Missing are key details like: at what price will these securities be purchased? Why $700 billion? What is the procedure for deciding how to allocate this gigantic pot of money? Does it go to the weakest banks, or the strongest? How do we avoid the massive moral hazard that no-strings-attached bailouts suggest? This is not a side issue: the Treasury's refusal to communicate is central to the proposal, which is why it explicitly denies courts or agencies any review powers.
Now, I do understand why Paulson thinks he needs broad powers and freedom from normal review constraints. The essence of this whole bailout is not to pick up the pieces, but to stop this mess from crashing the whole credit system. Hence, the Treasury wants to be able to intervene quickly. Having Congress, several regulatory agencies, and about a zillion judges sitting on your neck demanding a say is the enemy of speedy action. Nor has Congress proved exactly adept at handling the financial markets in the past. Still, for my extremely large contribution I'd like to have a little more confidence that there is some well-thought-out procedure for acquiring these securities. Arnold Kling is a must-read on this topic:
I am sure that Henry Paulson, Ben Bernanke, and Eugene Ludwig know more than I do about the current health of the banking system, the state of credit markets, and the potential risks to the economy. Note, however, that the news hour transcript also includes comments by Allan Meltzer, a historian of central banking, who argues that the financial crisis is not as bad as it is being portrayed.
But an issue about which they know less than I do is mortgage credit risk. To them, the problem of pricing mortgage assets is a detail to be worked out later, as when Ludwig sniffs that he is sure that "the plumbing can be taken care of." Well, I'm a plumber, and I don't think so. Based on my knowledge of pricing mortgage credit risk, I believe that the bailout proposal is far riskier than other alternatives.
How did we get into this mess in the first place? We got here because financial executives took on mortgage credit risk without understanding what they were doing. Some of them were new to the business, like the high-flying Wall Street firms who entered the industry during the boom. Some of them thought they were insulated from risk, because of new derivative hedging instruments. Some of the executives never belonged in the business in the first place, including Dick Syron at Freddie Mac, who in 2003 took over a firm where there was lots of knowledge of mortgage credit risk and proceeded to flout the warnings of experienced middle managers and the Chief Risk Officer about the firm's plunge into subprime lending. Congressional and Administration meddling in support of "affordable housing" played a role, and those folks are still around working on the latest legislation.
I am wearing two hats in opposition to the bailout idea. One hat is my libertarian hat, which does not like the power grab. The other hat is the applied financial economics hat, which was my career in the late 1980's and early 1990's. Speaking from the latter point of view, I have to warn that nobody involved in the bailout proposal has sufficient knowledge of mortgage credit risk. They are like Dick Syron--in over their heads without realizing it. The last thing we need in the mortgage market is another large, inexperienced player.
You can say that after the bill is enacted, the big boys will hire technical economists to deal with the plumbing. But that will be too late. Technical economists will not be able to fix a concept that has such poor risk-reward trade-offs built into it.
I would also very much like to know that the bankers do not get to waltz away from the mess they created without so much as a "You boys behave yourselves!" from Uncle Sam. I find it extraordinarily easy to sympathize with the bankers who genuinely believed that they had gotten better at pricing credit risk. I also find it extraordinarily easy to sympathize with people who dropped out of college to start a band. In neither case, however, do I wish to reward this behavior with large stacks of unearned money.
The Dodd plan has better oversight, but no better outline for how this money is to be spent, which is the core problem with the Paulson plan. This morning I listened to Pete Domenici, who is on both the budget and appropriations committees, explain to his colleagues, in tones of wonder, that Ben Bernanke had done his academic work on the Great Depression. These are the people who were in charge of approving Bernanke's appointment to the Federal Reserve chair, mind you, a task to which they seemingly gave less attention than they do to applying their television makeup.
At that, he's a massive improvement over the Democrats; as I write this I am enjoying the site of Byron Dorgan simultaneously illustrating that he knows nothing about financial history, and also lecturing us on how we should regulate the industry. At least the other things Pete Domenici said were factually accurate and logically coherent, even if that logic cohered around a not-very-well-thought-out endorsement of the Paulson plan.
This does not exactly fill me with soaring confidence in Congress's ability to allocate the money. I'd rather trust Paulson.
Half of the Republicans seem to have turned over their consciences to Hank Paulson in the name of party solidarity. Meanwhile, many Democrats seem to be more interested in discussing Wall Street bonuses and struggling homeowners than what to, y'know, do about the banking system.
I feel bad for the homeowners, and outraged that so many people got gigantic sums of money for screwing up the financial system. But that money's gone. The mortgage bankers have already mostly lost their jobs, because their market (and often their firm) collapsed. Much of the outrageous compensation was in now worthless (or nearly worthless) company stock. And even if we dun, say, the top executives at Bear, Lehman, and AIG (I'm not opposed to doing so if it's legal), we will get only a trivial fraction of the money lost in these markets. You know who made most of the money on the subprime bubble? Anyone who bought a house in the last ten years. Yes, that's right, you, with your low fixed interest rate on a reasonably sized house. You're the profiteer who laughed all the way to the bank.
