Kendall Harmon: My Two Cents on Yesterday’s Failed Vote on the Economic Rescue Plan
1. Katherine wrote:
This is a balanced assessment, Kendall, and thanks. The bottom line is that the people who will foot the bill, ordinary citizens, don’t support this bailout. It could be they’re wrong and the powers in Washington are right, of course. I have read commentary from reputable observers on the right, left, and center, and there’s not a consensus that this would work, how prices would be determined for distressed debt instruments, or that we should do it.
Markets appear to be stabilizing today, and the dollar is up, which means the U.S. is attracting capital.
September 30, 9:26 am | [comment link]
2. Philip Snyder wrote:
I would be more ready to believe that this is a terrible crisis with terrible consequences if the Congressional Leadership was behaving like it was a crisis. Several Democratic leaders were told that it was OK to not vote for this bill and now Speaker Pelosi is blaming the Republicans for the failure of the bill to pass.
The current economic mess can be traced to the fact that too many people were taking out loans for too much house and these loans were being guaranteed by Freddie and Fannie and those pseudo-goverenmental instititutions were being shielded from proper oversight by powerful Representatives and Senators (Dodd, Frank, Obama, Kerry, etc.)
September 30, 10:13 am | [comment link]
3. Katherine wrote:
Yes, #2, and I do think we have to add the private CDS market which was developed specifically to allow banks to avoid keeping sufficient reserves against risky assets.
If this were, or if the leadership of the House believed it were, a crisis with financial Armageddon looming, why would they play politics with it? Reports are that Pelosi wanted it to pass, but with only enough Democrats to get it through, so it could be represented as a Republican bill in case it went wrong. They miscalculated—or maybe they didn’t, and they really didn’t want it to pass. Hard to tell.
September 30, 10:23 am | [comment link]
4. Harvey wrote:
September 30, 10:30 am | [comment link]
I agree with what you say Katherine. Now if the US bailout $ were used to help both sides of the fence and most of the amount paid back over a long period of time at a low rate of interest I would give it some thought. Another thought; there were some new kids on the block that jumped into the game and lost their shirt trying to get this easy money - doggone it let them go. And as far as the European markets trying their worst to get in the US bailout, it is their fault for now losing their shirts. We bailed them out after WWI and WWII. We are going to have to straighten our house out. I suggest the Europeans should work in their own back yard setting up their own loan structures.
5. zana wrote:
I was an English major in college. I am certainly not UN-educated, but I feel quite so when trying to understand the financial situation in which our country finds itself. What would be really beneficial for me is someplace I can go to read about what happened/is happening/might happen that doesn’t contain the MSM tendency towards hype and hyperbole. Every news site I’ve visited this morning is preaching doom-and-gloom, end-of-the-world-scenarios, or at least leads with headlines screaming “THE DOW FELL OVER 700 POINTS”, with little actual text to say why, and what the consequences are, and what the average ordinary working folks should expect.
I realize what’s happened is dramatic and startling and cause for high emotions on all sides of the room. But someone somewhere has “just the facts, ma’am”, don’t they? Any suggestions?
September 30, 10:31 am | [comment link]
6. AnglicanFirst wrote:
Let us not forget how we got into this mess and blame it all on those who happen to have more money (capital) than the rest of us.
For example, those with capital (people with money to lend) were pressured by politicians (with ideological ambitions) to loan money
to persons who normally would be considered high risk borrowers (in the name of an ideologically driven dream of utopia to make home owners of everyone)
and irresponsible/criminal mortgage brokers (those who made deals and then shed their immediate personal consequences)
who sold high risk mortgages to financial entities that used those high risk (shaky/no-value?) mortgages as coillateral to borrow more money.
The people who were hurt the most were those of us with money; in bank accounts, IRAs, other retirement accounts, CDs, etc; whose money was used to make ‘shaky’ loans driven by left-wing ideology. Yes, there are some ‘rich’ people who have been hurt, but most of the damage has been suffered by average Americans who had money and will be suffered by those Americans who will pay the income tax to bail our country out of this situation.
And remember, taxes on businesses/corporations are merely passed on to the Amertican consumer as increased prices for the things that we purchase.
September 30, 10:36 am | [comment link]
7. Bob Lee wrote:
The American People did not think Hitler was a threat, either.
Especially in the blogosphere, this is regarded as a very unhelpful choice for reference….—Ed.
September 30, 11:12 am | [comment link]
8. Byzantine wrote:
September 30, 11:16 am | [comment link]
Go to mises.org and read the only economists who have called it right from the beginning.
9. Bob Lee wrote:
Furthermore, even though it was clearly Providence, “the people” crucified Jesus.
Somethimes the people are wrong. A true leader must do what is right, not always what the mob says. Pilate, who knew Jesus was innocent, allowed the mob to rule, as did the Congress yesterday. It is the easy way. It is the wide road, not the narrow.
September 30, 11:19 am | [comment link]
10. stevejax wrote:
#6 AnglicanFirst, that’s just it. They didn’t have the money to lend. Some of these companies were leveraged 30:1. No body knows the real value or debt help by some of these companies. It was all a house of cards. By the way, your bank accounts and CD’s are just fine —for now. Not sure about IRA’s and other retirement accounts (see house of cards above).
