August 11, 2007
Aid For Me, But Not For Thee
By Deborah Newell Tornello
from Tim Burton's The Nightmare Before Christmas.
It would seem that America's billionaires don't wear bootstraps. Or something:
Should the Federal Reserve help bail out billionaire hedge fund managers and millionaire traders — the very people who bought the risky mortgages that led to the current market panic?
That, in essence, is the question swirling around Ben S. Bernanke as he confronts the first crisis of his 18 months as Fed chairman.
There are no shortages of opinions, and some are being shouted. Jim Cramer, known for his histrionics on the CNBC financial news channel, angrily called for Mr. Bernanke to lower interest rates, something the Fed has resisted doing.
A week ago, Mr. Cramer charged that the Fed was “asleep” and that the chairman “has no idea how bad it is out there” in the markets. A video clip of his remarks has been viewed more than one million times on YouTube.
Lower interest rates would help operators of hedge funds and other money managers because the housing market presumably would strengthen as mortgage rates fell. A revived mortgage market would give the hedge fund operators and other holders of the risky securities a chance to sell them, which they are having trouble doing now in the current nervous market.
But others see a bigger danger for the economy in acting on the pleas of Mr. Cramer and others on Wall Street. Cutting interest rates to help the hedge funds would tend to encourage a resurgence of the very risky mortgage lending that has caused the current turmoil, rekindling the crisis.
The issue is often referred to as “moral hazard,” meaning that the risk-takers who brought on this panic would feel bailed out and would be more likely do it again — just as a young adult whose parents paid off a large credit card bill might feel free to run up a debt again.
“The argument is people did risky things,” said Jan Hatzius, the chief domestic economist at Goldman Sachs. “They are getting punished now, and if you ease interest rates, you reduce the punishment.”
Would that I could muster a mild amount of shock, or even surprise, that our "conservative" friends continue to serve up such laughably obvious hypocrisy, but no. I can't summarize it any better than does my friend Lisa in Baltimore, who writes:
Oh, I love this. The same people who are always yammering about "the market" and so-called "free-market capitalism" and the nasty "welfare state," and "pull yourself up by your bootstraps" and "no hand-outs" and "get the government out of my life" and "government is evil" blah blah blah--the very ones who brought us this disaster in the White House--now they want the federal government to bail them out. What a bunch of f***ing hypocrites. But of course the evil government WILL bail them out, just like we bailed out Chrysler, just like we bailed out the airlines, just like we bailed out Halliburton, just like we bail out billion-dollar corporations all the time, in so many ways. But conservatives don't like that pointed out to them.
Tsk tsk. An inconvenient truth indeed.
UPDATE: Economics and finance professor Dark Wraith analyzes the present situation; his disdain for the Bushian scourge of fiscal irresponsibility never disappoints:
Forget for a moment that what the Fed is doing is trying to inflate away a market crash. For the time being, we should hope only that the central bank and its friends around the world are ready to blow $40 billion every trading day to keep the welfare train on track for the Wall Street boys. It's a win-win situation: the fatcats keep their money, the suckers take the losses, the Bush Administration keeps its hero status for the rich, and the Fed maintains its reputation as both the enabler and the drug dealer for all the liquidity addicts and their conjoined Republican incompetents.
Hmm. Bailouts like these are probably wise, but to be consistent, the little guy should be helped as well.
Also, if I read Brad Delong's website correctly, this is the first time that the Fed has bought mortgage securities? During the S&L crisis, Congress created a bailout program, and the Fed lowered interest rates to keep the economy growing. (if I remember right)
Posted by: stm177 | Aug 11, 2007 12:27:08 PM
The article quoted is misleading. First, this isn't a "bailout" as most people understand the term. No money is being given away or debt forgiven. Second, this isn't being done to help hedge funds. This is being done to help lenders and borrowers broadly, and it will also particularly help those who have invested in lending on mortgages that are now distressed. I don't think it will help them enough to remove their incentives to be more prudent in their lending.
