Housing Bailout: Crony Capitalism Comes to America?

Or, who will be the Keating 5 of the 2000's? Perspectives from those of us who remember the East Asian crises of the 1990's.

From the NYT:

A 'Moral Hazard' for a Housing Bailout: Sorting the Victims From Those Who Volunteered

By EDMUND L. ANDREWS

WASHINGTON -- Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for "financial innovation."

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government -- now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at "moderate to high risk" of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates...

One paragraph in the article I find quite amusing:

Surprisingly, the normally free-market Bush administration has expressed interest. Treasury officials confirmed that several senior officials invited Mr. Taylor to present his ideas to them on Feb. 15. Mr. Taylor said he had also received calls from officials at the Office of Thrift Supervision and the Office of the Comptroller of the Currency, which is part of the Treasury Department.

To me, it is completely unsurprising that the Administration should be willing to bail out financial institutions. They are well connected in the way that the unemployed [1] or the uninsured [2] are not.

However, this is not a rationale for not intervening. As I've said before, "Just say 'no'" is not a viable policy. The key point is to realize that, just like some of the East Asian economies in 1997, we are well past the point about worrying about the impact of current policies on "moral hazard" (see this analysis [pdf]). We needed prudential regulation in the period leading up to the housing boom (sadly, policy makers failed in that respect). That is when contingent liabilities built up (see these posts on "looting" [3], [4]). Now, it is not possible for the government to credibly commit to not intervene, when the financial system's operation is at stake (i.e., as Krugman has said, the horse is out the barn door).

And make no mistake -- the financial system is to some degree already frozen, and there is little prospect for a complete unfreezing of the system without substantial government intervention. From Deutsche Bank Economics/Strategy Weekly (Feb. 22):

...Taking MBS spreads as an example, spreads have now widened beyond the levels reached in the convexity episode of 2003, and is approaching the highs of the LTCM crisis of 1998. We emphasize that it is important for the market not to anticipate the kind of mean reversion that occurred in those previous widening episodes. In 1998, the spread widening wasn't a result of a systemic problem (at least in the principal developed economies), but rather was narrowly addressed with the unwinding of LTCM's positions. Spreads moved back relatively quickly on GSE buying, as GSE’s then were a reasonably large part of the mortgage market at that time, unlike the current moment, when the GSE's have been and are still hampered by regulatory and competitive restrictions, and thus are too small to serve as a stabilizing force.

In this sense, the current crisis is very much like the S&L crisis. And as it looks more and more likely that the government will have to spend billions of dollars bailing out investors, banks, and households, it seems to me that accountability is required. Who in the Administration pushed to prevent regulatory oversight? Who in Congress pushed the interests of the banks?

And we should look very carefully at the proposals that are being pushed by the financial industry, even as we acknowledge that laissez faire is not tenable, and we seek to establish procedures and institutional reforms that will prevent a replay. In particular, thinking about a well-funded, integrated, regulatory system that is insulated from political pressures would be a good place to start.

Comments

[drmalaka:]

Truly an intellectually lacking article. Unfortunately this is what is considered intelligence in today's society. Scary to think this man is teaching economic students this garbage. This is not an article about a bailout, it is an article supporting socialism, every sentence drips for contempt for the capitalist system that has made this the greatest country in the world.

The problem with our system is not that it is broken, it is that the government, charged with protecting its citizens, does nothing of that nature. People who do wrong need to be punished severly, not saved by those who work hard for their money. Protectin citizens is punishing those who do wrong, not rewarding those who do wrong or make lousy choices.

How can anyone take any economic analysis seriously when the author quotes Paul Krugman who has spent eight years being consistly wrong on everything. I have a monkey that has more economic sense than him. Krugman is not an economist, he is a politicial hack, just by reading him and quoting him we know where this article comes from. I am sure Marx could teach economics at Princeton or UCSD but that would not make his ideas right, reality has already proved him wrong.

For some reasons people like Mr. Hamilton make excuse after excuse for why socialism fails in every attempt (other than of course killing 100 million people) but the greatest capitalism system that created the greatest country in the world is a failure becuase there are poor people. Well a system with 5% poor (most of which are lazy dumb people who make bad choices) is better than a system where everyone except the rulers are poor.

And who the hell mentions the Keating 5 after all these years. I wonder if the author has the NY Slimes article about McCain on his mind? As for the insinuation that the financial industry owns the current administration and the poor and uninsured have no contacts, last time I checked every wall street loser was lining up behind Hillbama. And what do the uninsured have to do with the housing crisis. You bought a house you could not afford so that has something to do with your health insurance?

As for the points. "Even as we acknowledge that laissez faire is not tenable." Who acknowledged that? It is certainly untenable when our first reaction to things is to have the government come bail us out and then figure out what regulations can be put in place for the future. Which is a great idea, becuase when we put more regulations on the economy we will undoubtedly have fewer bribes paid by the banks to politicians to have those regulations help the bankers. Regulation stifles competition, so established institutions do not mind them that much. I wonder why it costs hundreds of millions of dollars to take a company public, could it have something to do with the lack of competition?

