The Wall Street Bailout is Wrong
The Government that Created This Problem Cannot Fix It
Sep 24, 2008
Has the free market been exposed as a failure by the current crisis in the financial markets? Hardly. In fact, recent history shows us that the free market was nowhere to be found in the housing bubble that burst over the American economy and left a gum-like film over nearly everything and everyone on Wall Street. The current credit crunch was due to government intervention, and to ask for more intervention via bailout is the definition of insanity (doing the same thing repeatedly in the hopes of a different result).
A Seventy-year Trail of Government Folly
The first error was the creation of Fannie Mae (the Federal National Mortgage Association) to make it easier for banks to lend. By the 1960s, FNMA was spun off as a government-sponsored enterprise, along with a "competitor" - the Federal Home Loan and Mortgage Loan Corporation, or Freddie Mac.
When these "private" firms - created by the government with an implicit guarantee of government backing - started buying up bundles of mortgages made by true private lenders, it was perceived as the best of all worlds: homeowners get the home, the lender makes money off the loan, and the GSE assumes the risk.
Risk Mandated, then Downloaded
The government later mandated mortgage firms throw some loan standards out the window to prevent "redlining" - avoiding certain neighborhoods for mortgages. While the cause was noble (preventing racism in lending), it neglected to consider that many inner-cty neighborhoods were shunned by bankers due not to race, but to the unstable property values.
The government mandated mortgage firms to incorporate more risk into their business practices. However, with Fannie Mae and Freddie Mac, the government also allowed firms to download that risk off their balance sheets. As housing prices rose in over the last decade, Wall Street decided this wasn't risk at all, but rather a terrific investment opportunity. That was a mistake they would soon regret.
Bad Decisions Made Worse by Government Fiat
Under normal circumstances, the housing bubble would have damaged anyone holding mortgages and mortgage bundles. However, the underlying value would at least provide a partial return, one that could be projected on balance sheets across Wall Street - until the government told them otherwise.
Ostensibly in reaction to Enron, the government forced firms holding these assets to "mark-to-market," i.e., list as the asset value the price the mortage bundles could get on the trading floor. One can understand how this would please officials worried about a firm creating asset values out of whole cloth. However, firms holding mortgage bundles had to list asset values well below the underlying return if they were held to maturity. In effect, firms had to accept billions of dollars in artificial losses.
The Government Started the Panic, But It Can It Reverse It Too
With artificial red ink drowning their balance sheets and would-be corporate lenders running for cover, the large investment banks finally gave up the ghost this week. Now, Wall Street is begging the taxpayer to take their "toxic" assets off their hands. Yet the assets are not "toxic," merely undervalued by government mandate.
Remove the mark-to-market restriction and firms will have healthier (and more realistic) balance sheets. The end of Fannie Mae and Freddie Mac would return risk - and therefore discipline - to lenders across the land. Adjustments to the anti-redlining laws could enable firms to find diamond-in-the-rough lending opportunities without turning their business models inside out.
Yes, Wall Street is in a panic, but it was a panic started by government mistakes. By fixing those mistakes, the government can reverse the panic, too.
 |