Taking whatever money we can from the executives is worth doing pour encourager les autres. But the bigger concern is institutional. Any bailout plan needs to walk a very, very fine line. It must let straightened financial institutions sell the debt that is dragging down their portfolios. But it must do so in a way that does not convince future bankers that excessive risk taking can be nearly painless. That means paying just enough for the securities to keep the banks from failing, not enough to let them avoid painful losses. One way to do this is to make the deal less attractive, which the Dodd plan proposes to do by requiring equity warrants in exchange for funds.
But it also has to make buying overvalued homes unattractive. People were gambling on the housing market--nice, middle class people who would never carry a gigantic credit card balance or declare bankruptcy. In the face of the housing bubble, they took out ARMs they knew they couldn't afford to pay when the teaser reset, in the hope that rising home equity would let them refinance. (A fair number of them got away with it, too.) When pressed on this behavior, they claimed they had to because otherwise they couldn't afford a house--as if renting were a physical or moral impossibility.
Borrowers were not brought down by predatory lending. The terms that are causing trouble were clearly laid out in their loan term sheets, right on the top of their mortgage package. Borrowers were brought down by a willingness to gamble on rising home prices--exactly the same thing that knocked out Lehman Brothers. At least Lehman Brothers had the excuse that ten years of rising prices had completely screwed up their default models.
Bailing out home gamblers by freezing their mortgage rates, extending their loan terms, or otherwise forcing the banks to give them free money, will teach them the same thing we are trying hard not to teach Wall Street: if you gamble big enough, Uncle Sam will pick up your losses. Moreover, it's not exactly the cleverest idea to levy a huge regulatory taking on an industry that's already really shaky, and threatening to take the rest of us down with it in the event of a collapse.
Any bailout should not aim to help either homeowners or lenders for their own sake--we are helping them because if we don't, the rest of us will suffer more than the cost of the bailout. The health of the Fort Meyer housing market is not the proper province of the federal government, no matter how distressing the locals may find it.
So what do I think we should do? I'm not sure, exactly, except for a couple of broad principles: we should prevent banks from failing, but we should not prevent them from taking heavy losses, and managers and shareholders who require bailing out should have to pay heavily for the privilege. I find both the Paulson and the Dodd plan dissatisfyingly vague as to how we are to achieve this happy feat.
Megan,
Can you give any insight whether or not a plan to ensure continued payment on mortgages which go into default would address the situation?
It seems to me that it might be cheaper, more equitable and easier to set up an agency which, when a mortgage goes into default, would take the mortgage over, and ensure continued payment at some pre-specified rate (maybe 80%, maybe %100, no idea what the numbers would need to be). Some punitive measure would need to be applied to the mortgagee such that it wasn't desirable to walkaway from a loan, even if the mortgagee is upside-down.
Even so, wouldn't this address a lot of the underlying problem with the markets for the mortgage backed securities?
This seems pretty obvious to me, so I assume I'm missing something. Can you lay out what it is?
I think Paulson and Bernanke have been reasonably clear about how they would value securities that they purchased. You specify parameters and an amount, e.g., that you will buy $10 billion of BB RMBS with at least 7% credit support, backed by a pool with not more than 50% subprime mortgages and a current delinquency rate not greater than 8%, and take the $10 billion offered at prices that produce the highest yield to maturity. (These are just illustrative parameters; I'm not sure if there very many securities that match that description.) At the beginning, you'll get the most desperate institutions selling, but eventually prices will probably rise as price discovery takes hold.
What I'd like to know is how Ms. McArdle will figure out how much to get back from each solvent bank executive she can find. What if it turns out that the amount a person "should" give back is less than his losses from Bear Stearns stock: does the government make it up to him?
The whole theory of what the bailout is to accomplish depends on the pricing of the assets, and then what the government does with them. I don't think Paulson and Bernanke are saying quite the same thing. Is the Treasury still sticking with the reverse auction idea? Bernanke's ideas about pricing seem to be a bit different. Does the Treasury expect to hold the assets to maturity, as Bernanke has suggested?
It seems to me this stuff really has to be nailed down in the enabling legislation.
My gut feeling, obtained from being in and out, and in and out again, of the mortgage business for a couple of decades, is that there was fairly consistent pressure to relax underwriting standards, on even supposedly fully conforming, prime-grade, Fannie Mae paper. It certainly seems to me that buying a house with a Fannie Mae loan 20 years ago, with less than 10% down, and with income/debt ratio issues, and/or credit issues, was a lot more problematic in the mid eighties than was the case ten years ago, to say nothing of four years ago.
