Saturday, September 01, 2007

Moral Hazard

Tom Petruno analyzes the preznut's proposal for mortgage relief for an extra 80,000 homeowners, says its probably a Republican attempt to avoid larger government-scale relief and notes that the larger government bail out is probably going to come anyway:

History suggests that a larger-scale government intervention is exactly what we're going to get.

...

A few hours after President Bush spoke, the liberal-leaning Center for American Progress reached back to the 1930s to propose the re-creation of the Home Owners' Loan Corp., which during the Great Depression directly refinanced many delinquent mortgages.

A new Home Owners' Loan Corp. would perform the same function: It would take over, at taxpayers' expense -- and also at some loss to lenders -- a large chunk of the mortgages now in default or destined to land there.

The idea that a government entity should step in to save some significant number of people who can't make their mortgage payments has been gaining traction, and not just with the think-tank set.

Bill Gross, the bond fund guru at Pacific Investment Management Co. in Newport Beach, in his latest website commentary all but demanded that Bush rescue "millions of hard-working Americans whose recent hours have become ones of frantic desperation."

Of course, given the turmoil that wracked bond and stock markets in August -- much of it rooted in surging mortgage delinquencies that have caused mortgage-backed bonds to crash in value -- it's hardly surprising that big investors in general would support a plan that could damp markets' worst fears.

And if mortgage bonds stop plummeting, who benefits more than Wall Street?


But is it a good idea to have the government bail out millions of people who took mortgages they knew they couldn't afford or the investors who bought the bonds back by those mortgages by directly getting into the mortgage business itself?

Would this create a massive new bureaucracy? Of course. Could it be a boondoggle for taxpayers? Ditto. Could it foster "moral hazard" -- encouraging bad behavior by other borrowers (and lenders)? You bet.

The thought of a bailout has and will continue to infuriate millions of Americans who didn't succumb to the temptation of a temporarily cheap mortgage to buy a house they really couldn't afford, or to tap their home equity for that boat, RV or vacation villa that also was otherwise beyond their means.

Arlo Guthrie sang a song back in the 80's called "I'm Changing My Name To Chrysler" to make fun of the fact that the government bailed out a bankrupt Chrysler while it watched millions of Americans go broke in the horrendous economy of the late 70's and did nothing.

This time around, the politicians who are clamoring for a government bail out really do care about the people with problems (after all, it's almost an election year), but even more importantly, they care that Wall Street stays happy. The last thing they want is a 3000 point loss on the Dow or the S&P to fall below 1000 because of this subprime mess. Not only would this be bad for the economy as a whole, it would be very bad for many of the people who contribute directly to politicians re-election campaigns - like the unions with their pension plans invested in hedge funds backed by subprime mortgages or the big-time Wall Street guys who give the maximum amount allowed to politicians and get everyone else in their companies to do the same.

This whole thing is a mess. I maintain that a government-sponsored bail out will simply compound the problem by creating a moral hazard that says "Mortgage holders, don't worry if you bought a house you couldn't really afford or refiananced a mortgage so you could go to Hawaii on a cruise and now can't make the higher mortgage payments - the government will bail you out...And investors, don't worry if you invested borrowed money into hedge funds that borrowed more money in order to buy bonds backed by these shitty subprime mortgage loans that anybody with any foresight could have seen were problematic - the government will bail you out...

...so you all can do this stupid shit again..."

Barney Frank, chairman of the House Financial Services Committee, put it best:

"You can't just give people a free ride," Frank told the New York Times this week.


I feel for some of the homeowners, I really do. But real estate prices sky-rocketed as a result of the Greenspan-created Housing Bubble and many homes are now out of the price range of people who want to purchase but want to do it the old-fashioned way - with a downpayment and a fixed 30 year mortgage. Market conservatives always say the government should let the market sort things out, and that's what should happen here. Home prices must drop back to historical ranges (in proportion to the wages people make.) That process is already happening in most markets around the country. For the good of the country, it must continue.

And as for the risk-taking investors and speculators who drove the insanity of the bubble the last few years, it's ALWAYS a bad thing to bail them out.

If you bail out risk-taking investors and speculators, you are simply telling them to do it all again.

