The Bailout Round II: Adult Version?
In spite of its best efforts, the Bush administration failed to push through a $700 billion give away to Wall Street. President Bush conjured up scary images of the Great Depression on national television. He even partially backed away from his initial demand for a complete blank check for Henry Paulson. But the public refused to send their tax dollars to Wall Street banks run by incompetent bankers, and they insisted that their representatives in Congress listen to their wishes.
While the editorialists are busy denouncing members of Congress for surrendering to the vulgar masses, it's a good time to quickly check the score card. The United States is in a recession and facing the worst financial crisis in almost 80 years because the folks currently in charge were out to lunch.
They allowed an $8 trillion housing bubble ($110,000 for every homeowner) to grow unchecked. People like Henry Paulson, Ben Bernanke, and Alan Greenspan repeatedly insisted that there was no housing bubble as house prices got ever further out of line with fundamentals. President Bush regularly boasted about record rates of homeownership as the sleazes at outfits like Countrywide, IndyMac, and New Century pushed predatory mortgages on moderate income families, many of whom were black or Hispanic.
It just took a little common sense to see that a disaster was imminent, even if the exact timing and course could not be predicted. But, our elites lacked commonsense, and that is why we now face such a dire economic situation.
The main cause of the economy's weakness is not insolvent banks and lack of credit; it's the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble's partial deflation. Families used their equity to support their consumption in the years from 2002 to 2007, as the savings rate fell to almost zero.
With much of this equity now eliminated by the collapse of the bubble, many families can no longer sustain their levels of consumption. The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity.
And house prices are not going to come back. This is like Pets.com. We are not going to get the price of $200,000 homes in central California back up to $500,000.
The main problem in recovering from the recession will be finding ways to boost demand other than household consumption. In the longer run, this will mean reducing imports and increasing exports. In the short-run, we will have to rely on government stimulus to help spur growth and reduce unemployment. The Democratic demands for stimulus were not extraneous to the legitimate goal of a bank bailout bill. Fiscal stimulus must be central to any serious effort to boost the economy.
The weakness of the banks contributes to the downturn, but they are not the core of the problem. We would still be facing a recession even if all our banks were flush with cash. Hence the hype about the urgency of the bailout was an invention. It would be good to get our banks in order, but it also would be good to send $100 billion to state and local governments to support infrastructure projects and other spending.
How do we go about getting the banks in order? Almost every economist I know rejects the Paulson approach and argues instead for directly injecting capital into the banks. The taxpayers give them the money and then we own some, or all, of the bank. (That's what Warren Buffet did with Goldman Sachs.)
This isn't about begging for a sliver of equity as a concession for a $700 billion bailout, this is about constructing a bank rescue the way that business people would do it. We have an interest in a well-operating financial system. There is zero public interest in giving away taxpayer dollars to the Wall Street banks and their executives.
If Secretary Paulson constructed a package that was centered around buying direct equity stakes in the banks, he could quickly garner large majority support in both houses. Better yet, Congress could just construct its own package centered on buying equity stakes and send it to President Bush. If he balks, we can just threaten him with stories about the Great Depression.
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I agree with Dean Baker.
There is no interest from anybody on backing the failing banking system as it is and we all know that.
Only if the Plan included the working class and spending money for the good of the general public in all states it would pass.
"But the public refused to send their tax dollars to Wall Street banks run by incompetent bankers, and they insisted that their representatives in Congress listen to their wishes."
Not my Congressperson, Henry Waxman -- he voted for the toxic bill. No one is running against him.
"The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity."
Home equity? They probably don't even have jobs anymore.
I've heard Mr. Baker on several radio shows and applaud that he's one of the sane people talking about this issue.
I heard that the housing bubble was a result of the burst in the High Tech bubble at the beginning of Bush's term. All that money lying around had to be invested somewhere. Securitized mortage bundles looked like the safest bet around. Pushing too much money into one sector causes a bubble. Bubbles are destined to burst.