My instinct tells me that the descent into sub-prime hell was merely the continuation of a trend which is the inevitable outcome of having a mortgage industry dominated by a giant or two which benefits from an implied guarantee from the Federal government, while the Federal government tells the giant(s) that expanding home ownership is one of it's primary goals.
This was just a small point, but I don't get it:
"You know who made most of the money on the subprime bubble? Anyone who bought a house in the last ten years. Yes, that's right, you, with your low fixed interest rate on a reasonably sized house. You're the profiteer who laughed all the way to the bank."
I bought a $150,000 house in 2003 with 20% down at the basic interest rate at the time. No ARM. It was not an investment based on a rising market - beyond hoping it appreciates some over time. The market has dropped so if I have to sell my house now, I lose 10 to 20%.
Easy loans flooded the market with buyers so my house cost more than it should have if there were real standards to get a mortgage.
So I lose by paying an inflated price, I lose by not being able to sell at that inflated price and I lose by having to pay to bail out others who overpaid and can't keep up.
How am I a winner?
All anyone is talking about is how to do what we shouldn't do and wouldn't do if only things weren't so bad. So we'll do it anyway and then get back to capitalism - like that's likely to happen. Enough.
Let's talk about what rules/regulations have to be modified or suspended for the market to fix this. There will be bankruptcies, maybe even more than we'd like, but bankruptcies are part of the creative destruction that is capitalism.
It's time we stopped being so afraid of recessions and started recognizing that they are part of the business cycle and as bad as they may be they offer opportunities for future growth.
The answer to this mess is more growth not more borrowing - we've borrowed too much - it's time to take our medicine and get ready for the next boom.
Paulson is approaching this from an investment banker's perspective. His hope is that by having Treasury offer to buy the bad securities (at steeply discounted prices), a price floor will be set, at a level in which there will be a market for the securities once again, and they'll be cleaned out of the system. I honestly think he doesn't expect to use the whole $700 billion.
My fear is that he doesn't understand how DC really works, or how the private sector interacts with the federal government as customer. Government as purchaser is very different from bank as purchaser. When the government sets aside a certain amount of dough for the private sector to use and get something built/done, every last dime of that money will be spent, and then a whole lot more. Already, the vultures, oops, I mean lobbyists, are circling. The K Street bandits are pressing to make bad auto and home equity loan securities eligible. The bad auto loan securities are themselves worth hundreds of billions.
In short, I worry that this won't be enough, and not only will the taxpayer be out $700 billion, but the underlying problem won't be resolved. If that happens, we'll be in a world of hurt.
"When pressed on this behavior, they claimed they had to because otherwise they couldn't afford a house--as if renting were a physical or moral impossibility."
Agreed, but the raason a lot of good, financiailly sound folks could not afford a home with conventional financing was because the prices of homes were so badly inflated by the easy money and loose credit. I understad the need to inject cash into the system after 9/11 but it went on way too long, and made this bubble much bigger than it had to be. The perversities of the US tax code don't help either.
Neither candidate offers anything useful on this topic, so I'll support McCain on the grounds that he wants to kill the folks who want to kill us. On economics, these guys are both bloody awful - worse than the Bush Admin probably (I know that seems like a tough bar to clear).
Megan,
How, exactly, would the Fed tell us at what price securities would be purchased?
The whole point of the reverse auction mechanism is price discovery. The most desperate sellers will be motivated to offer to sell their securities at the lowest price they can accept. In the process, this government purchase will establish a "market price" for securities for which there is currently no ready market and thus, no known price.
If the Fed came out and told everybody what they were going to pay, we would not have price discovery and private players would not gain the pricing information they need to revive a private market for these securities. All they'd know is what the government declared they would pay, which doesn't matter at all to rational economic actors.
Also, if they were to come out and tell us their ceiling, the maximum price they would pay, sellers would generally just offer to sell the securities at that maximum price. As a result, the Fed would likely be paying more for these securities than they would if they just kept their mouths shut and allowed financial institutions to outbid each other in a race to the bottom.
I don't know whether I disagree or not. But, I get worried when you say things like the reason we should commit taxpayer money to the bail out is because it will be better for everyone. Where are our good libertarian instincts? The purpose of government isn't to lift the country's standard of living at every turn. That's the sort of argument that gets us liberal entitlements.
"How am I a winner?"
You're not.
Some winners are the people who managed to get into an oversize home under a sweatheart no-money-down deal in the several years before the credit boom drove RE prices into the sillysphere, i.e. subprime borrowers during the period roughly from 2000-2005. People who took out more traditional 10% & 20% down loans broke even at best, and probably lost equity if they bought in the last couple of years.
Another big batch of winners are people who took equity out of the market by selling their home near the price peak and moving somewhere with lower/more stable housing prices (My family falls into this group, BTW).
