Ever since the start of the mortgage crisis—whose origins and effects can be revisited at this post, or on this podcast—I’ve been waiting for the great taxpayer-fueled bailout to begin.
The bailout of Bear Stearns was a mere appetizer to the cliff we’re falling over now:
Government efforts to support mortgage giants Fannie Mae and Freddie Mac drew a restrained response from investors today, with the stock prices of the two companies rising only modestly after last week’s steep collapse, but by midday investors turned to a new target of the credit crisis: banks.
To recap briefly:
1. The investment banks and mortgage markets were effectively deregulated through the 1990’s and 2000’s…
2. …allowing the creation of mortgage backed securities…
3. …that were increasingly backed by shoddier and shoddier mortgages…
4. …making what was once one of the most stable and socially productive investments both incredibly risky and socially catastrophic, with no way for investors really know if and when the transition happened…
5. …leaving the investment banks, mortgage companies, regular banks and even the government sponsored enterprises on the precipice of catastrophic failure in a way not seen since the Depression, when these institutions were last similarly deregulated.
Market theory would tell us the government should not intervene—these institutions should be allowed to fail, the unwise investments allowed to collapse and the money to be lost. At the last height of Laissez-faire economic policy, in the 1920’s, that was the plan. The institutions were allowed to collapse one-by-one, causing the Great Depression.
That didn’t work out so well. In the 1930’s, sifting through the rubble of the US economy, the next plan was regulation. If we think of modern financials as being like junk food—made of many ingredients, intrinsically difficult to discern—knowing the providence of the starting materials really matters. Many of the New Deal regulations did just that—demanding that companies report honestly and completely on their health, that mortgages be attached to information about the borrower indicating an ability to pay and so on.
By making information about investments as honest, comprehensive and accessible, through laws and oversight, investors could avoid the most questionable of financial junk food and thus get fat on the rest. If they did pour money into something obviously dubious, it was far easier to allow the market to do its job, and make the investments as valueless as they had appeared to be. You could easily tell it was crap before you put your money in. You lose it, it’s your loss.
These were the regulations written out of existence, or circumvented, in the years leading up to the present crisis.
Like with junk food, the companies and people doing the processing make most of the profit—making the producers (the investors) and the consumers (the borrowers) pay dearly for participation in the market—all while whining they cannot afford things like complete and honest information about what they are selling. Loan agents eventually stopped checking income, employment, the value of the property or the credit history of the borrower, because the mortgage companies stopped asking the loan agents to collect this information, because the investment banks buying up these loans stopped asking as well. The investors buying from the banks didn’t really care, as the bond agencies gave the blended investments the highest ratings. The rating agencies, increasingly deregulated, didn’t bother asking for this information either. Without it, it was impossible to predict how the loans would perform. They guessed. They were wrong.
Even though only a small percentage of the borrowers failed to make their payments, without information to tell bad from the good investors became spooked. If the rating agencies couldn’t tell the value, how could an investor? The lenders rapidly pulled out of the market. First to fail were the investment banks, stuck with loans they could no longer sell to investors—even if the loans were good. Bear Stearns, such a bank, quickly grabbed a handout from you and I, the taxpayers. Next, the mortgage companies and their related banks start to wobble. Indymac just collapsed, and again the taxpayers are asked to reach into their wallets and pay off the FDIC guarantees.
Which brings us to the bailout of Fannie Mae and Freddy Mac. These are Government Sponsored Enterprises that were created to perform a basic and seemingly unavoidably safe and profitable task: Buy up high quality mortgage loans from banks and package them as securities that can be sold to investors at a profit. In essence, this is the honest version of what all the crooked private companies were doing—in which each loan is carefully vetted and matched to the borrowers ability to pay and the honest valuation of the property. These companies are of vast importance to the entire housing market, allowing banks to make far more mortgages than would be possible if each loan had to stay at the originating bank and not be resold. In the wake of the crooked mortgage-backed securities, investors have stopped buying the Freddie Mac and Fannie May mortgage-backed securities. With no investor money coming in, they can no longer buy up loans. In steps us again, the taxpayers. We’ve now committed our tax dollars to buy up mortgages—money we are ultimately borrowing from the Chinese.
These bailouts aren’t helping homeowners. The dishonest crooks—the loan agents, the investment banks, the rating agencies—are having their asses saved with our tax dollars. And, this is happening without any serious re-regulation, without a strong requirement for honesty and clarity on the financial industry’s part. From any perspective, this is the worst outcome, virtually guaranteeing another huge bailout in a few years. With no concequences, and so many of those well positioned getting filthy rich off the fiasco, why not do it again, and again, and again?
If we force those who demanded deregulation in the financial industry, who took advantage of the deregulation to dupe others, into an honest position, we’d let them all fail, dragging them out of their windows to the hard streets below, to live under overpasses and eat pet food like their parents and grandparents were forced to do during the last time they ran us all off the cliff. We’re too cowardly to do it and will likely pay an even harsher collective price thanks to this cowardice. We’re too frightened to let them fail, and suffer as well. I’m frightened of what the collapse will bring. Our political leadership, long greased with Wall Street money, won’t even demand rules that will truly complicate such thievery in the future. You should be furious.