Imagine what the bankers will do with all this extra money once they offload their more risky securities onto the taxpayer. I suspect they'll pack up and leave. After all, an Obama administration will not be a prosperous opportunity for them as they are the only people in the country who will get a tax increase.
Might as well retire in Monte Carlo, don't you think?
Is anybody here familiar with the Basel Accords, of which the U.S. is a member? THIS may be the real reason behind the alleged “credit crunch” ========Basel II is an international business standard that requires financial institutions to maintain enough cash reserves to cover risks incurred by operations. The Basel accords are a series of recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision (BSBS). Basel II improved on Basel I, first enacted in the 1980s, by offering more complex models for calculating regulatory capital. Essentially, the accord mandates that banks holding riskier assets should be required to have more capital on hand than those maintaining safer portfolios. Basel II also requires companies to publish both the details of risky investments and risk management practices. Basel II has resulted in the evolution of a number of strategies to allow banks to make risky investments, such as the subprime mortgage market. Higher risks assets are moved to unregulated parts of holding companies. Alternatively, the risk can be transferred directly to investors by securitization, the process of taking a non-liquid asset or groups of assets and transforming them into a security that can be traded on open markets. _________(The US has requested several time extensions to come into compliance. Time’s just about out to meet the requirements,or the OTHER banks who are in the accords WON’T LOAN money or deal with the US banks. )
LAST UPDATED: 28 Jan 2008
As usual, an excellent column by Dean Baker, an economist who has been warning Americans for years about the housing bubble.
I think the bailout crisis can be usefully compared to the US car industry. The car makers are saddled with lots and lots of "bad" cars (that is, SUVs and such that no one wants to buy), due to bad judgment on their part (whoever could have foreseen that gas prices would go up and consumers would want fuel-efficient cars?). No one in Washington is suggesting that the taxpayers buy up those vehicles and hope their value goes up. Instead, we give them a loan to keep them in business and the collateral should be (is it?) the full company, not just the bad debt that the SUVs on the lot represent.
This sounds analogous to the mortgage/Wall Street crisis to me. Taxpayers should not have to buy up the banks' bad debt and hope it turns around. Instead, we should do something akin to what we are doing for the car makers. We should look at the Swedish approach and demand real equity if we decide it's in our best interest to keep them afloat by loaning (not GIVING) them any money at all. (For more on the Swedish approach, see http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html?em. )
NO ZOMBIE GIVEAWAYS!!! KEEP THE BAILOUT DEAD!!
NO WELFARE FOR WALL STREET !!!
IF this taxpayer bailout of Wall Street was absolutely critical to keep the economy functioning, The REPUBLICAN Secretary of the Treasury would be able to persuade the REPUBLICAN Senators and Representatives to vote Yes. Unanimously. The fact that Paulson can't even get a third of the House Republicans to vote 'yes' makes it clear that this taxpayer giveaway to Wall Street is NOT necessary to prevent a depression.
Call your congressmember NOW. Keep the bailout DEAD.
If all those talking on t.v. will just say what needs to be done. All this "sky is falling" talk is not working this time. People have tuned out politicians for the last seven years because between Bush and those running congress they haven't been listening to us. Matter of fact, they haven't thought much about us but now they need us to understand. Understand what? Won't someone just tell the truth for a change. Bush, Paulson, and Bernake (sp) did a horrible thing by not tellng us things were going bad. People are more apt to respond favorably when they are told the truth. We all know what happened to Chicken Little when he yelled the "sky is falling" one to many times.
It has taken years to get to the place of a $700B bailout, buyin, or however folks won't to term it HOWEVER it should not take two weeks to get us out. What are other alternatives? Let us hear them and make this work for EVERYONE and not a select few.
I would agree:
1) We give the banks money, they give us stock (same as Buffet).
2) Government regulators sit on the Board of Directors (same as Buffet).
3) We get dividend checks (same as Buffet) used to fund Social Security (or offset taxes).
4) When banks recover, we earn a profit (same as Buffet)
5) Regulators on the board set executive compensation packages.