September 30, 11:21 am | [comment link]
11. Katherine wrote:
Bob Lee, that assumes that the leaders know what is right. Let’s give the benefit of the doubt to Representatives who voted against the bailout because they thought it was wrong policy.
September 30, 11:31 am | [comment link]
12. Jeffersonian wrote:
Kendall, I have to disagree with your assertion that the vote “failed.” The bill did not pass, but that doesn’t mean the vote failed in its intended effect. For that, watch to see what happens to the presidential tracking polls. I’m predicting the vote will have precisely its intended effect.
Just for the record, by “failed” I meant that it “failed to get the necessary votes to pass—Ed.
September 30, 11:37 am | [comment link]
13. Bob Lee wrote:
Trying to Understand Congress
At “A Dash” we have avoided taking an advocacy position on the proposal popularly known as a bailout or The Paulson Plan. Unlike many other investment bloggers, we have described positions in real time, including plenty of hedges over the last few weeks—win or lose.
In short, we try to analyze rather than to recommend.
Analyzing the House Decision
Last week we had an inquiry from an astute reader who is very much in tune with the popular sentiment on the Paulson Plan and especially on the GOP attitude. She agreed with all of the standard public opinion arguments—Paulson helping his pals, taxpayers on the hook for $700 billion in losses and maybe more, various allegations about money going to liberal groups, etc.
Here was my email response:
If you really want to understand what is happening, read this week’s piece by John Mauldin. Ideologically he is much, much closer to you than to me. He has a knack for explaining things, and he has good contacts.
Everything he describes is something I have written about. Despite the length of the piece and many contentions, I agree with nearly everything he says. You can understand it, but you might need to run through it once and then read again.
We are in a vicious circle that I call the “death spiral.” There is a school of thought that maintains that this is a normal functioning of the business cycle, that we were too highly leveraged, and that we must go through the de-leveraging process sooner or later. These people, including both academic economists and bearish market pundits (who are cashing in on short positions and selling books), have missed a key point.
This spiral has no natural level at which it will stop. There is no “correct” amount of leverage. The Mauldin column shows that we are way past any normal level in many securities.
The problem is that the average person does not (and cannot) understand this. The average Congressional Rep can’t either. It is as if we were in one of those movies where an asteroid was headed toward earth. Some folks think this is an act of nature or God and will hit us or not. Others think we should try to send missiles to intercept it. Those discussing the missile plan are arguing about what color the missile should be.
Seeking an Analogy: The Asteroid
As an analogy, let us try the Bruce Willis film, Armageddon. We’ll take some liberties with the plot to make our point.
Let us suppose that some scientists determined that an asteroid was on a collision course with Earth. The expected force would be similar to a nuclear explosion.
There is a group of scientists who expect the asteroid to hit Earth, with the effect of a nuclear weapon.
Some scientists disagree, using the “157 theorem”. They argue that the asteroid will have a minor impact and restore a normal and natural balance.
Others argue that the asteroid will miss earth.
Some contend that an asteroid strike is a matter of nature. We cannot repeal nature!
Some participants in the debate have real estate holdings in caves. They profit from the scare, and encourage it. Others are selling gold.
Some participants in the debate are selling books—why our scientists failed to see this earlier, why earthlings should buy gold and shotguns, and why we should prepare for disaster.
Some are attempting to destory the asteroid. They want to send up a team to destroy it before it strikes.
There is considerable debate about the best way to deflect the asteroid.
The program to attack the asteroid has a cost, possibly an investment in the future, and possibly a waste of money. It requires granting considerable executive authority.
The media harps on the potential for waste and possible scientific errors. Leading bloggers join in.
Congress meets in emergency session to authorize a plan. The public has no way of determining the merits of the contending scientific arguments. Members of Congress struggle to understand the contending scientific arguments. The legislators have the responsibilty of office. They have two choices:
Put a wet finger to the wind and do what constitutents believe to be the correct scientifict interpretation; or
Make their own determination of the facts.
The President, his top advisors, and the leadership of both parties advocate action.
A majority of legislators votes to take no action. What will be, will be. They do not want to face constituents. They have little cover from the popular media.
Everyone agrees that asteroid planning should have taken place eariler. Many pundits pontificate about which agencies were at fault. Few bother to look forward to find a solution.
It is wonderful to live in a democracy. We do not have to deal with tyrants and dictators.
The problem: Looking forward takes strong leadership. It requires the ability to explain consequences before they actually occur. No President gets credit for avoiding problems, since in that case the results never actually happen. It is only when the impact is palpable that public support develops.
By then it may be too late.
September 30, 11:56 am | [comment link]
15. LongGone wrote:
Cute, Jeffersonian, but “the motion fails” is standard Robert’s Rules jargon for “the motion does not pass”.
September 30, 12:21 pm | [comment link]
16. Widening Gyre wrote:
Another analogy—the walk through Moria. Sam and Frodo have been walking in the dark in Moria for a long time. They have lost track of time. Is it day? Is it night? They turn a corner and hear rumblings and see some light. Sam is convinced the light up ahead is daylight and the rumblings the sound of a waterfall. Frodo believes it marks the coming of a Balrog and they are doomed. Who is right? How do we find out?