This may be good for some hedge funds, but more importantly it will allow a huge segment of the economy that's tied up with the rest of the economy closely enough to affect the whole thing to function. Not to act might very well lead to a panic and other nasty stuff, with bad economic results for the rest of us.
According to Thoma at economistsview, the Fed hasn't been buying securities backed by mortgages but has been accepting more than usual as collateral. The amount is unprecedented, but the practice isn't.
Posted by: Sanpete | Aug 11, 2007 1:16:46 PM
No, no, no, no and no.
The Fed did not buy mortgage-backeds. It took MBSs as collateral for loans, something it has done for years now. There is no bailout. This is completely normal open-market work.
The Fed Funds target is 5.25%. If demand for reserves spikes (as it did), that rate will go up (as it did) and the Fed will inject reserves (as it did) until the Funds rate is back around its target (as it is).
The amount of the injection is high (though not without precedent: viz 2001), but in the grand scheme $38 billion is a pimple on the global markets. We don't worry about $38 billion. We worry about how unusual it is that such an injection was necessary to stabilize the Funds rate.
Moral hazard is a real problem, but this isn't it. The capitalist right wing is full of hypocrites (as is the anticapitalist left; I say, don't be a hypocrite -- be a hypocrite!), but wanting the Fed to function as designed is not a symptom of blinkered hypocrisy.
Posted by: wcw | Aug 11, 2007 1:25:52 PM
so, let me see, these guys (who, by the way, have already siphoned off hefty profits in the form of "management fees" which are taxed at around the same rate as the kid who works the windows at burger king), assumed a grip of bad loans, which have now defaulted. so now we are going to issue them a grip of loans because. . . because. . . because. . .
my simple country head can't really wrap around this as anything but a looting not unlike what we saw in the streets of bagdhad five years ago.
while i was at the beach my two doors down neighbor is a very well respected econmist and writer. he was trying to explain to me how the hedge funds and other similar markets work, but when he saw my eyes beginning to glaze over he said this:
try to imagine the action that would be generated by an off track betting window in an insane asylum
which is now something i don't have to imagine, it's happening before my eyes.
Posted by: minstrel boy | Aug 11, 2007 1:30:57 PM
Shouldn't you be saving that picture for a post about Giuliani?
Posted by: KCinDC | Aug 11, 2007 2:08:07 PM
Is the Fed giving loans to banks or to hedge funds? If the banks go under, would the Fed end up owning the mortgage backed securities?
Posted by: stm177 | Aug 11, 2007 2:22:43 PM
Sanpete and wcw beat me to it - this isn't about "bailing out" the hedge fund managers, this is about helping banks maintain liquidity during a moment when they are leery about making any loans at all, something that will hamstring most home buyers, even ones with good credit... never mind people with any sort of dicey credit history, who are already being frozen out of the market (and who, we should recall, are the people who were in the market for those "subprime" loans that are now pulling the market down). The argument against the Fed stepping in - which, ironically, tends to come from those right wing conservatives - is just the argument that litbrit's making, from the opposite direction: the market needs a correction and needs to work through this and if tighter credit is the result, well, that's what needs to happen. That argument will be meaningless if, as seems to be the case the past couple of weeks, what looked at first to be a momentary correction devolves into a full blown economic downturn, with significant deflation led by the housing market, which everyone agrees has become overheated and overvalued in many areas. The sensible thing, which the Fed is already doing, is to inject at least some cash back into the credit markets and see what develops; probably, though, it's going to need to be more than the "blip" of the last few days, and it probably means raising the ceiling on loans that can be purchased by Freddie Mac and Fannie Mae, a change that will open yet another can of worms, and revive some fundamental questions about how both of those operations have been mismanaged in recent years. The hedge fund managers, in many ways, are the least of our worries - banks have plenty of their own vested interests (i.e., their money) in the funds for the market to bail itself out in the biggest cases. But when Bob and Sue, that nice black couple in some random city, can't get a home loan - and we're going to have a lot of them in the next few months, of many races - that's a problem that can be easily understood by Americans and can deal a big blow to both the housing market and the overall economy. It seems to me, people who want to keep the American dream of home ownership alive would be in favor of keeping the credit markets liquid, if possible.