How about this idea. The banks who allowed this to happen out of sheer greed go under. The bankers who made tens of millions of dollars over the last five years creating these products get sued by the banks so that they have to return their enormous bonuses they stole from the American public (I personally would like to seem them punished a little more physicaly by the people who they screwed over, but violence is never the answer). The people who made bad decisions and bought homes they could not afford get kicked out on the streets. I keep my money that I worked hard for, creating my own company, sleeping on a floor and not buying a thing for myself for two years.

Where is it right that the responsible people in this country have to pay for others' mistakes? How in the world is this not going to happen again? Oh, new regulations! Do you think next time the bankers will steal money the same way? Every ten years they find a new way to rip off the American public.

All my sympathies to anyone who has to pay to learn economics from this intellectual light weight.

2008 Feb 24 11:31 AM

[flatman:]

The previous comment is far better than the original article.

2008 Feb 24 11:37 AM

[zb:]

Anybody with more than a passing knowledge of our economic system knows we don't practice real free markets. Never have. The rich and powerful exercise the greatest addiction to socialism through such programs as the topic of this post.
The connected and powerful are rarely held accountable and often use public resources for their own ends. I agree that's bad, but it is naive as heck to get mad about this.
In an ideal world, I would be in favor of letting bad mortgages fail, housing prices coming down to affordability, etc...But neither Republicans or Democrats will let that happen. Look at the campaign contributions.
I guess my point is: why are the commentators so surprised? Haven't you seen these things over and over again? What the author wrote is simply what is going on in every policy wonk's mind in DC.
You thought there weren't dark corners in the free market?

2008 Feb 24 12:37 PM

[pelican:]

Its not about being naive. Its about an article written by an author who thinks a bailout is the answer. Makes me wonder if he proposed the same thing when thousands of people lost thousands of dollars when the the stock market bubble burst in 2000. He says we are past the point of worrying about whether this is a "moral hazard" but I disagree. There is so much wrong with the self-serving ideas floated by the financial industry and the article states we should consider these proposals. Sounds like he's being naive. He acts like its doomsday if we don't do something. How does he know? People can understand a depression or a deep depression, particularly high unemployment, where millions are affected by things out of their control. But to basically save people and some financial institutions for being greedy...that's a different story. No wonder most taxpayers are outraged by the same ideas the author seems to think are necessary. Drmalarka had the best response. The above article, in my view, is idiotic.

2008 Feb 24 01:32 PM

[Menzie Chinn:]

In the interest of full information, the post is by <b>Menzie Chinn</b>, not James Hamilton. Chinn is solely responsible for the content of that post.

2008 Feb 24 03:14 PM

[Jack K:]

The first post was excellent. More useless socialist dribble from some useless overpaid, underworked academician.
I wish I could post like drmalaka!

2008 Feb 24 05:08 PM

[john1:]

HA!! See what you're up against Mr. Chinn? These people are still looking under their desks trying to find the Weapons of Mass Delusion! YOU point out that the current administration, the guardians of freedom and democracy and free-enterprise (Oh, did I say freedom and democracy and evil-doers, and freedom?) are "thinking about" bailing out their rich buddies and YOU are accused of being a socialist.

Let me explain something you might not know about REAL American politics – not your reality based version. The LIBERALS want socialism to bailout "those people". The CONSERVATIVES are for people standing on their own two feet and not asking for bailouts. Therefore, the liberals in the current administration, who are hidden in the state-department, are asking for the bailout knowing that they'll take this money and really give it to "THOSE PEOPLE", but great banking institutions (of THE greatest and most powerful and most morally pure country in the entire universe) will get screwed by "THOSE PEOPLE". This is ALL the fault of "THOSE PEOPLE", and liberals know it, and are trying to covering it up. THAT'S the reality you just don't get Mr. Chinn. You must be a LIBERAL which means you are an evil-doers and hate `merica.

Hope this clears things up. If you want to know how attacking other countries balances the budget and improves the economy, just let me know. It’s VERY simple, and also involves “THOSE PEOPLE”.

2008 Feb 24 06:50 PM

[fjd10595:]

To DrMalaka, you make some very valid points, but you are way too hard on the author, who made good points, 1) that we have a crony based system that benefits the few at the expense of the many, and 2) this system was actively encouraged in the last few years (by George Bush and friends) and these same people now wish to bail out these private investors. You say there is no bail out proposal. What has Paulson been saying? I say let everyone fail that should fail. You ought to question Bush and his "conservative" congress that have set this country back 50 years. They did far worse than anything we saw in the last democratic administration. It is the legacy of George Bush- fund today's largess by passing the bill to our kids. What a disgrace.