Connecting the dots. Frodo is Hank Paulson et al. who fear total financial collapse (“we must act” “we need rescue”). Sam is the majority in the House who don’t believe collapse is imminent and therefore have done nothing. A pretty scary game of chicken, isn’t it?
September 30, 12:26 pm | [comment link]
17. Jeffersonian wrote:
Cute, Jeffersonian, but “the motion fails” is standard Robert’s Rules jargon for “the motion does not pass”.
The motion may have failed, but the objective was attained.
Jeffersonian —for someone who has made me think hard in the past, that’s a remarkably and disappointingly cynical statement.
Could you explain how such a conspiracy was executed? Was it engineered by Paulson who set up the GOP with a big-old turd from the outset? Or by the House GOP leadership or Bush who couldn’t keep their voters in line? Come on, dude. Really?
The House Republicans, including the leadership, made it clear from the outset that they were not on board with this giveaway. That they would then vote against it is no shack. Nancy Pelosi made it clear she was steadfastly in favor, but did precisely nothing to pressure any of her caucus to vote in favor, in fact some have said that they felt zero pressure to vote aye.
Why would she do this? Well, for one it makes John McCain look like an idiot for suspending his campaign to come to Washington to help pass the bill. Second, it lets the Democrats and their surrogates in the media to continue the narrative of Republican-generated crisis. And both boost the prospects of Barack Obama…if you doubt me, check the polls.
Cynical? Not me, mate, but the people running this scam.
September 30, 12:40 pm | [comment link]
18. stabill wrote:
I think your assessment is generally sound. In particular, I heartily endorse your calling it an “economic rescue plan” rather than a “bailout”.
Last May I was assured by a retired banker that the subprime crisis would never hit his bank.
But it’s not that simple. The reports are that small businesses are having trouble getting new loans, and existing lines of credit in some cases are being reduced.
There’s a log jam in the credit markets. Something needs to be done to break it up. Reasonable people can argue about how to pay for breaking the jam. In the long run a good bit of it could be paid for by inflation, but I think it important that there be a plan to minimize that.
Bear in mind the plan that failed yesterday was valued at 700B over two or three years. When the vote went sour in the house, the stock market reaction generated a paper loss of 1200B as measured by the index known as the “Dow Jones Wilshire 5000”.
September 30, 12:44 pm | [comment link]
19. Philip Snyder wrote:
I could agree with your anology, but the people yelling “Crisis!” the loudest have told some of their members (40% of the marjority party voted against the bailout bill) that they do not need to support the bill. This tells me that the majority party does not really consider this a crisis, but does consider it an opening for political gain.
If this is a crisis (and I believe it is one) then we need decisive action by all our political leaders. Playing politics with it is not decisive action and yelling “Crisis!” on the one hand and taking a break and telling members of your own party that it isn’t important to support the bill on the other tells me that you don’t really believe “Crisis”
September 30, 12:45 pm | [comment link]
20. Katherine wrote:
The other problem with the “urgency” argument is that when Sec. Paulson first announced that this was necessary, over a week ago (I think), and a plan was formulated by Treasury and the congressional leadership, we were told that it must be passed NOW, yesterday if possible, Armageddon was coming! Grave fears were expressed over the delays caused by House Republican objections and alternate proposals. Friday was going to be too late! No, wait, we can hang on over the weekend, but Monday is IT! Now, Tuesday, the market has recouped 38% of yesterday’s loss, and the dollar is up. It no longer looks unreasonable for people to be proposing solutions for the underlying problems rather than applying expensive top-dressings on the symptoms.
September 30, 12:58 pm | [comment link]
21. Bill Matz wrote:
“American people are against the plan.”
Whoa! Not proven. There were a lot of calls to Congress, but broad surveys show a much different picture, e.g. 1/3, 1/3,1/3 for/against/undecided.
Concur with Bob Lee that Mauldin has had some good insight into crisis.
The fundamental issue facing any purchase plan, such as the Paulson one, is the price to be paid for the assets. The current panic market price (e.g. the Merrill 78% discount asset sale)? Face value (clearly not)? If the former, many firms will commit financial suicide by selling. If the latter, there would be huge losses for the Treasury.
The plan concept is that by providing a secondary market where virtually none currently exists, discounts will decrease below the current panic levels. So by paying something between the two extremes and helping to calm the market, the Treasury/fund should later be able to sell the assets at a small profit, avoiding any loss to the taxpayers. That’s the theory.
The problem remain that most of these assets are the kind that have been categorized as impossible to value, and the current crisis only makes valuation more difficult. Possible Catch-22. This may force Congress to move to the FDIC-based solution.
September 30, 1:02 pm | [comment link]
22. Jeffersonian wrote:
So if the polls move in Obama’s or Democratic Senate or House candidates, then the failure of this bill is due to a concerted effort to sabotage it precisely for a gain in the polls? Is that the only possible conclusion? Really?
I’m interested in what we can do in the next round—you seem to be interested in who’s to blame, and, apparently, it’s only the Democrats who can be at fault.
Hoyer got well more than half of his caucus to vote for the bill. Boehner didn’t. Now, Boehner can complain that Pelosi’s speech was too partisan (poor little guy, I really feel sorry for him), but isn’t it also possible that the deal that House Republicans and Democrats made was way too unstable, at least in part due to the poor quality of the bill?