Posted by: weboy | Aug 11, 2007 2:32:33 PM
Isn't the whole point of the Fed accepting securities backed by mortgages to mask the fact that they no longer have a demonstrable value on the open market? Is there any guarantee that these "assets" will ever regain a value sufficient to redeem the loans? If the markets don't recover, hasn't the Fed effectively "purchased" a huge amount bad paper?
A loan is only a loan until the point of default. Then it becomes something else entirely.
Posted by: WB Reeves | Aug 11, 2007 2:50:19 PM
We humans are rationalizing animals, aren't we?
However you wish to characterize this bailout, it is a bailout. It's big gubmint helping out the private sector. And however you wish to spin the result, liquidity for banks/lenders who desperately need it or helping out po' folks who couldn't get loans otherwise (and please, those folks won't be getting loans now despite the protestations here to the contrary), the result is big gubmint will take a step to once again reinforce the doctrine of corporate irresponsibility.
In fact, what this bailout will enable is the wealthy and the speculators to stay afloat and keep real estate prices inflated. And real estate is inflated far beyond most rational measures in a number of places throughout the country.
That will, in turn, prevent home buyers, and I said home buyers, not speculators, from buying and owning homes they will live in. That will keep the prices higher when they should be plummeting and that will keep control of things where it should be.
Once again, the status quo has been preserved. Society has fulfilled its function.
You can now go back to whatever it is you were previously engaged in.
Posted by: ice weasel | Aug 11, 2007 2:52:22 PM
Are we talking about hedge fund managers, or is this still about Scooter Libby's commutation?
Posted by: FS | Aug 11, 2007 2:53:17 PM
(and who, we should recall, are the people who were in the market for those "subprime" loans that are now pulling the market down).
As if those who made the loans had no fiduciary responsibility.
But when Bob and Sue, that nice black couple in some random city, can't get a home loan - and we're going to have a lot of them in the next few months, of many races - that's a problem that can be easily understood by Americans and can deal a big blow to both the housing market and the overall economy.
That would be the same Bob and Sue that you identify as "pulling the market down", right? Tell me, do you actually have any hard data to support your assumption that "nice black couples" amount to a drag on the market of such significance as to justify singling them out?
Oh and to save you some time, I did see where you tacked on "of many races" after the fact but that doesn't obscure what your default position is.
Posted by: WB Reeves | Aug 11, 2007 3:08:13 PM
ice weasel, I wasn't suggesting that by helping banks that, miraculously, people assessed as bad credit risks will be able to get loans; I think that particular problem (and we should point out here that we're talking about a lot of nice people who really just need a break, not deliberate scofflaws who won't pay) is going to bedevil us for quite a while and wreak surprising havoc... but the past few weeks have suggested that banks are seriously freaked and blocking loans to all sorts of people - including the wealthy and the speculators. Injecting some liquidity back into ending may, as you suggest, merely fuel a continuation of speculation and real estate overvaluation on the coasts and in vacation markets; however, I'd suggest that if that is the result, and ordinary people are blocked from ordinary home purchases, that too will feed a significant economic downturn. We will have to see what develops, and hope for the best but prepare for the worst - and I'm generally a market pessimist who suspects that no matter what the fed does, we will get both a pretty bad economic downturn lasting years and a devaluation in housing that will seriously hurt a lot of people both ordinary home owners and speculators. The only upside I can see is that it will, to some degree, be in the self interest of some lenders - smaller, and more community based ones, I'm thinking - to make loans available to the people who desperately need them in communities less touched by the speculative market. I agree with you, though, that no one should have illusions about banks suddenly becoming fine moral characters who give mortgages out of the goodness of their hearts to nice people -= unless they see everyday mortgages as key to keeping the economy moving, those loans probably will be very hard to get. As for the bailout question, until the Fed steps in more directly to prop up banks, I'm not sure "bailout" really fits, though certainly is this the Fed taking a very active role in managing markets. But, as others mention, that's what they were created to do. The alternative is letting the market handle this itself (back to those pure capitalist conservatives), and it's hard to see how that alternative will get anything like the result people who are concerned about ordinary home buyers would want to see; it would seem to me that kind of credit tightening would only be that much more focused on helping hedge funds and big corporate interests over ordinary folk.
