Why the Bailout Plan is Bad.
September 30, 2008
Written by: Katie
http://www.cnn.com/2008/POLITICS/09/29/miron.bailout/index.html?iref=mpstoryview
Editor’s note: Jeffrey A. Miron is senior lecturer in economics at Harvard University. A Libertarian, he was one of 166 academic economists who signed a letter to congressional leaders last week opposing the government bailout plan.
Economist Jeffrey Miron says the bailout plan presented to Congress was the wrong solution to the crisis
CAMBRIDGE, Massachusetts (CNN) — Congress has balked at the Bush administration’s proposed $700 billion bailout of Wall Street. Under this plan, the Treasury would have bought the "troubled assets" of financial institutions in an attempt to avoid economic meltdown.
This bailout was a terrible idea. Here’s why.
The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.
Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.
This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.
Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.
The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.
The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.
Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.
In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy’s allocation of its financial resources.
Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.
Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.
Further, the current credit freeze is likely due to Wall Street’s hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.
The costs of the bailout, moreover, are almost certainly being understated. The administration’s claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.
If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.
The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.
Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.
So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.
The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.
September 30th, 2008 at 9:12 pm
So you’re saying that paying off debt with debt is a bad idea?? Really???
If the economy crashes, we’re gonna buy a bunch of cheap stocks and move to Australia. :D
September 30th, 2008 at 9:29 pm
Yeah, great idea. Let’s bail these guys out so they can continue to lend more money to people who still don’t have the ability to pay it back so they can continue to lead their frivolous life and we can do this all again in five or ten years. Sounds like a plan.
September 30th, 2008 at 9:35 pm
Bail ‘em out so they’ll never learn from their mistakes. It’s America after all, the land of zero personal responsibility. Well, there’s my political commentary for the week. :)
October 1st, 2008 at 12:35 am
Thanks for posting this Katie, it was in good English and I understood 93% of it.
Now what a fine mess everything is in.
October 1st, 2008 at 5:32 am
I just heard on the radio this morning they have made a FEW changes to the bill and plan to reintroduce it today. I think it’s probably wishful thinking that it will bomb and not pass, but I’m praying it doesn’t pass. It may make for hard times for a little bit, but I think we are all kind of getting prepared for hard times bailout or not.
America is becoming known as the country of no personal responsibility. It is so sad.
Anyone else taking advantage of the cheap stocks? I overheard a guy yesterday say he refinanced his home to dump it into stocks. He will probably make out like a bandit, but I’m not quite as confident in our economy (or as daring).
~Gretchen
October 1st, 2008 at 6:19 am
What a fool to your refinance your home to buy stocks. This county’s economy is going to crash. Come on people! This is prophesied in the Bible. The coming of God is nearer than ever. Or don’t you believe that kind of thing. You will if you don’t now! Let’s see how proud everyone is when they stand before the power of God and his judgement throne.
Clear thinking with a sane mind is what everyone should be doing. Making sure you are ready for the coming of God and that your soul is right with the Lord. Not all this silliness. This county has a good reason to be afraid. I’m just glad I don’t have to be one of them. I know I have received the true and real salvation of the Lord as commanded in Acts 2 and 38. Without a doubt I won’t be here to live hell on earth as the tribulation with the antichrist as the problem solver for this worlds problem of economic disaster.
Look, if America’s economy crashes, then so will the worlds. They depend on us and what we buy from them and trade. If we crash, they crash!!!!!
Get off this computer and read Acts in your bible and then pray God would reveal his true salvation unto you so that you do not have to endue what is to come.
You won’t see me here. Just look in the clouds when Jesus has Gabriel sound the trumpet of the end of time. That’s where you will see me risiing to meet Jesus to leave this wicked sinful mixed up thinking, confused, warped in mind world.
