Topic: Economics
The Wall Street Bailout was Justified If I were a Wall Street banker right now, I’d be screaming blue murder at the government over this latest crisis and demanding redress. The plain fact is, through government legislation, we the people cost they the bankers 700 billion dollars or more.by Larry Warrick
(libertarian)
Monday, October 13, 2008
When you wrong somebody, you do the right thing.
I think Congress passed the bailout bill partly because they understood that they are a part of the problem. If I were a Wall Street banker right now, I'd be screaming blue murder at the government over this latest crisis and demanding redress. The plain fact is, through government legislation, we the people cost they the bankers 700 billion dollars or more. Now before you jump on your high horse, hear me out and maybe you'll see some sense.
Jimmy Carter signed the Community Reinvestment Act into law in 1977. The Clinton administration turned this Act, a once-obscure and lightly enforced banking regulation law, into one of the most powerful mandates shaping American cities and, as Senate Banking Committee chairman Phil Gramm memorably put it, a vast extortion scheme against the nation's banks. Under its provisions, U.S. banks have committed nearly $1 trillion for inner-city and low-income mortgages and real estate development projects, most of it funneled through a nationwide network of left-wing community groups, intent, in some cases, on teaching their low-income clients that the financial system is their enemy and, implicitly, that government, rather than their own striving, is the key to their well-being. Thus it was made practically compulsory for an investment bank to loan mortgage money to literally anyone who came along or face the wrath of government bureaucracy. The banks were so pressed to abide by this government mandate that they felt the need to offer a new kind of loan to make their product appear even more attractive the sub prime loan. Thus the story goes on.
For the next ten years, the banks were forced to abide by the law and deliver their quota of minority and subsistence wage earner loans. When I say subsistence wage earner loans, I mean that the banks were forced to accept Social Security and unemployment payments as earned income for mortgage purposes. Some companies quit asking for income verification altogether and provided the now infamous 'liar loans' simply to meet some government standard set by national legislative fiat. Meantime, we the people made hay on the stock market and congratulated ourselves on how smart we were and how well we were doing.
In fact, anyone who had any inclination to 'play the game', found a new fountain of wealth in their home and used it like an ATM machine or a one-way piggy bank, living beyond their means, sometimes way beyond their means, gambling (and recently losing) the proceeds on the stock market, of all places.
Simply put (and in case you've been living on a desert island for the last several years), a sub prime loan is a mortgage agreement that offers a substantially reduced rate of interest for some initial, and comparatively short, period of time. After the expiration of this low interest period, these loans then reset to a level of interest more reflective of the 'going rate'. Hence it was made possible for a low income, high credit risk person to gain a mortgage on a hyper-inflated home and afford to make the initial payments, giving the impression that the loan was a viable transaction and worthy of further investment (more on that later).
So far, so good. All over the United States, and indeed the entire civilized world, underprivileged and low-income people were buying homes of their own and servicing the loans on them. The financial industry was making loans in record numbers and the stock market was rewarding this success by bidding up the price of stocks and shares to new highs on a daily basis. This new demand for housing prompted a boom in new housing construction and existing real estate values were rising at record rates. Homeowners who found themselves in a financial pickle could simply get a 'refi' to their current (inflated) home valuation and all was well again. Effectively using their home like some never ending fountain of cash. This worked well for the beneficiaries, as long as home prices continued to rise.
Of course, once these loans reset to a more realistic rate of interest, often doubling or tripling repayment amounts, our unfortunate borrower is unable to meet the commitment and defaults. Foreclosure follows and ownership of the home is transferred to the creditors for liquidation at a substantial discount. Even previously responsible mortgage borrowers were taken in by the hype and found themselves stuck with an inflated home loan that they are now hard-pressed to service. Add to this misery the psychological effects of the inevitable market correction on both home valuations and the stock market, thus we now see a situation where many feel justified in simply throwing up their hands and walking away.
Many homeowners now find themselves deeply in debt, way above and far beyond what they can afford, and unable to service the payments on their primary residence. With easy money comes easy loss. Ask any gambler. Many of us understood through our Austrian economic education and sheer common sense that this was yet another fiat currency bubble (yawn) and were smart enough to avoid getting caught up in all the hype and the ensuing financial bloodbath. As with any government interference in a free market, those who suffer most are the most vulnerable and can least afford it. The nightmare of being dependent on government handouts and facing the prospect of homelessness must be a terrifying prospect for anyone, particularly those with young children and the elderly.
If this were the end of the story, that would be bad enough, but it isn't. Many financial institutions on Wall Street who underwrote these mortgages started seeing a rise in default rates and alarms were going off in boardrooms all over the world. The 'solution' was to package these mortgages into financial instruments known as CDO's (Collateralized Debt Obligations, an unregulated type of asset-backed security and structured credit product.) and offer them as investments on the open market. Initially these were ranked based on risk and interest paid accordingly. Those considered low risk were offered at lower interest, higher risk, higher interest, and so on.
