Quote:
Originally Posted by Penn
nmap, Is it correct to assume that this article on the governments action, forestalls a world wide depression, caused by the bad bets in the mortgage markets? And is it also true, that the sub prime mortgage market that was created is linked to the Feds willingness to lend banks money without oversight on their balance sheets? If they are both true, is it correct to assume that by creating this new agency, the Government is, in essence, buying out the debt via a guarantee on the American economy and taxpayer?
If these assumptions’ are correct; how then are those who made their bets in this market held responsible. Secondly, would not the Government take possession of the assets as well as the debt? And would the debt be sold off, a la Milkins junk bonds, which create a new market? And the hard assets, would they be sold?
Or, are we, the American people, guaranteeing a bad portfolio with no hard assets and nothing to recover or sell?
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1) It may have prevented a depression; keep in mind what Team Sergeant said about a house of cards. That house rests on some key supports, one of which is relatively cheap and available credit. If people and banks hoard cash, because they are afraid they won't get their money back, then credit ceases to be available. Without credit, business activity declines a lot. If money is the blood flowing in our commerce system, the present halt in lending is like a heart attack. It's also worth noting that Bernanke is far more concerned about deflation than inflation. Declining housing prices, the recent decline in commodity prices, and reduced business activity cause some to think that the real threat is deflation - and, from the perspective of fighting deflation, the bailout is probably a good idea. Here is a link to a speech in 2002 by Chairman Bernanke
SPEECH.
The problem is a bit more troubling than just bad bets in the mortgage market - rather, the entire mortgage market was structured so that those originating the mortgages could make a great many loans, including bad loans, with minimum risk to their own capital and with most of the risk transferred to others. After a mortgage broker with no risk exposure made the loans, the loans were sold and packaged as securities few understood. Then, the underwriters (the ones who put the packages together) got bond ratings based on what the creators of those packages told the rating agencies - with NO independent analysis by the rating agencies. Brokers then sold them to investors who trusted the rating agencies. Notice that no one with direct contact with the borrower has any chance to evaluate that borrower. In fact, those who do the transactions make money no matter what the borrower does. The problem is not bad loans, it was (and is) a bad design.
The present system takes the risk away from the banks or other mortgage lenders and transfers part to the borrowers (home buyers) in the form of adjustable rate loans. It also seeks to transfer risk to people who buy packages of loans. Notice that the loan originators have zero risk - and hence, no incentive to be cautious. As long as they can find a borrower (no matter how dubious) and a buyer for the loans, they make money. In essence, the core of the problem is a group of smart people who were either too optimistic, or who bent the truth to their own ends. I suspect it was a little of both.
2) On the second assumption - Fed willingness to lend - it is my understanding that problems with the mortgage loans came first. The rapid escalation in housing prices - far above the level implied by wage rates - was ringing alarm bells some time ago. A fairly obscure paper from 2004 (
HERE ) discusses implementation of a variety of emergency policies, including what we are seeing today. It became (again, according to my understanding) a hot topic in Fed circles along about 2006. The problem is that we had a high-tech stock bubble, which crashed. Greenspan then encouraged a housing bubble to offset the effects of the failed stock bubble. Now we witness the consequences. What pulled the trigger on the housing crises? My (probably biased) suspicion is energy prices. People had trouble with gas prices, then fell behind on their mortgage payments, and the flaws in the system became manifest. That said, I strongly suspect the Fed knew there was a problem long before we did - they just did not want to deflate the bubble because the consequences were likely to be painful.
3) Third assumption - Yes, the U.S. taxpayer is about to make a big guarantee. This will involve a great deal of money; perhaps a big part of a trillion dollars.
4) Those responsible for creating, packaging, and selling these securities will never be held accountable. They have looted the economy - from the borrowers (who share some culpability), to the investment managers of pension funds and other entities that purchased the bonds. The victims include banks and other investors from Japan to Germany to the U.K., as well as in the U.S. Those who did the looting made millions and tens of millions. Were we sharing a cup of coffee, I would probably say some things about the justice they deserve. However - those who bought the securities, especially on behalf of pension funds - share some guilt. The buyer has a responsibility to do their homework. These buyers did not.
5) The debt is an asset. Those mortgages have some value. Perhaps it is only 22 cents on the dollar - as when Merrill Lynch liquidated some of the mortgage securities it held. Given time, the mortgages may have greater value. What if the government has to foreclose on a property? Then the government owns a property, such as a house. This all happened before, back in the late 1980's with the Resolution Trust Corporation. A certain very exclusive neighborhood and country club were owned and managed by the RTC for a time - as were a great many more modest properties.
6) The government could sell the debt, but probably will not. A mass sell-off would drive prices down to low levels, resulting in a greater loss to taxpayers. It would be wiser to hold the debt and, perhaps, repackage it or sell it off gradually. The hard assets, such as houses, will be sold over time.
We, the taxpayers, may come out of this with only (Only! I can't believe I wrote that) a hundred billion lost, and maybe less. We'll probably see some inflation. But our real problem is deeper and more insidious. The market imposes discipline through risk and loss. If an investor makes a poor decision, they lose money - and they avoid doing it again. However, if they make a poor decision and get a bailout, they learn that the risk is small, and the chance for profit is large. Therefore, they do it again. So - wait 15 to 20 years and you will see a repeat performance of the present situation. It will be more expensive and painful. At some point, it becomes too big to bailout, and then a true monetary failure occurs.