Sunday, September 21, 2008

From Republicans: throw money at the problem but let the bankers control how it is used

The proposed bail-out legislation appears to be a banker's dream proposal. Of course, these are the same bankers to have demanded freedom from government regulation so that the "magic of the market" is the only control on them. Or in other words, we are watching the financial industry indulge in magical thinking just like alcoholics or drug addicts do.

At the base of the current credit crisis that is killing venerable financial institutions is the combination of financial deregulation and the housing bubble. The deregulation allowed too many financial banks to leverage their investments to increase profits. Bear Stearns and Lehman Brothers were both leveraged at over 30 to 1 on the assumption that the markets would always go up. Leverage increases profits in an increasing market, but it equally increases losses in a falling market. The wall street gamblers cannot themselves be expected to limit their optimism and leverage, and they will always hate limitations on their ability to take risks.

The housing bubble was a case of too much money following a limited real resource - housing. Alan Greenspan kept interest rates low and pumped up the money supply to keep the economy rolling. The investment community worked to expand the number of consumers who had money by easing limits on who they would lend money to in exchange for higher fees and interest rates. Those are the ARMs and so-called sub-prime loans. Naturally the prices paid for homes increased because there was more money to spend. Unfortunately, those prices became based on anticipated price increases instead of the level of earnings to the home buyers. Home buyer income has not significantly increased since about 1970.

Then the banks booked those mortgages at the higher prices and called them assets on which they could borrow more money to lend even more. This permitted the banks to grow. Unfortunately, with the sub prime "magic" mortgages removed from the markets home prices should drop to the levels that the average family can afford to pay from current income. In other words, home prices should drop to the levels that renters could be expected to pay. That means that banks have a lot of mortgages on their books at prices to high for the market to sustain. If those mortgages are reduced to realistic prices, the banks themselves will shrink.

The Republican Party as a whole supports the bankers, not the home buying public. Bankers want the mortgages to remain at their unrealistically high levels on their books. Home owners want mortgages that realistically value the value of the real asset - the home. So this is what the banker's lobby is doing:
Also, according to the Journal, finance industry lobbyists are already giving orders to Republican hill staffers not to allow any meaningful reforms or protections for taxpayers. So, just the money. No strings attached.
House Republican staffers met with roughly 15 lobbyists Friday afternoon, whose message to lawmakers was clear: Don't load the legislation up with provisions not directly related to the crisis, or regulatory measures the industry has long opposed.

"We're opposed to adding provisions that will affect [or] undermine the deal substantively," said Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, whose members include the nation's largest banks, securities firms and insurers.

A deal killer for the group: a proposal that would grant bankruptcy judges new powers to lower the principal, interest rate or both on a mortgage as part of a bankruptcy proceeding.
The Bush administration is sending Henry Paulson out to Congress to horrify the Congressman with tales of the scary events that can be expected if Congress doesn't rubber stamp the very one-sided take-over attempt represented by the proposed bail-out legislation.

"Give us the money!" they demand, "But don't you dare hold us responsible for what we do with it! Trust us to do thing right! We are the experts! If you don't, we can't be held responsible for what will happen!"

But of course, these are the same deregulators and bankers who have created the problems we are supposed to hand them money to solve, and they still believe the same flawed ideologies that led us into this disaster. They just don't want to take the hits involved in forcing the mortgages on their books down to realistic values. That's why allowing bankruptcy judges to adjust the value and terms of mortgages is considered a deal-killer.

It was also the reason why the credit card companies got the stiffened bankruptcy law passed a few years ago so that credit card holders found it a lot more difficult to not pay the credit card bills in bankruptcy. Then the banks started offering even more credit cards to people with even worse credit while they added more exorbitant fees and started increasing interest rate charges if even other credit card holders got behind on payments or defaulted.

But the current financial meltdown really is quite serious, regardless of who created it. AIG was mostly a well-run profitable company, but it needed loans as part of its normal operations and the lenders simply no longer trusted that they could be repaid. What Paulson and Bernanke appear to be trying to do is get the financial system past the fear of making any loan to where there is some level of normal operation in the financial markets. He wants a sleek, trimmed down bail-out bill that will do that, and then leave Congress to redesign the financial system at its leisure.

I don't think that will work. The Republicans are already in obstructionist mode, and there is no reason why they will not continue to be next year. That's what the story of the lobbyists talking to the Republicans demonstrates. The bail-out bill has to include some urgent reform of the financial system because the lobbyists will gum up the works when there is no panic pressure forcing passage of some kind of bill. The Republicans want back into power, and they are willing to do whatever damage they can to the nation to get there. It is their standard obstructionist tactic.

In other words, while I suspect that Paulson is operating mostly as a well-meaning technocrat trying to resolve a really massive problem, he is also part of the Republican Party. Americans have no reason to trust Republicans. That was what the 2006 mid-term election results were all about. It's also what this Fall's election is going to be about now that reality has forced the media to quit listening to the McCain distractions.

The Democrats need to add provisions that bail out the underwater mortgage holders as well as the bankers who created the problems we all now face. Expect a lot of screaming and Republican obstructionism on that point, though.

One interesting thing is going to be whether Congress adjourns this coming week to go home to campaign as originally planned. I'm watching for a lot of media noise right up to the deadline with a last minute cave-in by one side or the other, possibly after a short extension of the adjournment.

Who'll cave? Probably the Democrats. They style themselves as the responsible party of governance. The Republicans have nothing to lose by being obstructionists. They already are being blamed for causing the problem. Delaying or preventing a solution can't damage their image any more than it already is damaged.

By the way, I wrote Congrats, taxpayers. The American financial industry now owns you. back in march of this year. It is clearly working out much the way I thought it was going to. The details and timing were not clearly predictable, but the fact that the Wall Street bankers now have the power to reach into the taxpayer's pockets to replenish their gambling stakes was clear even then.

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