Posted by: weboy | Aug 11, 2007 3:09:39 PM
WBR - I'm sorry, I may not have been clear - I think it's clear the "subprime crisis" is about unscrupulous lending by a set of bad actors who issued highly questionable, speculative loans for the benefit of friends and business partners (much like the S&L scandal). I think a lot of good, ordinary folks - the Bobs and Sues of many cities - were simply caught in a trap designed to benefit those bad actors, by taking bad loans that were likely to spike higher after a few years (while I think we could wonder about some people making realistic choices in accepting those loans, knowing that they might well have trouble paying down the road, I tend to give most people the benefit of thinking that they would manage somehow, not realizing how bad it would get). This is absolutely about lenders and their bad practices, not the recipients, and yes, this does hit minority communities harder than others, which was the only point I was making about hypothetically casting Bob and Sue as African American. As I said in the post above, the people with dicey credit records are in many cases good people who need a chance, and a break. We need lenders to take that chance, which is why, it strikes me, giving them more liquidity to take chances seems like a good thing.
Finally, the other point here is something I've been talking about for a while here and on my blog: the bigger problem with housing speculation and housing policy generally is that we've taken a great deal of the possibility of finding affordable housing out of the equation for many people. The reason many people took bad subprime loans with balloon rates is because those loans helped perpetuate an illusion that home prices weren't spiking out of reach of many buyers. The collapse of those loans has made the problem more plain, but the fact is, no one's really talking about the lack of affordable housing in cities, or offering a lot of ideas about how to fix it - and counting on deflation to solve it is a mistake both because it's unlikely and because deflation would create a lot of other problems for our economy. Fixing our lending problems is a start, but I've suspected for a while that housing is a the big issue for 2008 no one's talking about, and if this gets that conversation going, that too strikes me as a positive development.
Posted by: weboy | Aug 11, 2007 3:21:49 PM
Thanks for the clarification Weboy. Perhaps the search for answers to some of the problems you point out could be discovered by examining the post WWII housing crisis.
Posted by: WB Reeves | Aug 11, 2007 3:38:29 PM
I don't think the point of buying mortgage-backed securities is to mask something; possibly it's supposed to show something, that the Fed thinks they have a certain value. If they don't really have that value, then the Fed may end up with some unsecured loans, which won't release the borrowers from the obligation to repay them. If the borrowers default, then there will be a problem for both the borrowers and the Fed. Of course, part of the goal is to prevent that from happening by stopping a panic before it happens, something the Fed is designed to do.
Weasel, you're rationalizing. Even laissez-faire Milton Friedman recognized the place of government in stabilizing the money supply. Accepting mortgage-backed securities as collateral is standard practice; the only thing different here is the amount accepted. No money has been given away; no debts forgiven. To call this a "bailout" is to stretch the word well beyond its common meaning. This doesn't release any corporation from responsibility.
This will in fact help responsible parties to purchase homes, as well as other things (this has ramifications beyond the housing market). It makes more money available for loans. I think speculators who don't have the collateral to get loans will still find it difficult in current conditions.
