grimmeissen
Administrator
Join Date: 1/14/2004
Posts: 1217
|
|
|
Posted: 10/2/2008 8:54:42 PM
|
|
|
 Over the past few weeks I have been watching the financial markets closely. Some of my regular readers have been asking me why I haven't been writing with all of this turmoil going on. Why am I not on here ranting like crazy? The simple truth is that I absolutely cannot believe what I am witnessing. I was so dumbfounded by the situation that I was put in a place where I had nothing to say. I was still trying to figure out if I lived in Red China or in the country that supposedly leads the free world. To top off my confusion, my "capitalist" government decided to ban short selling of stocks to prevent them from going down, while days later "Communist" China was legalizing it. Faced with the reality that the United States and China are moving in opposite directions when it comes to economic freedom, I really had nothing I could say. But since I've gotten some requests, I'll go ahead and detail the proposed Wall Street bailout and I'll prove why our government's desire for socialist paradise will once again cause way more harm than good.
Before I go into detail with my thoughts on the "rescue" plan, I will outline the major points that I am going to make. You could really read just read the following bullet points and understand the entire concept of why this bailout is a bad idea, but I will give you the thorough analysis anyway.
1. The easy credit days are numbered whether the government provides a bailout or not.
2. The credit system has proven to be a failure, so why try to bail it out or keep it alive?
3. Since the bailout will not prevent the inevitable, why allow the people who perpetuated such a system get off without losing while the rest of us get burned?
4. The bailout will only serve to keep bad companies in business, rather than getting them out of the way.
5. This was not a failure of the free markets. It has been a failure of government intervention in the markets. The credit bubble that we are seeing explode now began several decades ago. Government deficits became a regular routine. Political leaders from both sides of the aisle decided that they could spend money without limits. They spent money on a massive arms build-up, even after our only major international enemy was going bust in the 80s. They spent money on pork projects, foreign aid, welfare, and anything else they could think of. But the biggest driver of the credit bubble was when they decided that the "American Dream" was for everyone in the country to "own" a home.
The beginning of the story actually goes back many decades earlier. Fannie Mae was first created in 1938--along with many other New Deal programs that ushered in the era of economic socialism. To help more citizens achieve the "American Dream" that the government decided for them, the United States opened up its credit lines for real estate buyers. It seemed at first to be a good idea (as most government programs do). The credit markets were very tight coming out of the depression and it was difficult to purchase property without saving for it first. What a dreadful situation it must have been to force yourself to save before consuming. So Fannie Mae was created, at first as an outright government institution. Not surprisingly, this institution became a huge bloat on the federal balance sheet, so only a few decades later they were looking to "privatize" it.
In 1968, Fannie Mae was finally removed from the federal balance sheet and turned into a private corporation. However, because the law makers still wanted to use it to provide socialism in the mortgage markets, they turned it into what is now known as a government sponsored enterprise (GSE). The books were out of federal hands, but the company maintained direct credit lines with the Federal Reserve and operated under an implicit guarantee that the United States Government would never let it fail. To provide "competition" for Fannie Mae, the government created a separate GSE called Freddie Mac in 1970. Freddie Mac entered the same market with the same beneficial ties to government as Fannie Mae, thus creating two monsters--neither of which operating on the same restrictions as other free market financial firms.
The GSE's operated mostly in what is called the secondary mortgage market. To encourage lending at the local levels, Fannie and Freddie would buy up loan assets from regional banks and take them off the balance sheets of these institutions. This created an excellent situation for banks, who could make loans on the open market, take their fees, and then sell the loans--along with the risk--to the GSE's. Because of the direct lines of credit to the government, very relaxed rules on capital ratios, and the implicit government backing; Fannie Mae and Freddie Mac could leverage themselves with much more debt than regular banks.
