benefit from the distress of those who did. I am afraid that if we bail out the bad and crooked bankers now, we'll just get more of the same crooked crap in the future.

But obviously a credit crisis is bad for the economy, and good credit risks need to be able to borrow in order to do good business. I just can't figure out if good credit will dry up if we don't transfer all these bad loans to the taxpayers.

I do believe that no matter what happens, and no matter who wins the election, the government will be forced to enter a period of increased fiscal responsibility. If that doesn't happen, we are truly doomed.