The moment of truth came when word got out that some banks and financial institutions such as Bear Stearns and AIG were becoming insolvent due to losses rooted in the now famous 'housing bubble'. They were heavily invested in mortgage securities and were seeing record default rates leading to foreclosure and loss of value through discounted resale of the secured assets. In response, many banks tightened their loan qualification requirements (illegally!) and home sales slowed to a painful crawl.
As a result of this credit tightening, new home construction has all but ceased. Many projects, considered viable at the outset, lie half-finished and abandoned. Finished projects remain empty and a liability to their owners who envisioned huge profits at inception. Real estate valuations have plummeted at record rates and continue to fall, contracting some markets as much as 50%, with no bottom in sight.
All this is a direct result of government interference. The solution is, of course, yet more government interference. Financial institutions and even manufacturing concerns such as General Motors are being bailed out at record rates. Government is buying up worthless financial instruments (the now famous 'toxic securities') at wildly inflated prices in an attempt to inject liquidity at every conceivable point in the system. Even before the $700 billion bailout bill, we saw individual bailouts to favored Wall Street firms and now we hear that $700 billion may only be a down payment. I guarantee that it is only a down payment and predict the total collapse of the world fiat financial system as a result of the world's central banks inflating in unison in a vain attempt to shore up the collapsing economies they oversee. The collapse will finally come when the central banks are no longer able to inflate at ever increasing rates and public confidence in the resulting massive currency bubble erodes to nothing. Just like it did for the housing bubble, the savings and loan bubble, and all those before it.
With currency inflation, prices will rise. This general rise in prices will not happen overnight. It takes time for all this new money to filter down through the market and bid up prices. Those who receive the money first will see the most benefit, as they will spend it before prices rise. Those who receive it last or not at all will see no benefit; many will be poorer in real terms as the value of their fixed incomes is eroded away and wage increases fail to keep up with rising prices. Those who follow government figures will notice that the reports will not reflect what they see in the marketplace. This will be due to selective inclusion or exclusion of market segments (oil and housing are recent exclusions) to provide the illusion that inflationary price increases are not as high as they are in reality. This is an old trick that is consistently used to hide the embarrassing truth.
The real human tragedy in all this is that it was entirely avoidable. Constitutional government has no authority to act as a savings and loan company, a stock market player or a rich uncle to failing businesses. They also have no authority dictating to free enterprise who should merit the risk of being granted a loan, under what terms loans should be offered, or how many loans should be granted under some legal 'quota' system. There is no constitutional provision for regulation of any market or the setting of any standard of business etiquette. There is provision in the constitution for congress to regulate the quality of money and that money is to be gold and silver, not some debt-based system of paper coupons generated by monopoly fiat and created from nothing.
So, you see, we the people, through our duly elected representatives, did indeed put the Wall Street bankers in the hole to the tune of many billions and possibly trillions of dollars.
In the end, it is our fault that our financial system is falling apart all around us. We as a nation stood by for literally scores of years whilst our government took diabolical liberties with our financial system and once free markets. We as a nation stood by as our constitutionally inalienable rights were slowly eroded away and we as a nation did nothing. We as a nation still have the right to demand honest money and the freedom to use it as we see fit in an open market, free of government intervention. With every crisis comes an opportunity. We as a nation have an opportunity to put right what has been wronged. Now is our opportunity as individuals to educate others and give them the opportunity to educate themselves. Uncertainty and fear have the effect of focusing the mind and making once indolent people sit up and take notice. As this debacle unfolds, fear will turn to panic and panic to.........?
Recently, people who once smiled politely and changed the subject when I spoke of constitutional government are asking me questions and listening to my replies. They are beginning to worry that I have been right all along and now it's too late. Now is the time to stick to our unbending Constitutional principles and speak up. The first step to healing this collective insanity is understanding and reconciliation. Answering people with kindness and understanding will help our cause to win friends and influence people. A humble foreign policy starts with a humble approach to one's neighbors with answers that they identify with and see a future in. The road to honest money begins with the first step to educating our friends and neighbors and helping them to understand the root of this unspeakable evil and ending it.
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Posted By: Walt Thiessen
Date: 2008-10-13 08:52:09
Your analysis might make sense if the bankers had nothing to do with all the spending, but unfortunately it's not true. The spending happened because the money was made available to the government in the first place by the bankers, in the form of the Federal Reserve.
We can't make sense out of what it going on until we realize that the Fed is managed to the joint benefit of the bankers and the government. It's purpose is to raise gigantic amounts of money for the government's use by creating loans out of thin air. The money from these loans goes to the government. The interest collected from these loans goes to the bankers. The people get stuck with the bill long after the borrowing (via creation of money out of thin air) has taken place.
