View From Table 9

September 22, 2008

Cash for Trash, or Save the Loan Holder…I mean Home Owner!

I’ve got to agree with Krugman on this one – this ‘rescue’ deal is throwing good taxpayer money after bad. I especially don’t like that the taxpayer doesn’t gain ownership over anything in the deal – just bails out those who should rightfully lose their shirts based on the risks they took. That means both the investors in mortgage-backed securities AND the people who borrowed more than they could pay back.  Krugman writes:

So let’s try to think this through for ourselves. I have a four-step view of the financial crisis:

1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?

Well, it might — might — break the vicious circle of deleveraging, step 4 in my capsule description. Even that isn’t clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.

Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I’m not happy with this plan?

The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

Another interesting tidbit – now Morgan Stanley and Goldman Sachs, the other two investment banks, get to become holding banks (i.e. banks like BofA and Wachovia). Lucky them! This gives them access to the discount rate that banks borrow from. The bad news for them is that they’re more highly regulated. The good news? They don’t go under.

Now this sweet deal which will be packaged to “Save the Homeowner!” when in reality the market does not give a crap about the homeowner, they care about the loan holder – or the holder of that mortgage backed security that’s tanking. Those holders would be primarily large investors, who would lose all their investment.

But, to get the TAXPAYER (who will not make a dime off this ‘rescue’ in it’s current form ) to buy it, they’ve got to position this in more populist terms = Congress doesn’t want you to lose your house because some mean old bankers made a bad loan to you. So we’re going to give them a pile of your money to go away so you can keep your house. That’s on top of the pile of money they already have. Oh, and your taxes are going to have to go up and that whole healthcare business? Yeah, don’t have any money to fix that, we know we said that before we ‘found’ $700 billion extra but hey, now we really mean it. Until the next time our rich friends need a bailout. Except since we’re already in the largest debt ever thanks to Iraq, this is just going to add to the multi-trillion dollar credit card bill (i.e., the federal deficit) we have going here that your great great grandchildren will pay off.

Thanks, but I’d rather just lose my house, deal with a bad credit report (hey, everyone will have one now!) and go rent and maybe have a shot at decent Veterans benefits and healthcare packages for everyone. Let the big investors take the hit. They did, after all, take the risk.

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2 Comments »

  1. Would you be interested in exchanging blogrolls links with my site? Please email me if you are interested

    Comment by Susan Kishner — September 22, 2008 @ 11:18 am | Reply

  2. Interesting take on this mortgage crisis. I still believe that the government shouldn’t bail people out. I have one of these types of loans and knew what I was doing when I signed up. I believe we all did. Nice post. Thanks.

    Comment by christopher@ Home Insurance — September 23, 2008 @ 9:27 am | Reply


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