Comments:
I'm still coming to terms with a report that major Aussie banks are out to pick up our version of sub-prime customers.
Is the whole world going mad?
 
reality, you wrote:

"Arlo Guthrie sang a song back in the 80's called "I'm Changing My Name To Chrysler" to make fun of the fact that the government bailed out a bankrupt Chrysler while it watched millions of Americans go broke in the horrendous economy of the late 70's and did nothing."

First, the government provided LOANS to Chrysler, which were REPAID. You and everyone else with limited financial knowledge confuse the extension of credit with free money.

The federal government stepped up to LOAN money to Chrysler when all the private sources -- Wall Street, banks, etc. -- refused. Then, after a painful reorganization, Chrysler REPAID the loans. Where is the problem?

The alternative was to let Chrysler fall into bankruptcy. You need to understand what Chapter 11 bankruptcy is all about.

When a corporation files for Chapter 11 -- corporate reorganization -- it enters a fascinating world. Suddenly, the company is given lots of time to work out its bills. Also, the company gets to cancel its labor contracts.

In other words, had Chrysler gone into bankruptcy, the bankruptcy court would have terminated the UAW contracts for Chrysler workers. I guarantee you, that is the last thing the UAW ever wants to experience. Because if one auto company can cancel its labor contracts, they will all head down the same path.

The result is either a strike -- which would lead to large and possibly permanent job losses -- or cuts in pay and benefits, but fewer job losses.

No UAW union leader wants to be around when that day arrives. At the moment, Ron Gettlefinger is the guy who is going to get roasted when Cerberus demands wage and benefit cuts for Chrysler workers.

When Chrysler was in deep trouble last time, the were not as many foreign car-makers to rush in to fill the gap should Chrysler fail completely. That meant the impact of a Chrysler failure would hit the entire US economy with much more force.

Today, if Chrysler were to file Chapter 7 -- complete liquidation -- there would be a minor economic impact. If it files Chapter 11, the US economy won't skip a beat. But either way, some employees will feel pain. It's inevitable.

The challenge is how to minimize the pain all the way around without rewarding failure. It ain't easy.
 
reality, you wrote:

"I feel for some of the homeowners, I really do."

Based on other statements of yours, the preceding statement is not true.

You wrote:

"But real estate prices sky-rocketed as a result of the Greenspan-created Housing Bubble and many homes are now out of the price range of people who want to purchase but want to do it the old-fashioned way - with a downpayment and a fixed 30 year mortgage."

There's always a reason some homes are beyond the means of some buyers. Big deal. The usual solution is to buy a less expensive home, save more money and move up when it becomes possible. That's what reasonable people do.

You, by claiming prices are "too high" are suggesting government control of housing prices. That is a disastrous idea.

You wrote:

"Market conservatives always say the government should let the market sort things out, and that's what should happen here."

That's okay by me. But that's not what you are actually saying, as evidenced by your following sentence:

"Home prices must drop back to historical ranges (in proportion to the wages people make.)"

In other words, you believe there is a "correct" or "fair" price for real estate. That's code for price regulation.

On Wall Street, analysts will plainly state that a stock is trading rich. Or cheap.

How do these claims work out? Sometimes richly priced stocks continue to go higher and higher, and sometimes cheap stocks go lower. And sometimes they move in the direction the analyst has predicted. But it is simply impossible to determine absolute values of any asset.

You wrote:

"That process is already happening in most markets around the country. For the good of the country, it must continue."

In other words, you think it is patriotic for American to go broke. Wow!

That's okay with me, but this sentiment suggests you are undergoing a huge change in your economic views.

Meanwhile, I mentioned the concept of "moral hazard" here about a week ago. I guess the idea resonated.
 
Cartledge, I'm not sure what you're referring to. Can you illuminate?
 
RBE, a recent economic news item here stated that our big banks were now scrabbling to pick up this country's low doc (sub prime) lending market.
It just goes to show there isn't much logic in the markets.
 
I see what you're saying, cartledge - while banks in the U.S. are shunning the subprime and Alt-A mortgage markets, the Australian banks are fighting with each other to win that segment of the market.

I suppose it is okay if the subprime and Alt-A loans are backed with documented salaries, down payments, etc. But if the Aussies banks are handing out no-doc, no money down loans, watch out!
 
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