Posted by: Sanpete | Aug 11, 2007 3:44:52 PM
"I think it's clear the "subprime crisis" is about unscrupulous lending by a set of bad actors who issued highly questionable, speculative loans for the benefit of friends and business partners"
The subprime crisis is about making loans to people with bad credit, no credit history or shady income streams; you could reasonable argue that they lowered their lending standards to do so, but predatory practices were not the root cause. The subprime banks then sell these higher risk loans to investors, conduits or other banks; but the purchase contracts requires the originator to buy back bad loans or the whole package if the default rate hits a certain percentage (my knowledge of this side of the business is a bit shaky, so I may have some subtleties incorrect) and this is where the problem started. The subprime banks didn’t have the capital to buy back the loans so some banks starting going out of business (some just got out of this all together) and others file bankruptcy; or, because of the snowball effect, can’t get access to capital to continue to originate.
Your point about housing prices skyrocketing is pretty good. This reduced the risk to banks, allowing them to do more ALTA and subprime, because the risk was mitigated by the house, the asset. People who probably shouldn’t be borrowing hundreds of thousands of dollars were able to.
Posted by: DM | Aug 11, 2007 3:47:42 PM
by the way, i agree with the "this is not a bailout" commnets. this is the role the Fed plays in our financial markets. i think one can be anti-gov't on the margin and still back this move by the gov't.
Posted by: DM | Aug 11, 2007 3:53:12 PM
DM, your comments seem to indicate that, for you, the issue of fiduciary responsibility is nonexistent.
Posted by: WB Reeves | Aug 11, 2007 3:57:31 PM
For whom? The borrower or the bank? I'm not sure what you're getting at.
Posted by: DM | Aug 11, 2007 4:03:23 PM
If the borrowers default, then there will be a problem for both the borrowers and the Fed.
It's worth recalling at this point that the "borrowers" in question are corporate entities, the explicit purpose of which is to limit the liability of those who collect the cash. The "problems" such entities might face are of a very different magnitude and import than those faced by the individual.
Posted by: WB Reeves | Aug 11, 2007 4:04:19 PM
DM, since the entire thrust of your post seemed to be aimed at refuted the suggestion of malfeasance on the part of the lenders, I would have thought my meaning clear.
Posted by: WB Reeves | Aug 11, 2007 4:07:38 PM
Ahhh, I thought you were going that way but just wasn't sure. Malfeasance wasn’t the issue. These banks are highly regulated, at the federal, state and local levels, to the point of pain. Most of them, the big ones especially, do their best to stay within the law; they take predatory lending serious. Sure, there are “bad actors” out there, but that’s not the norm, nor the root of today’s problem.
The point of my post was to a) explain the mechanics of what actually happened and b) to point out that this was not about unscrupulous lending practices by a set of “bad actors”. The banks issued bad loans to people who didn’t have a history of making good as borrowers (again, either by lending to those that didn’t make good in the past, or those without credit history). They were able to get away with this for a while because the underpinning asset, the house, was rising, not falling in value.
Posted by: DM | Aug 11, 2007 4:33:28 PM
"The little guy should be helped as well"
Where was help for me when I shorted Yahoo and Amazon in 1999? Lost my shirt (and much more). And, given the bubble back then, my position was more in line with the economic realities of dot-com firms.
So, are we only helping people - large and small - who make economic choices that are contrary to the "real" financial conditions?
Posted by: Quiddity | Aug 11, 2007 4:37:09 PM
The idea that a stable, functioning banking system is anything but a benefit to all economic actors is baffling. I feel like someone in the 'reality-based community' confronting the moonbats in the GOP for whom ideology dictates reality. Please, please, please learn the elementary mechanics of credit and banking before you post again.
Won't someone please think of the children?
Posted by: wcw | Aug 11, 2007 4:57:24 PM
i still bet that there are few foreclosure or for sale signs by the sandy beaches and shingled mansions of the hamptons,the homes of the hedge fund managers and traders weekending away from wall street.
.....i know nothing about economic theories, but i had an uncle with little booksmart education, and much experience.....
he once said, "if all of the money was taken away from everyone, rich and poor alike, in just a few years, the rich ones would be rich again, and the poor ones would be poor, just as before.
....that also, must be some sort of truth and law of economics.... or something.
Posted by: jacqueline | Aug 11, 2007 4:57:52 PM
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