Well, if Speaker Pelosi really though this was a dire emergency that needed to be resolved, don’t you see her dispatching her Whip to twist an arm or two? Phil in #20 is exactly correct…members were cut loose instead of being pushed to vote for the bill. Why do you think this is?
September 30, 1:06 pm | [comment link]
23. Clueless wrote:
“This spiral has no natural level at which it will stop. There is no “correct” amount of leverage. The Mauldin column shows that we are way past any normal level in many securiti”
Exactly. When the amount of leverage is 500 Trillion world wide, with a world GDP of 50 trillion, and a US GDP of 15 Trillion, then handing a Trillion to Wall Street is like holding back the Tide by sweeping the waves back with a broomstick.
The idea that when an “asteroid” is about to strike then executive authority should be used to do “anything it takes”, however stupid or costly, to stop it is a fallacy. This is not a “asteroid”. This is a guided missile that was fired by Wall Street beginning 30 years ago, in order to line their pockets at our expense. Giving Wall Street a blank check at our expense to “fix” the problem is like giving an enemy nation authority to take over our military defense system to stop that enemy’s fire. Yes, they are the “experts” on the missiles tragectory, but they are NOT OUR FRIENDS.
Any economic “fix” should be engineered by NON-Wall Street economists, and Paulson as one of the chief architects of this disaster when at Goldman Sacks, should resign, and face prosecution for fraud like the rest of Wall Street.
In point of fact, the only reason for the unseemly haste used to ram this particular piece of dreadful legislation down our throats is because Paulson, has ALREADY overstepped his authority, by permitting banks to use FDIC covered deposits to cover their losses in CDOs. Thus taxpayer money is already at risk, and the newest plans to “help” the taxpayer by raising the FDIC limit to 250,000 to 500,000 is simply another way of using FDIC funds to cover derivative based CDOs.
Please read this article for detail.
Instead of Paulson’s plan, I would much rather insist that the banks modify and write down the loans, go out of business, and insist that the FDIC cover ONLY depositors accounts (perhaps to a higher threshold for small businesses).
September 30, 1:40 pm | [comment link]
24. Byzantine wrote:
#19 - “Wealth transfer” would be the most accurate of all.
“In the long run a good bit of it could be paid for by inflation, but I think it important that there be a plan to minimize that.”
Here is how you minimize inflation: don’t print money. And making savers, those on fixed incomes, and your children and children’s children pay for your drunken binging? Shameful.
September 30, 1:43 pm | [comment link]
25. Katherine wrote:
The disconnect here, Matt and some others, is in thinking that Paulson and Bush represent “Republican” thinking on this, and therefore more Republicans should have voted for this. The very reason that Bush is not in high favor with many conservatives on economic issues is that he has not governed as an economic conservative. He failed repeatedly to veto spending bills until very recently. Paulson himself was considered a Democratic-leaning if not Dem-affiliated nominee for Treasury. From the first announcement of this rescue bill, conservatives have viewed this as something proposed by their adversaries, not by their side.
I don’t look at Pelosi as Machiavelli—she’s been far too ineffective for that—but there is something very fishy about the fact that this “urgent, immediately necessary” action wasn’t considered important enough for the Democratic leadership to work the numbers and try to get the party unified on the vote.
This bill was an orphan. Republicans didn’t want it, and Democrats either did, and didn’t want to admit it, or didn’t either.
September 30, 1:45 pm | [comment link]
26. Clueless wrote:
And here are a few more little Trojan horses embedded in this proposal.
1. The FBI investigations of Wall Street are off, and instead there would be a “Special Investigator General for Troubled Assets Program” (read Wall Street crony) who would be responsible for investigating wrong doing.
2. Further hundreds of billions could be spent without Congressional approval by an “interim Assistant Secretary of the Treasury) (read again, Wall Street crony).
3. Banks are permitted to hold zero percent real capital (this was put in by a single, highly duplitious changing of a sentence which says simply:
“Section 203 of the Financial Services Regulatory Relief Act of 2006 (12 U.S.C. 461 note) is amended by striking ‘October 1, 2011’ and inserting ‘October 1, 2008.’”
What would this effectively do? It was intended to speed up the enactment of this section of the law from 2011 to this week.
And what is the impact of the change in this law? (Take a moment to let this sink in.) This wonderful bipartisan bailout proposal, negotiated into the wee hours of the morning by sleep-deprived members of Congress was designed to come with a furtive Trojan Horse embedded by Wall Street lawyers. Banks already in trouble for lack of capital would get to hold as little as “zero” capital for transactions.
4. And as noted above, the FDIC has already essentially agreed to let CDOs come in ahead of depositors if a bank goes belly up. (No wonder Goldman Sacks hurried to become “just a bank”).
Read it all.
Shameful. Just Shameful. And the only thing that would have been more shameful is had our legislators been stupid enough to pass this bill.
September 30, 2:01 pm | [comment link]
27. John Wilkins wrote:
Good post, Kendall.
AnglicanFirst, you’re blaming wall street’s shananigans on… leftist ideology? So.. Wall streeters were in fact socialists, pressured by the left-wing government?