What this means is that big government politicians haven't had to worry about pissing off the voters because they get to spend money without raising taxes directly. Instead, they have been able to continue to make promises that cost more than they collect in taxes, which is why Ron Paul calls inflation the "hidden tax."
This is why most Americans still are not clear about how costly the past 95 years have been and how costly the next few years will be As the financial crisis continues to play out, it will become more and more apparent to everyone where they really stand, and where they (we) really stood all along.
This is the way the game has been played since 1913. So no, the bankers are not victims here. They are perpetrators, in cooperation with the Federal government. We, the people, are the victims, and most don't understand how or why it has happened.
Thanks Walt, good points. I see no non sequitor in this though. The root of the argument resounds around the legislation that enabled this loose fiscal policy in the first place. The fact that the banks were more than willing to concur in this action is secondary to the initial government intervention. I know this is just one instance in very many whereby government and the banks have acted in concert to enrich each other and their friends at our expense. In this instance, however, the bankers can now point to this legislative interference and, of course, deny culpability, whilst trying to hold their faces straight, and demand that government borrows more from them so they can give it back to them! At interest! From nothing! Millions of hours of labor commanded at the stroke of a computer key.
The real message in all of this is the opportunity that presents itself whilst we have the luxury of attention we did not have before, and that presents the opportunity to educate.
I have a few questions about the connection between the CRA and the current financial crisis:
1. I don't understand the timeline of events. The CRA was created in 1977, expanded by Clinton in 1995, and revised by Bush Jr. in 2005. If the CRA is the principle cause of the current financial crisis why didn't the meltdown happen earlier, during the Carter, Reagan, Bush Sr., or Clinton administrations?
2. What were the quotas of risky (under-qualified, sub-prime) loans banks were required to make? I haven't found any quotas in the text of the CRA, so how did the banks know what quotas they had to meet?
3. George W. Bush revised the CRA in 2005, how did his revisions affect the dynamic that you describe in this article?
4. I understand that only federally insured banks had to comply with the CRA. What percentage of institutions involved in mortgage lending since 2004 federally insured and thus required to comply with the CRA?
5. You say that banks were forced to make loans, which implies that the banks knew that these mortgages did not make sense, did not want to make them, and only went ahead because the government was forcing them to. What were the penalties for non-compliance? Was any action ever taken against a bank for non-compliance?
6. You note that the "solution" was to create CDO's, bundling the bad mortgages together. Who invented/created CDOs? Didn't the creation of CDOs make the problem much worse by leveraging bad bets, effectively magnifying the crises far beyond what it otherwise would have been?
Thank you, and I agree with the above poster, that we now have the luxury of attention we did not have before and must take this opportunity to educate ourselves.
There's an interesting article by Pater Schiff in the Washington Post (of all places) published today (10/17):
"Absent from such conclusions is the central role the government played in creating the crisis. Yes, many Wall Street leaders were irresponsible, and they should pay. But they were playing the distorted hand dealt them by government policies. Our leaders irrationally promoted home-buying, discouraged savings, and recklessly encouraged borrowing and lending, which together undermined our markets. "
And this posted by Matt Hawes at C4L (same day) after some very good quotes from Andrew Jackson:
"There are two main courses of action to take. First, we must educate ourselves so that we can not only articulate sound economics, but also adequately combat the pro-fiat arguments. Second, we must spread the word. One great step toward that second goal would be to forward around Dr. Paul's CNN interview from earlier this morning to your friends and family."
It appears I'm not the only one seeing this connection and the opportunity it presents................
Perhaps you did not mean your post as an answer to the questions that I posed, but I will point out that the article does not answer any of the questions I posted above, and perhaps more importantly, the author of the article does not appear to believe the bailout was justified, as you do.
The author's conclusion is that the bailout is just giving borrowers more credit when the true answer to the crisis is saving, or less credit, not more.
Further, The Wahington Post article you linked, does not support your analysis regarding the CRA. The author does not refer to the CRA as a primary cause of the financial crisis, instead pointing to mortgage interest tax deferral, the ability of primary lenders to turn long-term risk over to the government, artificially low interest rates set by the Fed, and "solutions," (like the bailout) that re-inflate the credit bubble.
I would agree with the Washington Post article on these four points. In your article, you claim the bailout was justified and support that claim by stating that the primary cause of the financial crisis (and thus need for any bailout) was government interference in the form of the CRA.
Your argument seems to be that the bailout is fair because the government caused the problem by passing the CRA legislation, thus the government should have to fix it. The Washington Post article does not support either the idea that the CRA was the primary cause, or that the bailout is justified.
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