Another group of "winners" refinanced paper equity out during the last couple of years, spent the money on something, and are now walking away from the loans,sending in jingle mail and/or declaring bankruptcy.
I have a question regarding the bailout package and the coming economic nuclear winter so many fear is upon us if Congress does not pass the bailout package.
For the purposes of this argument, let’s assume that the worst case scenarios are all going to come true.
There seems to be a growing counter-opinion (as seen by recent articles in the Economist, FT and statements from US economists) that it is far from certain that this $700 billion + bailout will have the desired effects, because nobody really knows the size of all the bad debts out there. For all we know, it could be much, much larger, in which case, $700 billion will simply be a band aid on a severed limb. I’m inclined to believe this is true, seeing that, as recently as 2 weeks ago, the feds believed nationalizing Freddie and Fannie, as well as AIG would be sufficient to calm the storm.
But I digress…
If the $700 billion is insufficient to get us out of this crisis and the worse case scenarios come true; isn’t it better for the Federal Government to conserve its funds? If we do face economic catastrophe, this country is going to have to go into survival mode. If our middle class gets absolutely decimated, we could be looking at serious civil unrest. If I remember properly, the government (in the 1930s) was very worried about communism taking hold here and this was much of the logic behind launching the New Deal. What’s to say the same won’t happen again? If not communism, perhaps another pernicious ideology.
Not only do we have to fear civil unrest, but the destruction of our middle class could put the US on the road to global irrelevance (for more details, just look at the Soviet Union).
My point is this: If $700 billion does us no good; is it not better to conserve these funds which may be desperately needed to provide massive social insurance to the millions who could potentially wiped-out by another depression? I don’t like the idea any more than you do, but preserving some semblance of social order may require it.
Do we go “all-in” now on the bailout, or do we preserve our resources to perform damage control later? Honestly, I have no idea!
In response to some agonising from Tyler, I put this up earlier over on MR:
"Martin Wolf in the Finacial Times is already using the past tense about the Paulson plan. Wolf is also running Luigi Zingales critique of Paulson.
There seem to be four "plans" now in play:
Paulson based on buying the garbage.
Dodd based on making them give an equity stake in return for clearing the garbage,
Metzler making them take loans to clear the garbage, on conditions that hurt them.
Buffet with a polite and measured combination of Metzler and Dodd (as offered to and accepted by Goldman Sachs for clearing the mess the garbage has left there).
Subject to seeing the detail, I reckon a Buffet-type plan is the US Federal authorities' (including Congress) best bet on all counts."
The key is, of course, that Metzler and Buffet price the risk of the borrower, they do not try to price the mortgage risks - on which plumber Kling's opinion looks final.
And if it is good enough for Goldman Sachs, something a touch or two tougher should be good enough for the rest of those players who are potentially solvent.
I also think it needs to be said, and reflected in conversation, that the government is actually buying something rather than giving this money away. It is an investment, not a giveaway.
Now, one can argue about the value of what the government receives versus the cash it's laying out. And there is obviously a reallocation of risk from the private sector to the public sector.
But there's as much chance, and probably a greater chance, that the Feds make money as lose money.
Eventually, the value of mortgage securities depends on the value of the underlying mortgages. The value of the underlying mortgages depends on the default rate of borrowers. Even if a historically high number of borrowers, like 20% of them, go into default, the ultimate value of these securities will be in the 80% of par range.
However, because of desperation among financial firms, who have already written them down to far less than that, and the lack of a liquid market, the Feds will be buying these securities for far less than that. They can do so because the Federal government is stable and well-capitalized enough to wait for the underlying mortgages to pay off, whereas private institutions don't know they'll be around that long. They should, in theory, be willing to sell these things for the bare minimum they can afford to receive, and the government can make a tidy profit after holding its investment for a period of time.
We don't know what this bare minimum is, so we need a price discovery event like a reverse auction. Sadly most politicians and casual commentators don't even know what that is.
Megan,
Me again. Two more of the questions you pose at the beginning of your post are addressed in my first response:
"What is the procedure for deciding how to allocate this gigantic pot of money?"
A reverse auction. Holders of securities bid to sell their securities to the government. The government buys the cheapest ones first, on up. So the funds are allocated to those that offer to sell at the lowest price.
"Does it go to the weakest banks, or the strongest?"
In theory, the weakest banks. Again, in a reverse auction process, sellers name their price and the buyer picks off the cheapest assets. The banks in the poorest shape are going to be the most desperate to sell and receive cash for their mortgage assets. If they're the most desperate to sell, they're going to be the ones offering to sell at the lowest price. Per the above, they'll be the ones that receive the money.
What TH said. I'd be interested in hearing from an intelligent skeptic (a category which seems to include Ms. McArdle, but not anyone in Congress) what is wrong with the reverse auction procedure that TH and I have sketched.