Wait: remember that the Republicans controlled congress for most of the time.
They had control of the entire congress and executive branch for six years. I’m willing to admit dems drank the kool-aid, but your partisan rhetoric doesn’t make a lot of sense.
Lenders enjoyed loaning money because they could get away with it. And poor borrowers? Well, if someone is handing you free cash, it’s easy to take it. But the fact is that nobody was minding the store. Ask Phil Gramm why.
The dream of the “ownership society” is one that was claimed by Republicans, not just Democrats.
You might also want to examine the incentives created by a system that made investing in US treasuries negative. The feds were themselves giving out lots of free money.
The real cost of a bailout to the tax payer will be about $100 billion. the cost for not passing the bailout was more than 1.2 trillion dollars. I’m glad democracy worked, of course: it was a long time coming.
And I think people know, if we’re going to always offer a welfare state for the rich, why haven’t we done so for the middle class and poor? I commend Anglican First, and Jefferson for their ideological clarity on this matter.
Perhaps what we can see is what utter destruction the myth of the “free market” or “tax cuts” has wrought. Perhaps those who believed most heartily in it will realize that the rich and powerful never believed it to begin with. They always knew that the government was there for them, while insisting it shouldn’t be there for anybody else.
September 30, 2:09 pm | [comment link]
28. BJ Spanos wrote:
Greetings all posters -
It is such a pleasure and relief to read a blog discussion of a political nature without all the invective. To read these well thought out comments demonstrates we can discuss politics in a reasonable and respectful way. I have learned a great deal from your comments and again, thank you!
Warm regards -
This elf agrees and thanks all who have made my eday easier.
September 30, 2:34 pm | [comment link]
29. John316 wrote:
It’s interesting that Republican Jim McCrery, ranking minority member of Ways and Means, voted for the bill. McCrery isn’t running for reelection.
September 30, 2:37 pm | [comment link]
30. Chris wrote:
the dollar is advancing (most in 15 years), gasoline is down, and the Dow is at 10,800. It looks like the House Republicans called everyone’s bluff and everyone is bluffing.
September 30, 3:39 pm | [comment link]
31. Jeffersonian wrote:
She would have had to twist TWELVE Democratic arms, and she had stated that she wanted a bipartisan bill. Republicans had promised half their caucus, and didn’t deliver. A Democratically supported bill, with strong Republican opposition, would have looked damagingly partisan. So she had two problems: switching twelve Democratic votes would have been very hard at the last minute, and doing so would have made the bill a Democratic bill. No one would have wanted that, and no one should have wanted that, even if this weren’t an election year. (It’s really important to emphasize that she didn’t pressure more Democratic members to vote early on for the bill because she had been promised half the GOP caucus by Boehner and Blunt.)
Would you have been happier if Democrats had forced a bad bill down the country’s throat?
No, I don’t want any bailout bill. You can’t turn a sow’s ear into a silk purse no matter how many votes you have. These mortgages are going to have to find their true value no matter who holds them. I’m paying on my mortgage every month; I don’t want to pay on someone else’s, thank you…let those who hold them do that.
I find your explanation informative, but not persuasive. Twelve members of the current Democratic caucus is chicken feed. The House Democratic Whip was even instructed not to do his job. Pelosi let this fail for exactly the reasons I pointed out.
September 30, 4:31 pm | [comment link]
32. Dave B wrote:
I have some quick questions. Since the Dems control congress are they not responsible for writing the Bill? Why did Pilosi allow a bill to come forward that was a “bad” bill? If Pilosi wanted it passed why didn’t she hold Democrates feet to the fire? If she couldn’t get Dems to support how did she expect to get Republicans? Did speaker Pilosi think that insulting Republicans was the way to garner wide spread bipartisen support? Where is Senator Obama? The bill and it’s failure is squarly at the feet of Nancy Pilosi….
September 30, 4:39 pm | [comment link]
33. Bob Lee wrote:
Nice try, Wilkins:
September 30, 1999
Fannie Mae Eases Credit To Aid Mortgage Lending
By STEVEN A. HOLMES
In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.
September 30, 4:59 pm | [comment link]
The action, which will begin as a pilot program involving 24 banks in 15 markets—including the New York metropolitan region—will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.
Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.
In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates—anywhere from three to four percentage points higher than conventional loans.
‘‘Fannie Mae has expanded home ownership for millions of families in the 1990’s by reducing down payment requirements,’’ said Franklin D. Raines, Fannie Mae’s chairman and chief executive officer. ‘‘Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.’’
Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.
‘‘From the perspective of many people, including me, this is another thrift industry growing up around us,’’ said Peter Wallison a resident fellow at the American Enterprise Institute. ‘‘If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.’’
Under Fannie Mae’s pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000—a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.
Fannie Mae, the nation’s biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary market. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.
34. Philip Snyder wrote:
This is not a collapse of free markets and tax cuts. The bubble probably would not have happened (or it would not have been so big) without the Government Entities known as Freddie Mac and Fannie Mae. They encouraged banks to make bad loans and then to sell those loans to Freddie and Fannie. Originally, these loans were made under the Community Reinvestment Act (revised under Bill Clinton) where community organizers, such as ACORN could cause problems with banks for not making enough loans in economically depressed (read poor) areas.