The secondary mortgage markets created a system where banks no longer operated on the fear of mortgage default. The GSE's began buying up almost any loan, especially when government officials berated them about getting more sub-prime borrowers into homes. The now-massive supply of credit coming from these government-sponsored enterprises created a new supply of buyers in the housing market. Over several decades this surge in demand caused home prices to skyrocket. It started taking ever more debt to purchase even the most modest of homes, but the GSE's continued to supply the funds.
Fannie and Freddie then began to package their loans into instruments called "mortgage-backed securities". These securities were purchased on the open markets because of their high yields and their perceived safety--again, because of the implicit government backstop. Mortgage-backed bonds were packaged together in massive, complicated derivatives. Sub-prime mortgages were lumped with prime, good rates with bad, but all of them were given outstanding credit ratings because of the government presence. Some of the banks who originally sold their mortgages to the GSE's actually began buying them back. Rather than in their original form where the banks knew and understood the risks, this time they took them back in packages that even the most sophisticated financial analysts could not understand.
Finally, in 2007, the straw broke the camel's back. The unsustainable run-up in housing prices started to pop. Because of the massive leverage built into the system based on the huge debt loads of the GSE's, even the smallest price declines caused ripples in the credit markets. The values of the mortgage-backed paper, and the home values that they were based on, began to plummet. By now, we have financial institutions sitting on paper in which they have no clue what the value is and at this point there are NO buyers. Fannie Mae and Freddie Mac--built out of the benevolence of our trusty government--have created a bubble so huge that it could take down the entire financial system when it pops.
So now that we know how we got here, I will describe what is happening in the credit markets and how the government plans to fix the problems. Unsurprisingly, the government and financial institutions plan to repair an unsustainable bubble by continuing to blow air into it. Their solution is to continue throwing money at the situation, never allowing prices to come down, and never allowing the markets to fix themselves. Even those with limited economic knowledge can see how this activity will only serve to perpetuate and make worse the condition that we are in now. It's like trying to put out a fire by dumping gasoline on it. Put more bluntly, it's like trying to end a credit bubble by issuing more credit!
The Secretary of the Treasury Henry Paulson, The Chairman of the Federal Reserve Ben Bernanke, many officials in Congress, and nearly anyone in banking or on Wall Street believe that the answer to the problem is for the government to step in with $700 billion to purchase some of the mortgage-backed bonds that are rotting away on the balance sheets of major banks. They believe--and rightly so--that this bad mortgage paper has hurt the capital situation of the banks so badly that they are unable to provide the required credit for the financial system to function. On this assessment they are correct. The credit markets are tightening drastically, making it difficult for anyone to borrow for anything from car purchases to lines of credit for small businesses. They are clearly able to see the major problems in the system, but where they are going wrong is with their proposed solution.
As I mentioned before, the financial system as it has operated for the past few decades is unsustainable. The banking system has made debt very easy to come by, largely aided by Fannie Mae, Freddie Mac, and their direct line to the Federal Government's printing press. When a bank or the government issues credit, they are in essence creating money. And by creating such a massive amount of new money, they created price inflation. The same amount of people were chasing the same goods and services, but were doing so with tons and tons of new money; either real money or that created by the stroke of a pen in a loan agreement. As the new money forced prices to rise, it created a self-perpetuating bubble. The bubble grew bigger, and even more debt was needed for the average person to pay for things at the new prices.
So if you understand the process by which credit created the massive price inflation we have seen in housing and other areas, and you can see that this system based on debt rather than savings is unsustainable, then you must be able to see that throwing more money at the problem would be a huge mistake. The government doesn't have $700 billion. They would have to resort to the printing press to create it. This would create 700 billion new dollars that would hit the market to prop up home prices. And what about those people who have saved dollars and have them currently? Well, they would be holding money that would be worth $700 billion less, and will not be able to see the day where home prices can come back to a sustainable level where they may actually be able to buy one without excessive debt.
It is my opinion that no matter how much money the government throws at a problem that they themselves created, they will not be able to win the war against the market. The market has already shown that it is resistant to our current financial system. Never-ending creation of money through credit drives up prices and forces people to live on even more credit. The bubble continues getting bigger and bigger until the day it pops. That day is now.