(I think TH and I basically agree, though he or she can speak up if I am wrong.)
"Essentially, we're recapitalizing the banks with federal money"
I have to disagree. That statement is entirely dependent on the price paid for the assets. It seems to me that there could still be many institutions that fail.
Give the vast numbers of topics that you post on and know nothing about, and further, don't even bother to research before going on at length, I'd be a little more charitable in throwing that sort of characterization around.
Which is just plain good advice anyway.
Given that some of the proposals involve helping out homeowners with their mortgage payments, that is, actually paying off the banks rather than sensibly defaulting on something that is worth less than they owe, I'd say that what I just wrote above applies in spades.
HAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHAHA!
I'm at the far end of that ten-year period. I bought in '98. With the standard 20% down and thirty-year fixed rate mortgage. And my house is worth less now than it was three years ago. I've got no complaints, believe me. But to claim that I somehow 'made money' is ludicrous in the extreme. In fact, just the sort of know-nothingism mein host was just decrying.
The other thing that needs to be done is to parade these execs on TV and have them publicly admit they screwed up and were definitely not worth their compensation packages. The way to get clear of this mess requires, among other things, that libertarians/right-wingers/conservatives publicly admit that THEY WERE WRONG.
Otherwise, we're just going to see a rerun of the same old same old in ten, fifteen, or twenty years time.
No, the terms were _not_ clearly laid out. I'm a PhD candidate doing some rather abstruse work in toroidal ring valuations and free resolutions using Grothendieck's spectral sequence ideas. When I looked at the contract for my house the first couple of times, I really did not have a clear understanding of what the terms were at all, in fact, I had to have a few friends help out (and modify!) with the attendant clauses, subclauses, specialized jargon, and Missouri codes.
Yes, the argument can be made that the people who signed those papers shouldn't have signed them without a clear understanding of what they were getting into. But that's a different argument. It also shows that Megan doesn't realize that most people are under the impression that their friendly realtor is on their side, not the seller's or the banks. Not true.
Please try to be consistent within one post. Up above you wanted to make sure some semblance of a banking system was intact, and you affected to sneer at anyone who doesn't think that is a priority. Yet here, you completely abandon the idea. The alternative to not renegotiating the terms between owner and lender is to have the owner default, in which case the banks will receive nothing. It is also the logical option for the homeowner, given that what they owe on is worth less than what they are expected to pay.
This isn't rocket science.
We should also, loudly and clearly, take down the mythology once and for all about unregulated market places, or taxing capital gains at preferential rates, or high-flying company officers being worthy of their pay, etc.
Because if we don't . . . the same thing will happen again and again and - you get the idea.
sent to me;
The $85,000,000,000.00 bailout of AIG.
give $85,000,000,000 to America in
a We Deserve It Dividend.
To make the math simple, let’s assume there are 200,000,000
bonafide U.S. Citizens 18+.
Our population is about 301,000,000 +/- counting every man, woman
and child. So 200,000,000 might be a fair stab at adults 18 and up..
So divide 200 million adults 18+ into $85 billon that equals $425,000.00.
Give $425,000 to every person 18+ as a
We Deserve It Dividend.
Of course, it would NOT be tax free.
So let’s assume a tax rate of 30%.
Every individual 18+ has to pay $127,500.00 in taxes.
That sends $25,500,000,000 right back to Uncle Sam.
But it means that every adult 18+ has $297,500.00 in their pocket.
A husband and wife has $595,000.00.
What would you do with $297,500.00 to $595,000.00 in your family?
Pay off your mortgage – housing crisis solved.
Repay college loans – what a great boost to new grads
Put away money for college – it’ll be there
Save in a bank – create money to loan to entrepreneurs.
Buy a new car – create jobs
Invest in the market – capital drives growth
Pay for your parent’s medical insurance – health care improves
Enable Deadbeat Dads to come clean – or else
Remember this is for every adult U S Citizen 18+ including the folks
who lost their jobs at Lehman Brothers and every other company
that is cutting back. And of course, for those serving in our Armed Forces.
As for AIG – liquidate it.
Sell off its parts.
Let American General go back to being American General.
Sell off the real estate.
Let the private sector bargain hunters cut it up and clean it up.
This plan only really costs $59.5 Billion because $25.5 Billion is returned
instantly in taxes to Uncle Sam.
Birk
T. J. Birkenmeier
What's wrong with the reverse auction idea is just that there doesn't seem to be much evidence that (1) it will work and (2) the taxpayers won't get killed on the deal. I mean, the markets are trying to tell us that the worst assets out there are not likely to perform well. The Treasury wants to dump $700 billion in a kind of procurement auction on the worst assets the financial industry can dredge up, and somehow we assume that this action will just happen to be exactly enough to restore liquidity and solvency to our banking system and that the assets will perform well enough that the taxpayers will come out ahead? Dr. Pangloss is a skeptic on this deal.