This opened the flood gates to “no down payment” and “interest only” loans or to the infamous “balloon payment” loan where no or nominal interest is charged for x years and then there is hell to pay.
Therefor, because of bad government policy, there was a too much cash chasing too little housing. This caused an radical increase in housing prices in certain areas. People began to speculate in housing, rather than purchasing housing for a residence or as a rental property, they were short cycling homes hoping to make a huge profit. Too many people used too much credit to by houses at too high a price. They were speculating in real estate on margin (remember 1929 or 2000?).
Likewise, we had banks making bad loans knowing that they could sell the paper to the GSEs (Fannie or Freddie) and they would still make a profit because of the fees associated with the loans.
The final piece of the puzzle came in to place when Freddie and Fannie used its vast wealth to lobby certain members of congress so that enhanced enforcement was not met. If Freddie or Fannie had to abide by the same laws on asset evaluation and oversight and accounting that the rest of the mortgage industry did, they would have folded long ago.
This is a story of greed by politicians (both Republicans and Democrats but the biggest blocking of oversight came from the Democrats) bankers, and people and we are all now paying the price.
September 30, 5:02 pm | [comment link]
35. Clueless wrote:
Here is an alternative proposal that would at least prevent a run on the banks (the key point in any stabilization scheme). This is what the Irish government has done.
This fax is making the rounds as something reasonable to ask your Senator to vote FOR. (Congressional phone numbers are included).
Today the Irish government announced a surprise decision to safeguard the Irish banking system for two years, guaranteeing all deposits, covered bonds, senior debt and dated subordinated debt of the four main banks.
Investors welcomed the news. By 0755 GMT, Allied Irish Banks PLC (AIB) rose 14%, Anglo Irish Bank PLC (ANGL.DB) rose 22%, Bank of Ireland PLC (IRE) rose6.7% , and Irish Life & Permanent PLC (IPM.DB) rose 22%.
Why Ireland’s Plan Works
What Ireland is fighting is the same thing that the Fed is trying to fight here (outflows from banks and money market funds into short term government debt.)
The problem is NOT mom and pop pulling bank deposits, it is corporate treasurers and state treasurers whose jobs are on the line pulling deposits from weak banks and putting them into stronger ones.
The fastest way for the US and other governments to solve this is to raise deposit insurance ceilings. This is a far better option than ballooning the Fed’s balance sheet more.
Furthermore, I would highlight that fully guaranteed deposits would put the US government even more at the top of the capital structure of banks. Existing senior debt is all of a sudden now fully subordinated to a potentially unlimited amount of insured deposit debt.
Why the Paulson Plan Fails
The Paulson plan fails because it does not stop mistrust between banks or mistrust by depositors. All it does is throw $700 billion in taxpayer money down a black hole.
The Paulson plan is also unconstitutional. There is no constitutional authority for the US Government or the Federal Reserve to use public (taxpayer) money for what is definitely a private purpose (bailing out Wall Street).
Finally, the Paulson plan takes time to implement fairly, and there are many holes in the oversight process.
Stop The Run On Banks
Temporarily guarantee all deposits at US Banks. Implement rules to ensure weak banks do not misuse this privilege by adopting risky lending practices. Orderly shut down all undercapitalized banks.
Senator Push the Paulson proposal aside, and try something that might work, that is constitutional, and does not put taxpayer money at risk.
September 30, 5:12 pm | [comment link]
36. John Wilkins wrote:
Re #39 and #40. I’m not sure what your point was. That Freddie and Fannie May were government backed? Yes they were. Since 1968. Now they were privately owned and managed. They were a public stock.
Where did the problems begin? There were a couple reasons, and not just partisan. Greenspan kept offering cheap money. He also decided that foreign investment in US treasuries just weren’t going to happen. So the great pool of money looked for other investments. Further, by eliminating the wall that separated banks and investment institutions, this helped create the perfect storm we have today (say the gramm-leach-bliley act).
Note the sentence in the article #39 mentions: “In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers.” This is interesting. Why were they doing this? They seemed to want to. They were not forced to, except inso far as they wanted to make a profit.
If you think I’m denying the Democrats are responsible… well, let me say here that I do think many Democrats - like lots of bankers, and Republicans - didn’t understand what was going on. They bought into the deregulation mantra, without understanding what was being deregulated. But if you’re going to deny the greed of capitalists, the ideology of “deregulation” had anything to do with it, I’m flummoxed.
Capitalism doesn’t penalize greed. It doesn’t punish cheats. Unless there are rules that do so. Someone has to enforce those rules. Perhaps if we were sinless, we could rely on corporations to do it themselves. Alas, that has not seemed to work.
September 30, 5:46 pm | [comment link]
37. Byzantine wrote:
Capitalism doesn’t penalize greed. It doesn’t punish cheats.
Yes it does. That’s why Wall Street wants to be bailed out from market forces.
September 30, 6:17 pm | [comment link]
38. Pageantmaster ن wrote:
Well I have a degree in Economics but I am not sure that helps me to understand this or whether the bailout would have worked. The figures quoted were just enormous. Movement of a few billion $ can distort markets and have extraordinary effects. While the sub-prime issue is a big US problem which has been exported it is only the tip of the iceberg. There has been massive and prolifligate lending world-wide. People have forgotten about capital adequacy ratios and that prices can go down as well as up.