Shell
October 1st, 2008 at 7:21 am
Thanks for posting this! I’ve struggled to make heads or tails of the whole thing, but this article really helped me to understand. Interestingly enough, I just heard Dave Ramsey talking about this same issue on a DVD a couple of weeks ago. These DVDs were recorded over a year ago; I hope to find out what he thinks now of the bailout. And while I’m not convinced of the imminent return of our Savior (I’m sure there were Christians thinking He’d show up in the clouds any day during the Great Depression), I do agree that refinancing your home to buy stock is an unwise decision. Have we learned nothing?!? Refinancing homes and pocketing, redirecting, or spending the equity is part of what got us into this mess in the first place. Better to get out of debt and be assured of a home to live in no matter what happens with the economy than to go deeper into debt and risk losing your home altogether!
October 1st, 2008 at 11:17 am
EEEEMommy, and others. The prophesies of the end of time, were not almost fullfilled during the Depression. There are only 3 prophesies yet to be fullfilled. The rebuilding of the temple, the antichrist reveled and, the war of Iraq joined by Russia on Israel.
It’s dissapointing that so many people that visit here are so uneducationed on Gods word. Revelation is the last book of the bible for those that do not know. It is the book that prophesies the most on the end times to warn Gods people to prepare themselves and their spiritual lives for the coming of Christ.
I know many people in the Depression looked for God. If they had looked in Revelation, they would have seen that this time, was not their time. That it was later on. My grandmother lived through this time and I know much because of her. The time we are living in now will be much, much more worse that the Great time of the Depression. I don’t think many people realize just how scary it is going to be. No food, no jobs, no homes, no resources, and everyone will be desparate and looking for any sign of hope to save them from this horrible time. This is where the antiChrist will step in with all the answers. No one will question this as, no one else will be able to offer the hope that this man will be able to offer.
The church will be raptured away soon after this acknowledgement of the worlds savior who will not be God. Be warned, this is not scare tactics nor religious fear mongering. The bible is one of a few books that have crossed the decades and is the #1 book acknowledging the written word of God. If you believe the Bible to be the true breathed word of God. I suggest you get reading.
Shell
October 1st, 2008 at 11:58 am
We don’t own a home, we pay someone elses mortgage. A year ago we were in the process of buying, but God closed those doors.
We have been thinking about buying in the next couple of months. Would that even be advisable? If so, how do we really know if the mortgage company won’t declare bancruptcy?
What do you all think?
Emily
October 1st, 2008 at 12:55 pm
A very well-written article explaining the current mess.
Thank you for posting it.
You have some of the best links! I’d love a copy of your favorites list!
October 1st, 2008 at 2:34 pm
Agree with much of what he says. Some not. This for instance:
“Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.”
First of all, it is not scare-mongering. If the credit system does freeze up, it will be financial Armageddon. He may be right about the current conditions being exacerbated by the financial community waiting to see if the “lender of last resort” - you and me - will pay more for their junk assets than the market. However, his idea that “a profit opportunity exists for someone else” is off the mark.
If profit were to be made lending to broken financial institutions, they would be doing it now. Foreign central banks have had their fill of our dumping bad debt on them. They will not be a source for this lending. Foreign banks large enough to make this kind of impact are in Europe. Did anyone see that 3 banks were nationalized in Europe yesterday? They have their own problems.
Sorry, but this is a real and present danger to our nation. Bailing out the banks is what the Fed was created to do. It will take a vast political change of climate in Washington before anything else of substance can be done. I doubt that Americans will do that absent much pain. Is this pain imminent? Maybe, maybe not. Depends on if confidence can be temporarily resorted to the financial markets. My guess is they will succeed, but no guarantees on that one.
October 2nd, 2008 at 9:51 am
Emily, I’d say go ahead and buy if you can find something you like, it fits your budget, and it is a good value for the local market. Sure, debt has risks, like if you lose your income, but that would make it difficult to pay the rent too. Don’t worry about your mortgage company declaring banckruptcy, that won’t affect the terms of your mortgage and the company taking over will be sure to collect your payments just as regularly as the previous one would. The caution I’d apply if you did decide to buy is to be certain to get a conventional fixed rate loan (no higher than 80% LTV). Additionally, you are much better off with a 15 or 20 year term, because the interest you’ll pay over a 30 year period will exceed the purchase price. Of course, this will make your monthly payment a little higher, but it will hopefully force you into a home that you can more easily afford. This is just good conservative financial sense in any market condition.