Why not loans then? Why a bailout gift? If we believe that all this money will rescusitate these companies, shouldn't they be required and presumably able to pay it all back in a couple years?
judson,
I would suggest that Mr. Birkenmeier use his cut for math lessons.
Allan Meltzer said to just loan the 700 billion to the troubled institutions.
SOV, what is this "unregulated marketplace" to which you refer? The one which was dominated by two players which had an implied taxpayer gurantee attached to the paper they issued?
Yancy,
Birk is probably using the British definition of "billion," which corresponds to the American "trillion" (American "billion" being British "thousand million").
So he needs not math lessons--he got that right using Brit math--but some notion of the size of the US economy and Federal budget.
For someone who has no formal education in economics and has only spent one summer working in finance, you seem rather sure of your own analysis.
Parsing your posts, it seems like you are doing little more than regurgitating the conventional wisdom found in other places. What exactly are your qualifications for thinking you have the "right" answers?
MutualMatt, is there something about the phrase "I'm not sure, exactly" which indicates to you that someone is excessively confident in their analysis?
I'm surprised nobody has laughed at Megan for using the word "site" instead of "sight" when referring to her observation of Byron Dorgan. It's as though everyone knew she meant the actual sight of Dorgan on TV, and not that she was perusing his website.
SOV, what is this "unregulated marketplace" to which you refer? The one which was dominated by two players which had an implied taxpayer gurantee attached to the paper they issued?
Posted by Will Allen | September 24, 2008 4:40 PM
I presume he means the one where they (and the rest of the investment world) were not required to follow sound lending practices, regardless of that "gurantee."
I'm at the far end of that ten-year period. I bought in '98. With the standard 20% down and thirty-year fixed rate mortgage. And my house is worth less now than it was three years ago.
So is mine. But I'm pretty sure I'm still ahead of where I was in '98, when I bought it with 5% down. How about you?
It will be interesting to see if my tax valuations go down next spring. Not holding my breath on that one...
Borrowers were not brought down by predatory lending. The terms that are causing trouble were clearly laid out in their loan term sheets, right on the top of their mortgage package. Borrowers were brought down by a willingness to gamble on rising home prices--exactly the same thing that knocked out Lehman Brothers.
This is a bit flip, Megs. Yes I'm sure a lot of borrowers were betting their houses would be worth more in the future; maybe even all of them were. But you also had mortgage brokers telling them everything was dandy, go ahead and take that ARM. You had "flip this house" TV shows extolling the virtues of buying to renovate and sell, netting a quick profit (how do you think the buyers financed those renovated homes). I think there's plenty of evidence that predatory lending did occur, in at least some instances. Laying it all on the borrowers for being greedy is to some degree blaming the victim here.
Do we go “all-in” now on the bailout, or do we preserve our resources to perform damage control later? Honestly, I have no idea!
Posted by Tyler | September 24, 2008 2:53 PM
What I'm continually hearing is, if we don't do some kind of bailout now there may be no point trying to do damage control later.
Thanks a lot, wise old men of Wall Street! Heckuva job! We gave you the deregulation you asked for, and what did you do with it? Ran hog-wild. What a mess.
Channel surfed past MSNBC's horse race coverage just a moment ago and it got me to thinking.
Is it possible that getting this bailout right is more important to our country for the next four years than which of our alternatives is President?
Megan said:
Why should shareholders ever require bailing out?? One key for me is that I think shareholders of bailed-out institutions should take a major haircut. That's why Prof. Zingales' idea of a mandated debt for equity swap appeals to me.
Jim
"What's wrong with the reverse auction idea is just that there doesn't seem to be much evidence that (1) it will work and (2) the taxpayers won't get killed on the deal."
I don't know how one would prove that any idea is certain to work. But if I had the CEO of Goldman Sachs and the chairman of the Princeton Economics Department recommending something, I would weight that a lot higher than Senator Dodd. I would weight it even higher than Megan McArdle.
y81:
Well, if we can't question anything proposed by Paulson and Bernanke because their authority trumps all, I guess we're done here.
These are a great series of posts, and I am learning a lot. I thought the line about "sympathy" and college bands was great. But there is this one point that seems pretty importantly off to me:
You know who made most of the money on the subprime bubble? Anyone who bought a house in the last ten years. Yes, that's right, you, with your low fixed interest rate on a reasonably sized house. You're the profiteer who laughed all the way to the bank.
Those fixed low interest rates, I think everyone can agree, were part of what was driving an unsustainable rise in the price of housing. So "you", who bought your house with a low interest rate mortgage in the last few years, also probably paid a lot more for that house than it's really worth. Which seems to me to pretty much cancel out your winnings.