I listened to and have some sympathy with newscasts of ordinary Americans complaining that these enormous sums would be advanced and yet there would be no improvement in the position of those standing to lose their homes and businesses. This is a fair point and I was alarmed at the reply for how the figure had been arrived at which was in effect “we thought of a number”.
The problem is now world-wide and at root has come about because banks have stopped lending to each other. I am not sure that shovelling money at the problem will start them lending again. This it seems to me is the real problem.
My suspicion is that we need an international solution to an international problem along the lines of Bretton-Woods.
September 30, 6:33 pm | [comment link]
39. jkc1945 wrote:
Surely we can all agree that, when the bill “failed,” the DOW dropped 7%, but the sky did not fall, credit on ‘main street’ did not dry up overnight, we all ate breakfast the next morning, and the DOW came back about 5%. Certainly, this is not an equities problem. This is a potential credit ‘crunch.’ But nothing had to be done overnight. We have some time. I don’t know what all the motives of Congress were, but the idea that we had to rush something through just to have something passed, is nonsense.
September 30, 7:35 pm | [comment link]
And I would guess that Speaker of the House Pelosi, for whatever political reasons, really did not want the bill to pass. I watched and listened to her speech, and there is just no reason for that kind of overt attack when one is asking for the other party’s support, unless she really didn’t want that support.
40. DonGander wrote:
Sorry, I just got home and didn’t read the above comments. Just wanted to relate that my bank sees no repercussions to either they or me. I will be obtaining a fair-sized personal loan shortly.
September 30, 7:37 pm | [comment link]
41. Philip Snyder wrote:
My point is that this is not a purely market problem, but it is, in large part, a problem caused by and encouraged by government. It is not that the free market did not work, it is that government tried to overturn economic fundamentals by fiat. It forced (or coerced) banks into making bad loans - loans the banks would not make on their own. It virtually guaranteed that the loans would not cause a problem for the makers by purchasing the loans after they were made. F&F;purchased bad loans in massive quantities and, since they were government secured, they required a massive bail out. The ramifications of those bad loans are being felt today and will be felt for years to come. Who is to blame? I would say that politicians of all stripes are to blame as well as bankers who made bad loans and pushed bad loans on too many people and we can also blame the people who gamed the system trying to flip just one more house before the bubble burst.
Who will pay for this? Well, my wife and I will pay for a chunk of it. My kids will pay for a chunk of it and so will their kids.
September 30, 9:43 pm | [comment link]
42. Chris wrote:
Gawain #43, here are the facts:
“beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.
This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.
Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.”
Now who controlled all 3 branches of the federal gov’t in 1977 and for 2 years in the 90s plus the Presidency 1993 to 2001? You and Iraneaus need to come clean and admit this FM/FM thing was a Democratic cooked fiasco. The most pathetic thing to see is Frank and Dodd and the other Dems completely unwilling to admit their complicity in all this matter. The Dem. Gov. of Iowa was on Fox tonight, and when confronted with the evidence, could only muster: “we don’t need to be assigning blame at this point, we need to blah blah blah….” - that’s code for: “yes we are at fault and I’m trying to change the subject.” [please note there was some disgraceful conduct on the part of a few aiding and abetting Republicans as well]
Does anyone else here see paralells between the Dems and 815? Two peas in a pod if you ask me, neither is interested in taking responsibility for their actions….
September 30, 10:19 pm | [comment link]
44. Katherine wrote:
Hi, Matt. It seems to me that the next two years facing the new President will be entirely different than they looked a few months ago. Major financial reforms are required. Freddie and Fannie need to be privatized and broken up. Risky and affirmative action lending should not be pushed or rewarded by government policy. (We have plenty of anti-discrimination statutes to protect individuals.) Federal spending needs to be reined in to pay for the actions already taken to shore up markets.
McCain would relish these tasks. Obama would hate it.
October 1, 1:18 am | [comment link]
45. John Wilkins wrote:
My point is that the idea that the government and the market are somehow separate and opposing institutions is now revealed to be a myth. It has never been so, except in the minds of ideologues and utopians. And those who really wanted the government to be outside the free market, have demonstrated that greedy people need regulation. You mention fiat: did you know this is actually a description of how money works, rather than, for example, gold?
” It forced (or coerced) banks into making bad loans - loans the banks would not make on their own.”
Um… there was no coercion. It offered incentives. Banks go where money goes. It did purchase bad loans, but… it was a private company. The government wasn’t to blame. Blame its stockholders and trustees. Blaming the government is ideology, Phil.
Chris, I’m not that partisan. There were a lot of incentives at work. Remember the Savings and Loan fiasco? Long Term Capital Management? Jonathan Lebed? I think you have a partisan axe to grind. If it seems like I’m letting Democrats off the hook, I’m not. But the supply-side, tax-cutting, deregulating worldview has demonstrated that nobody really believes it. Not in practice.
