Mr. B

The U.S. Economy After the Bailout

In principle, I am not in favor of government intervention in markets. I do not like the socialization of risk and losses by the government. However, the federal government has been a key part of the problem in this case.

The bill does not address the root causes of the problem. Government has fundamentally contributed to this mess with the Community Reinvestment Act and the GSEs (Fannie and Freddie). The CRA needs to be repealed or modified so that traditional lending standards can be applied to all extensions of credit, including low and moderate income borrowers. The GSEs need to be downsized and their function needs to be placed entirely in the private sector without a government guarantee.

Turning the US Treasury into a distressed debt hedge fund is a bad idea. The US Treasury does not have the skills to manage these assets. Outside managers should be retained to manage the assets. PIMCO said it would do it for free, simply covering their costs. 100% of the profits must be returned to the US Treasury.

The price discovery process for the purchase of assets must be thoroughly vetted and be made available to taxpayers. And, yes, if done correctly, there could be a meaningful profit for the UST. (My confidence level here is not high.)

Transparency with the flow of funds, including purchases, sales, expenses and gains and losses, must be made available to taxpayers. In other words, follow the money. Sunlight is the only way of keeping behavior on responsible terms.

Regarding housing prices, the demand curve shifted to the right because people used new mortgage products to buy more house then they could afford and because loans were made to unqualified, low income borrowers under CRA mandates and GSE assistance. Now demand, supply and home prices are returning to a normalized level and this will take time. This bill will not stabilize home prices nor stop foreclosures.

Mark-to-market accounting needs to be changed to valuation based upon expected cash flows. This is being addressed in some fashion. Mark-to-market accounting has contributed to volatility in the prices of illiquid assets, misrepresented the prices of securities and adversely impacted the capital ratios of banks thereby contributing to the contraction of credit.

While I object, this bill is loaded with pork. The idiots in Congress cannot grasp moral hazard issues. No one would lend the Big Three auto makers money, but Congress gave them $25 billion. Can you say corporate "subprime" loans? Have we learned anything? I don't think so. (As an aside, the ACORN provision in a draft of the defeated bill was a complete affront to any thinking person.)

The TEMPORARY increase in FDIC coverage should help stop the "run-on-the-bank" driven failure (although the threshold of $250,000 is too low to address institutional money which moves faster than retail deposits), save the FDIC from needless bank failures and allow for a more orderly price discovery process on impaired assets.

The plan does not ensure that banks will resume lending. This cannot be legislated nor should it be. But this is a major assumption and risk in the proposed plan. My view is that credit has permanently contracted in part because of tighter lending standards and in part because consolidation among banks reduces capacity (e.g. Citi lends $50 million and Wachovia lends $50 million, but after the merger the new Citi will only lend $65 million). The cost of credit will be higher for the foreseeable future. This will impact valuations and demand across the entire spectrum.

The bill will not save us from a recession and there are many other excesses that will need to be worked off. No economy has ever expanded during a period of contracting credit.