Sep 232008
A few weeks back, when I posted about the necessity of raising taxes and cutting spending in order to reign in the national debt, I did not anticipate that the market would force us to take such an enormous step towards insolvency. The bailout proposed by the Bush administration would cost us $700 billion, but many predict that its actual cost, after Congress adds its own trimmings and attempts to include some relief for homeowners in danger of default, will reach $1 trillion or more of money that we don’t have. The irony of paying for bad debt with more debt might inspire a grim sort of humor if we weren’t in such a big hole already. The plan as initially proposed is completely outrageous, but I have little doubt that Congress will find some way to make it worse.

The fundamental problem is that a mortgage-backed security is not a mortgage. The holder of a mortgage has the right to foreclose on the property (thus recovering real assets) if the loan is not repaid, but the holder of a MBS does not appear to necessarily have this right. The security spreads the risk from a pool of mortgages among a pool of investors; as such, no single investor can be said to “own” a particular mortgage (except in the case that he owns all the securities from a given pool). It’s not clear whether the owners of MBS own anything other than debt; it is possible that they do not own the underlying loans. And these are the simplest vehicles assembled from residential mortgages… the real value of more exotic derivatives may be impossible to assess. This has serious implications for the proposed bailout, because there is a very real chance that we taxpayers will end up paying billions of dollars for smoke and mirrors. Before we release one penny from the Treasury for this rescue effort we must ensure that what we purchase with our money will give us a right to the underlying property, as well as the authority to modify the mortgages so as to diminish the default rate. We must not be left holding a bag of air.

The uncertain relationship between the securities and the actual mortgages underscores the unseemly nature of the whole affair. People who did not have the wherewithal to own homes got mortages from unscrupulous lenders who should never have given them out. These mortgages were packaged into vehicles that were treated like gold by credit raters, and then purchased by investors who probably should have known better. Only a fool could have imagined that the housing boom would continue indefinitely. The push by credit providers to make bankruptcy declarations more difficult for individuals had the unexpected side effect of increasing defaults. Holding negative equity on their homes in a plunging market, homeowners simply turned off the lights and walked out. The invisible hand failed to reign in the cascade of short-sightedness, stupidity, and outright malfeasance, and the credit market landed on its head with an audible crunch.

This would be bad enough on its own, but it set off a chain reaction leading to ever more violent flailing on the part of the Treasury department and the market players themselves. Because the securities had been insured, AIG took a hit and needed billions of dollars of government money just to die quietly. The failure of Lehman Brothers left money market funds holding worthless paper; the Reserve Primary Fund broke the buck and skittish investors started to flee. With all business in danger of grinding to a halt because of the shortage, the Treasury insured these investments with the Exchange Stabilization Fund. Because this insurance is not capped, small banks are now worried that panicked customers may move all assets in excess of $100,000 into the money market, leaving them short on cash.

Keating Five member John McCain, long a friend to unscrupulous financiers and enemy to the kinds of regulatory oversight that might have prevented this crisis, has been difficult to pin down on this issue, in large part because his position changes every time the sun comes up. His initial position, that we should stop bailing out financial giants, is understandable and at least has the virtue of being consistent with his free-market philosophy. His later attitude, an acceptance of the reality that these companies must be bailed out in order to protect the investors who acted in good faith, was more realistic. Exposure to the toxic mortgage-based securities put the other assets of these companies at risk, and it would be unconscionable to destroy the investments of good actors as punishment for the deeds of bad actors who had already escaped on golden parachutes.

(In McCain’s defense, at least he said something, even if it was insane, and Joe Biden’s response tracked a similar trajectory. As for the other presidential candidate, Barack Obama couldn’t manage anything better than “I’ll get back to you on that.” Who will you choose in November: the madman or the slacker?)

Bailing out rich people stinks, but it stinks more when we don’t really have any money to do it with. Section 10 of the proposed legislation increases our national debt limit for the fiscal year to $11,315,000,000,000. Given the authority to hit that ceiling, I have no doubt that the Treasury department will do so, meaning that our interest outlay in the next budget will be even higher than previously anticipated. Every new program you’ve heard politicians mention during this election cycle has just evaporated. The cost of a bailout is a credit crunch on the government, at the worst possible time. I’ve already proposed the solution to the problem: we must increase income and cut outlays. Otherwise, we’re just bailing water from the yacht into the lifeboat. Specifically, the wealthiest Americans must be willing to pay higher taxes, because it is they that benefit most from the financial institutions the rest of us will be breaking the bank to rescue, and it was their exploitation of those markets that got us into this mess.

Of course, I haven’t yet gotten to the most malodorous part of the whole proposal. It’s bad that we don’t know whether what we’re buying will be worth anything, and it’s worse that we’ll significantly increase the national debt to do so. But the really despicable part of the legislation is this:

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

You know, at least with the absurdly-named Patriot Act these Republican pricks had some kind of flimsy excuse for their totalitarian actions. This is sticking a thumb in the eye of Democracy just to show you can. It was a lack of transparency and honesty that got us into this whole mess; we cannot get out of it by spending $700,000,000,000 at the sole discretion of faceless bureaucrats from an abominably opaque and secretive administration. The estimated cost of the Iraq War to date is around $582 billion, a massive number but still less than the amount proposed in this legislation. It defies reason and sense to insulate the choices made with this massive amount of money from oversight and accountability. The very request for opacity suggests that the whole operation is being undertaken in bad faith.

Bernanke and Paulson continue to insist that Congress must act immediately. Nothing in their past behavior, however, suggests that they possess the competence to make this analysis, or the honesty to accurately convey their analysis to the media or to the legislature. Clearly, something must be done, but handing out $700 billion to the same nitwits that got us into this mess, without anything even resembling appropriate oversight, is more likely to bring economic disaster than salvation.

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