But I question a few of your facts. Subprime is more 1990’s once the usury laws were relaxed. In fact the definition of “subprime” is someone who DOESN’T qualify for Fannie and Freddie. Some loans were deliberately not well-documented - and shame on them. But I think the blame goes at those who were making the money. And it wasn’t the government.
I think Wall Street destroyed F & F because they took advantage of the fact that the government trusted them. Wall street sometimes bought their own subprime companies (say when Merrill Lynch bought First Franklin). And remember: who controlled the treasury over the last 8 years? In the end, it is the “toxic waste” mortgages that were sold by Wall Street - not F&F;which are responsible for our crisis. Again, those were NOT owned by F&F;.
“The market can stay irrational longer than you can stay solvent”
October 1, 1:24 am | [comment link]
46. Philip Snyder wrote:
The government laid the ground work for the crisis with the revision of the Community Reinvestment Act. This act gave both positive incentives to banks to make bad loans and negative incentives to not make bad loans. It then allowed the banks to bundle the bad loans with good loans and sell them to F&F;. That is the basics of the crisis. This worked only as long as home prices continue to skyrocket (the result of both demand increasing faster than supply and and money supply for homes increasing). When the bubble burst, we were left with people owing much more on their homes than the homes were worth. They did the economically rational thing (as well as the thing that made them poor credit risks to begin with) - they walked away from the homes - devaluing them even further.
This can be laid at the feet of greedy bankers and greedy politicians (Obama was the second largest recepient of F&F;lobby funds in the 20 year history of them giving money to politicians and he’s only been in the Senate for less than 2 years!) and greedy people who wanted to purchase too much home or flip homes.
I say we blame Washington, the executives at F&F;, the bankers who gave loans to people without checking to see if they were could pay the money back and we blame the people who won’t payback what they borrowed.
October 1, 9:47 am | [comment link]
47. Bill Matz wrote:
John is absolutely right tha Fannie/Freddie did not cause this meltdown. To a large extent they are victims of the crisis, although they have plenty of problems that Dole, Hagel, McCain attempted to reform in 2005-6. But Phil, it was not just CRA; the HMDA racial monitoring and other political pressures created a climate that pushed lending beyond prudent limits.
However, John (and most of America) is very confused about what is “subprime”; it is not just “other than Fannie/Freddie”. Other major categories include jumbo, portfolio, VA, FHA, FmHA, etc. True subprime (e.g. Option 1, 1st Franklin, New Century, and the B-C arms of Countrywide, Wells Fargo, Chase, Lehman, etc.) were chiefly characterized by their willingness to lend to folks with credit scores down to 500. But there were massive differences in subprime loan offerings and underwriting standards. Unfortunately, as the less responsible subprime loans began to come to light, the entire subprime sector became tainted. As subprime failed and started dragging down values, the taint spread to other sectors like a series of dominos, ending with the seizure of Fannie Freddie and the current freeze of the credit markets. Unfortunately, many of these distinctions are being overlooked by the mass media.
October 1, 11:32 am | [comment link]
48. John Wilkins wrote:
I think we’ll have to disagree about the “groundwork.” The CRA might be one part of the puzzle, but you seem to conveniently avoid the incentives on the wall street slide. The CRA, in itself, didn’t need to be part of the subprime lending fiasco. Banks and mortgage companies weren’t coerced into offering NINA or poorly documented loans. The point of CRA was to combat redlining and encourage banks to offer loans to people who needed just a little help.
Remember that in 2003 there was a problem: everyone who wanted a home equity loan and qualified for one probably had one. As there were no other guaranteed low risk investments, the great pool of money went to fannie and freddie. Perhaps if Greenspan had kept interest rates high and made the treasuries worth investing in (say in 2001), money managers would have made different choices.
And numbers matter. It is the he toxic waste investments that were completely the invention of wall street, abetted by the deregulation of banks, which won’t offer any return. Plenty of houses are still worth something. Those investments, nothing at all.
October 1, 11:47 am | [comment link]
But as I said, the idea that the market can exist without help from the government has now been revealed to be a myth used to line the wallets of those claiming its creed most loudly.
49. Katherine wrote:
Matt, if there’s one thing about McCain that is consistent over his career, it’s a commitment to reduced federal spending. He has never asked for even one earmark, for instance. My major frustration with Bush has been that, as you say, he cut taxes, which is good, but utterly failed to rein in spending, which is bad. Although I disagree with McCain on several points, his one very strong point is opposition to spending increases.
I’m unable to know what Obama would do. I don’t know if what he says now is sincere; if so he’s changed most of his principles 180 degrees since the primaries. I suspect he will revert to the ideas he had in twenty years in Chicago, in which case, he’ll support exactly the wrong things to do in a recession.
I won’t be able to continue this exchange, as I am away from home base and will have limited computer access for two days.
October 1, 3:14 pm | [comment link]
50. Little Cabbage wrote:
John Wilkins, I’m for once in full agreement with you. Thanks for the excellent analysis. And watch out: the second ‘bail-out’ bill before the Senate contains hidden tax breaks (read: pork) as well as the infamous rule change allowing banks to value their own toxic real estate holdings at whatever sum they wish to assign, rather than the current market value. This is a GIANT LOOPHOLE allowing these institutions to reap $$$ on over-valued holdings! NO!!!
October 1, 6:44 pm | [comment link]