2008 Feb 24 08:01 PM

[Jxyzzy:]

This is so entertaining.......han... handouts, God my hand is starting to really hurt as I reach into my pockets again to "help"
the deep pockets and the numbskulls.
Hardworking Realtor,,unemployed untill my next appt.!

2008 Feb 25 08:57 AM

[Pent up demand:]

Still waiting for a liberal economist to explain to me how a federal bailout to prop up the cost of housing is good for the working class. And waiting...

2008 Feb 25 10:07 AM

[john sabia:]

Wow! Finally I found a blog that is not lacking in intelligence & common sense.

2008 Feb 25 10:57 AM

[akapital:]

No liberal or socialist would advocate a bailout that supports inflated housing, inflated gov't, inflated markets, etc. to support the existing disparity of wealth in America...that would only be supported by the status quo of Dems and Repubs...anyone that thinks otherwise doesn't even know what a liberal or socialist gov't is...it's all hybrids these days anyways, what we have here is corporate welfare...fare thee well..

2008 Feb 25 01:08 PM

[Harry Troop...:]

I don't agree that our financial system will collapse without a taxpayer bailout. The extent of the problem isn't even known yet, it may not be as bad as those pushing for a bailout want us to believe. The cavalier bankers and Wall Street Investors, and the dishonest or foolish borrowers and mortgage brokers are of course pushing for a taxpayer bailout. What else do you expect from dishonest and/or foolish people? If you reward that don't complain as the following episodes continue to roll in, and all the next 'victims' expect the same taxpayer bailout. Personally, I have already emailed the President to let it be known if this republican administration signs on to any bailout, I will never again vote republican.

2008 Feb 26 03:04 AM

[jjason:]

Put the bankers in jail. Bankers got away with the same incompetence in the S&L crisis in 1990. The taxpayers footed the bill. Let people like Mozillo at Countrywide pay for the bailout. And close your accounts at Bank of America...I did.

2008 Feb 26 06:51 AM

[Regulate:]

fair use only
Subprime Safeguards We Needed
Washington Post
By Nicholas Bagley
Friday, January 25, 2008
As the federal government scurries to prevent the subprime mortgage crisis from sending the economy into a deep recession, people are asking why it waited so long to intervene. But, in fact, a few years ago an obscure federal agency torpedoed legislation from a handful of states that would have made institutional investors far more chary of buying mortgages that were likely to fail. If the legislation had been permitted to take effect, the crisis we now face would probably look a lot less grim.....To combat this surge in predatory lending, some state legislatures decided to stanch the flow of easy credit to subprime lenders. In 2002, Georgia became the first state to tell players in the secondary mortgage market that they might be on the hook if they purchased loans deemed "predatory" under state law. Before, downstream owners of mortgage-backed securities might see the value of their investments drop, but that was generally the worst that could happen. Under the Georgia Fair Lending Act, however, players in the secondary mortgage market could face serious liability if they so much as touched a predatory loan....Enter the feds. Some of the biggest players in the secondary mortgage market are national banks, and the states' efforts to curb predatory lending clashed with banks' fervent desire to keep the market rolling. So the banks turned to the Treasury Department's Office of the Comptroller of the Currency. The primary regulatory responsibility of the OCC is ensuring the safety and soundness of the national bank system, but almost its entire budget comes from fees it imposes on banks, which have the option of incorporating under state law. Put another way, the agency's funding depends on keeping the banks happy. Little surprise, then, that the OCC acted when the national banks asked it to preempt subprime-mortgage laws such as Georgia's, arguing that they conflicted with federal banking law...Despite the banks' thin legal arguments, the OCC issued regulations in early 2004 nullifying the state laws as they applied to national banks. The agency reasoned in part that the states just got it wrong. As the then-comptroller explained in a 2003 speech: "We know that it's possible to deal effectively with predatory lending without putting impediments in the way of those who provide access to legitimate subprime credit."

With the state laws nullified, national banks and their subsidiaries were free to engage in the practices the states were hoping to stamp out. (Indeed, Georgia scuttled its law because it didn't want to give national banks a competitive advantage over its state institutions.) Facing pressure from subprime lenders and Wall Street, and left without a real chance of holding investors responsible for purchasing ill-advised loans, state legislatures gave up on trying to meaningfully expose downstream buyers to liability for facilitating predatory lending...As federal officials move to clean up the subprime mess, it's worth remembering that they helped to create it.

2008 Feb 26 11:25 AM

[Jean-Marcel:]

Why should the taxpayer pay the price for the risk taken by greedy lenders and irresponsible borrowers. If we look at the auto industry todas which is almost bankrupt, it should remind us the Chrysler was bailed out in the 80s. Had they not been bailed out the auto industry may have started taking seriously the problems they were facing.

2008 Mar 27 05:19 PM