6) New bank regulations prevent this from happening again.
From what I understand, out of our 51 million mortgages about 2 million are under water.
If they are $400,000 on average let say, that's $800 billion.
This is the way it needs to be explained to the citizens.
Now the GOP in the House who try to stop regulation whenever they can won't bail anyone
out but would rather everything collapse and then we have to come up with unemployment
and FDIC insurance when the depositors loose it all if banks fail.
And the latest news is that the GOP in the Senate is blocking Altenative/Renewable Energy
incentives up for renewal as oil remains around $100 a barrel even as a world recession looms.
The GOP has to pay a heavy price for this insanity. They deserve Palin. But is that enough of a punishment?
Those numbers make sense to you and me. But to the investment banks who sliced and diced mortgages into securitized investment packages and sold them 2, 3, 4 times around the world to sovereign funds, retirement funds, etc, the increased make believe book "value" of the funds (doubled each time they changed hands) is in the Trillions!!!
They want That! Not a few hundred billion here or there. They want this Loony Toons fractional banking system where $1 dollar gains the value of $10 everytime it is loaned out or sold as a debt, to be the basis of the bailout. And as long as we buy into their Fairy Tale definition of banking and money, we will be paying $700 Billion as the down stroke and the rest for generations.
that is absolutely what I am afraid of... We could be paying off the Gamblers bad debts forever... They are not looking out for the working class.
Lenders must be forced to keep the loans they approve. This is b u l l s h i t to give out questionable loans and then sell them to people who will change the tenor of the loan so that they can get more out of the loan through late charges and other cheats. For example, you get a loan from the bank that says you late date is 10 days after the due date. Then they sell your loan to another company who changes the conditions so that your late date is now 4 days after it is due. Gee, now your payday is 6 days after you payment is due and that is just too bad, late payment every month. Most ordinary people are one payday away from the street. No money saved for an unexpected emergency, and yet they still want more.
"Most ordinary people are one payday away from the street."
That may be so, but why does an "ordinary person" (whatever that is) couple such economic misery with the self inflicted gunshot wound of an interest only or adjustable rate mortgage?
This "ordinary person" today has a 50% savings rate. I could live big but I don't. In the past I used to have a 20% savings rate and even when I was on a minimum wage job as a student I had a 10% saving rate. Why? Because I have seen what living on borrowed money did to the life of my parents. They did not have a choice. I did. And I exercise it.
My personal rule for taking out a loan for a new home is that I have to be able to pay the loan for a full year while being unemployed. A full year. I turned down three homes over the past two years because my criteria were not compatible with the asking price. That's called fiscal discipline. You don't buy larger than you can truly afford.
Brilliant lesson. Well spoken. Thank you.
I am ok with that !! However, you should be ok with banks lending out less and when they do, it will be at higher rates.
The whole liquidity in lending markets come from securitization. If you are opposed to securitization, you have to accept higher rates.
cant have it both ways
Muddy Waters said it best...
"You can't keep what you ain't got, you can't lose, what you never had.."
"many of whom were black or Hispanic"
So I should be pointing my incredulous finger at blacks and mexicans because they intrinsically understand less about the nuances of mortgage financing than whites???
No? Everyone who fails to read the fine print (regardless of color) is to blame? Ok then.
Great article!
What an excellent article. How refreshing, to read facts instead of wild-spinning headlines. The following, in particular, should be cut and pasted anywhere and everywhere human eyes can see.
"The main cause of the economy's weakness is not insolvent banks and lack of credit; it's the loss of $4 trillion to $5 trillion in housing equity as a result of the bubble's partial deflation. Families used their equity to support their consumption in the years from 2002 to 2007, as the savings rate fell to almost zero.
With much of this equity now eliminated by the collapse of the bubble, many families can no longer sustain their levels of consumption. The main reason that banks won't lend to these families is that they no longer have home equity to serve as collateral. It wouldn't matter how much money the banks had, they are not going to make mortgage loans to people who have no equity."
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