So if the bailout plan can't win against the market's desire to force us to save rather than consuming on credit, what exactly would it accomplish? Well, firstly it would keep a lot of bad companies in business. Although they operated on a manipulated platform thanks to the efforts of our government and the GSE's, the banks still willingly entered themselves in these transactions and operated for several years with no tolerance for risk. Any of these businesses deserve to go under and our government should let them. Wall Street is using "systemic risk" as an excuse for us to provide them $700 billion to bail them out of deep water. You don't see any kind of rescue packages offering money to the common people do you? And they are the ones who are supposedly going to get hurt by this mess. How about we let the market correct, and in the meantime just give the money to the people? It's still socialism and is a terrible idea, but I'd rather let them have it than some greedy banker.
And this brings me to my final point about "greed" in the markets or "failures" in the market. Leftists are correct when they say that players in the market are greedy. That is the whole nature of business. They only exist to make money, and they will use any method available to them and allowed within the system to make money. So in that case I do not blame the banks for writing so many loans or the borrowers for taking so many of them. They made mistakes and deserve to get punished as their free ride goes away, but in reality they were just playing in the system that our government gave them.
Had the free markets been allowed to operate without government intervention, banks would have never gotten so heavily into the credit markets. If they were forced to keep the loans on their books and mange the risks themselves, without the help of the secondary market provided by the United States and its GSE's, they would have been much more careful who they loaned to. While there still may have been some greedy players in the game who took advantage of people, they would have never been able to create such a stress on the entire financial system.
Only the federal government has the power of a printing press and the power to take sweeping action that affects the entire population. So if we have systemic risk, it is because of the system that our government gave us. They have again proven to us that socialism, big government spending, and manipulation of the markets does not work, and because of their efforts, we are possibly looking at a depression in this country. Do not blame the deregulated, greedy businessman. Blame the government for writing him a blank check.
We are going to face a painful economy in the next few years whether there is a bailout or not. If we don't get a bailout, many companies will go bankrupt. The credit system will freeze and it will take a while for people to adjust back to a lifestyle where they depend on savings rather than endless debt to finance their lifestyles. And while the bailout cheerleaders on television might say that this is a terrible situation, I do not agree. Although it will be a very painful transition, it is one that we must take if we want to return to a stable financial system.
If we do get a bailout, they will never be able to pump enough money into the system to trick financial companies back into making the ridiculous loans they made in the past. The banks will immediately dump all of their bad paper, placing the burden on tax payers, and they will still tighten the reigns anyway. You get the exact same outcome as with no bailout, except that some of those greedy, failed businessmen will stay in power. They might be able to delay the credit correction for a little bit, but they can't stop it. Do you want to have a 10-year depression as we did following FDR's failed New Deal policies, or do you want to have a couple of years of recession and come out much stronger on the other side?
Unfortunately, the choice is not yours. I have no doubt that Congress will pass the bailout bill within the following weeks and they will begin their campaign of economic socialism. Despite the fact that polls show an overwhelming disapproval of the bailout by citizens, you have to remember that the government knows what's best for you better than you know what's best for you. In many ways we deserve it for being complicit with our government corruption. Today's Republicans are only a faint reminder of their free market past. They have allowed religion, corporate greed, and a desire to fight wars with everyone to cloud their judgment and they have continued to vote for the neocon corporatists. The Democrats have blamed free markets every step of the way, and yet it was they who pushed so hard for FDR's New Deal programs and they have been the ones fighting to keep Fannie and Freddie in power. They might take shots at Republicans for their corporate socialism, but who's taking shots at them for their leftist Communism?
I have a desire to see us return to free market principles and to a sound financial system, but I am beginning to realize that this is not possible with a failed government system. Our government has become the socialists that we feared decades ago, and the voters have gone right along with it. We've made our bed and we're going to have to lie in it.
|
|