The person who sold that house made a lot more money, flat-out, than he should have. So that would make him a winner. But he also probably had to buy a new house, which he bought for more than it was worth. Bye-bye winnings. And then, you, the house buyer, probably also sold your previous house for more than it was worth, perhaps making you a winner again.
But ultimately, at the end of this game of musical chairs, if you bought a house in the last 3 years then you are still likely stuck with a house that is worth less than you paid for it. So you're not a winner. Right?
"I don't know how one would prove that any idea is certain to work. But if I had the CEO of Goldman Sachs and the chairman of the Princeton Economics Department recommending something, I would weight that a lot higher than Senator Dodd. I would weight it even higher than Megan McArdle."
So if the recommendation was that the Harvard endowment should be split 50/50 and transferred to Goldman Sachs and Princeton would you still weight the opinions of the CEO of Goldman Sachs and the chairman of the Princeton Economics Department?
Before you say "fine, but that doesn't explain why the chairman of the economics department of Princeton would say that", do you know what the holdings of the Princeton endowment are? They've got $8.3 billion. Think there's nothing there that's going to get bailed out by the government?
Megan, when you say that house buyers over the last several years are the ones who made the money, I'm pretty sure you meant to say house sellers instead. It's not the guy who buys at the peak of the market that makes the money.
When Bill Clinton eased banking restrictions in California, he also dished out $8-billion dollars for "community reinvestment loans.” Did the money ever get paid back: no. Undoing regulations sets a precedent, as does "comping" real estate. With the influx of cheap capital, properties already overvalued at $125,000 inflated to $525,000. When the “creative financing” schemes fell through, as is their wont whenever 30-million Mexican nationals buy inflated properties and default, it left bankers around the world in the lurch (see global economy). Never mind that the aforementioned demographic is the new face of the Democratic Party; because of rampant “creativity” and subjective prices, Congress simply cannot determine the worth of the financial instruments. It’s a $90-billion bailout at best. But if you want to thank someone, thank Hillary Clinton. She knew who’d get the loan giveaways; she knew whose votes she’d buy. So, why should hardworking Americans perpetuate the housing bubble? Why write the people who created the bubble a blank check? Now they're saying pony up a trillion-dollars, as a cost of doing business. The bubble is the problem; let it burst. Let the Dems pickup after themselves, let those 18-million cracks pass the hat: http://theseedsof9-11.com
Steve Johnson: actually, if there's one thing I am fairly confident of, it is that Chairman Bernanke does not spent a lot of time devising measures with an eye to helping the Princeton endowment.
"actually, if there's one thing I am fairly confident of, it is that Chairman Bernanke does not spent a lot of time devising measures with an eye to helping the Princeton endowment."
It's funny how people end up being convinced that actions that help them and their friends are the ones that are absolutely necessary and right. Guess it's a little evolutionary trick; easier to convince everyone else if you're actually being sincere.
Heads should roll in congress for their part in this.
ScentOfViolets - I am only a lowly electrical engineer, but I have taken 5 mortgage loans over my lifetime. I have had both ARM and fixed loans. There really aren't that many variables. For ARMs, the initial rate, the absolute max rate, when it is adjusted and how much per adjustment, what it is indexed to. For fixed, the rate, the term. In both cases, whether or not there are prepayment penalties. To mention a few.
I have never found it difficult to understand the basic terms of the loans - unless you are applying for something truly exotic, it isn't rocket science. A couple of things that bother me that I have heard noone mention:
1) the role of fees (they *are* hard to understand - probably because many are utter BS ). In the case of fees, a lender has no risk in the event that a borrower defaults - because it is paid up front. My sense is that lenders were more interested in collecting fees than in the loan as an income stream. This is perhaps something that deserves regulation.
2) People are qualified for ARM loans based on the teaser rate - even under guidelines regarding percentage of your income can go to paying installment debt. I guess the theory is (wishful) that the income will rise by the time the rate adjusts upward. Or maybe they don't care.
"I'm surprised nobody has laughed at Megan for using the word "site" instead of "sight"
She also missed the difference between straightened and straitened.
Thank you so much for giving me hope that someone has a clue about what is going on.
Now, could we please allow Americans trapped with huge amounts of retirement funds to tap them to get themselves out of debt without having to quit their jobs?
Desperate times, desperate measures.
Andrew, you never cease to amaze me.
Though you FINALLY came around to realizing that Bush and co. were unrepentant liars (a fact that some of us understood back in 2000) and you FINALLY came around to the fact that the republican party is utterly morally bankrupt (a fact that some of us recognized back in the 90s) You STILL insist on a perspective that makes the perfect the enemy of the good.
I point to this quote. "This does not exactly fill me with soaring confidence in Congress's ability to allocate the money. I'd rather trust Paulson."
Really? You'd really rather hand a Wall Street deregulator a blank check for 700 billion. You'd really rather have a Bush appointee deciding how to spend taxpayer money than the imperfect, but at least somewhat responsible, idea pushed by democrats?
Andrew, I love ya, but you're still held captive by the core conservative ideal that government is inherently dysfunctional and is incapable of doing things better than private enterprise.
I admit that private enterprise is better at SOME aspects of society. Innovation, for example. But government bureaucracy is practically made for repetitive, routine tasks. And with recent advancement in technology, there is no reason to believe that such bureaucracy is incapable of being streamlined to be both effective and fair to the taxpayer.
Medicare and Medicaid and government sponsored health care are ALL more efficient and reliable than the private variety. Yes, as a member of the armed forces I had to wait in a line to get medical care. But since I LEFT the armed forces, my health care has been strictly hit-or-miss, depending on the half-dozen jobs I've had since my discharge.
I understand you are, at your core, a conservative. I can respect that. But at some point you must accept that pure conservative ideology results in the grotesque mismanagement of the nation.
I know that you've espoused many of these views in the past, but many of your posts still reflect the reflexive anti-government, pro everyone-for-themselves views that conservatives are known for.
And then, much to my dismay, I realize that I posted a message for Andrew Sullivan in Megan McArdle's blog.
Color me stupid.
OK, now for something constructive that nobody will like. We have way too many leaches and not enough producers in this country. Easy for me to say, since I am a leach of sorts myself. After all, those are the only jobs left to take. If you want a job that actually does - or God forbid, makes - something these days, you have to either be an entertainer or go into business for yourself. And even entertainers are quickly becoming commodities. But our tax, insurance and credit systems screw sole proprietors to the wall and make sure they don't try too hard to be productive or original.
For the last 28 years, our elected officials have basically been saying to anyone who wants a real job and markets that sell real things, "What's the matter with you complainers? Are you too good for cheap, mass-produced imports that fall apart every five years? Why they've gone out of style by then anyway! There are new marketing campaigns we need to support. Now go find a job at XYZ insurance consulting and max out your credit cards like everyone else."
Averting a total financial meltdown is all good in the short run, but we need to totally readjust our whole economic system. (1) Our tax code needs to be more transparent and easy to understand, so people can plan their finances with confidence. And (2) we need to regulate the shit out of the banking industry. You will note that part two, rather than being revolutionary or even liberal, is in fact conservative and maybe even reactionary. We actually had these regulations in place from FDR up until Reagan. Looking back on those times, they don't look so bad now, do they? You fucking greedy idiots. And trust me, I understand that none of this will ever get fixed because Americans long ago lost touch with the fundamentals of life, which are also the fundamentals of economics. Welcome to the bed you've made.
The one idea I don't hear and think would be most instructive is to wait and see what happens. We don't really understand the dynamics of our current financial system and it's not assured that the same people who were advising us that everthing was fine just a few months ago are now proposing the right solution now that they have had their Saul to Paul conversion.
Once the markets get the idea that we can be fearmongered into payouts you can bet the markets will all run to one side of the boat, jump up and down and scream, "We're all going to DIE!" Yawn.
I find all this melodrama rather offputting.
Paulson will direct a good deal of the money to GS and other banks he happens to favor. This really isn't any different that what Cheney did with Halliburton.
Buffett sees the future and puts a big chunk of cash on the GS square albeit at onerous terms for them. Bill Gross is salivating so hard that he's offering to come carve up the mastodon for free.
In other words, the vultures are circling over the carcass of all the soon to be dead regional banks, ready to pick the bones clean.
We need to show a little more intelligence here than a typical jarhead if we don't want to get fleeced. You aren't helping all that much, unfortunately.
The most important thing we can do right now is simply say NO. NO BAILOUT until the new president is sworn in. Simple. Sensible. Unlikely.
Two problems that I see with the Reverse Auction.
First you will buy above market (maybe only slightly). The firms can sell at market so the only think that induces them to sell to the government is a higher price.
Second, within any asset class you will buy the worst of the bunch. Not all A rated mortgage backed securities are created equally. And in the reverse auction we will be guaranteed to get the worst of the bunch.
John Allison, CEO of BB&T, and fellow Objectivist, has written congress on his thoughs about what congress should consider doing next. Needless to say, the "bailout" in any form that it is being considered is NOT on the list of 14 points to consider, and the primary cause of the mess, govt intervention via Freddy and Fannie, is articualted clearly.
A limited address of hte mortgage crisis only is recommended and not via any sort of purchase of assets, instead to help the workings of private mechanisms of clearing of these issues.
The full letter can be read here:
http://media.gatewaync.com/wsj/pdfs/2008/09/allison.pdf
I'm interested in your thoughts on it.
Kendall Justiniano