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Bankruptcy, not bailout, is the right answer

Discussion in 'Politics & Religion' started by browntwn, Sep 30, 2008.

  1. #1
    Bankruptcy, not bailout, is the right answer

    Editor's note: Jeffrey A. Miron is senior lecturer in economics at Harvard University. A Libertarian, he was one of 166 academic economists who signed a letter to congressional leaders last week opposing the government bailout plan.

    CAMBRIDGE, Massachusetts (CNN) -- Congress has balked at the Bush administration's proposed $700 billion bailout of Wall Street. Under this plan, the Treasury would have bought the "troubled assets" of financial institutions in an attempt to avoid economic meltdown.

    This bailout was a terrible idea. Here's why.

    The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

    Worse, 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.
    SEMrush
    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.

    The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

    The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

    Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

    In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

    Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

    Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

    Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

    The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

    If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

    The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

    Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

    So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

    The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer. source

    _______________________

    This pretty much sums up my thinking on the matter, but it sounds better coming from a senior lecturer in economics at Harvard University.
     
    browntwn, Sep 30, 2008 IP
    guerilla likes this.
    SEMrush
  2. Firegirl

    Firegirl Peon

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    #2
    I agree with this as well. I read this and it makes total sense to me. I woke up this morning, and guess what, the world is still spinning and people are still going to work and making money. I've heard some people chattering around work about wanting to take ALL of their money out of the bank. Greed created the mess and stupidity is going to prolong it.....

    It's funny you mention this article. I just busted some people on another political forum passing it off as their own writings!
     
    Firegirl, Sep 30, 2008 IP
    guerilla likes this.
  3. korr

    korr Peon

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    #3
    Dow rallies 350 points on arrival of economic apocalypse.

    Err, the stock traders were trying to bluff their way into a handout yesterday.
     
    korr, Sep 30, 2008 IP
  4. debunked

    debunked Prominent Member

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    #4
    You might be right on that.

    The whole oil mess is full of bluff. I won't be surprised if it hit $50 again.
     
    debunked, Sep 30, 2008 IP
  5. korr

    korr Peon

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    #5
    I sit here watching CNBC most of the day. While they were sitting around yesterday morning giddy about the bailout they expected, they brought in a bunch of these "experts" to say where people should be invested when this big chunk of cash comes in from Washington.

    Houses? No. Equities and banks? Oh heck no.

    They said, "The smart money will follow real value. The best place to put your money after the bailout is oil and food."
     
    korr, Sep 30, 2008 IP
  6. debunked

    debunked Prominent Member

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    #6
    Great! Then we would make the poor - poorer....

    Commodities have their value, but if a portion of that money went to those commodities it would have a crippling effect on people.
     
    debunked, Sep 30, 2008 IP
  7. korr

    korr Peon

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    #7
    This is why the bailout is as bad of a disaster as no bailout! If they could inflate housing without inflating everything else, they could have fixed this problem by now because they've been trying to inflate housing in a desperate way for the last year.

    But it is the intervention that is driving up prices on the necessities of life. This is exactly what Hoover did - he put price minimums on food to help farmers. We're putting a price minimum on housing, food, gas, etc... and wondering why average people are suddenly underwater.

    This is a vicious cycle of forced inflation when the "invisible hand" or what I call "economic gravity" just wants to deflate the system and take some of the extreme excesses of monetary growth out of the pool.

    Bailout: $6-8 gallons of milk or gas by Summer '09, but we'll still be standing on a series of bubbles that require maintenaince to keep in tact

    No Bailout: $100,000 average house prices by '11, the economy sucks, but we start thinking of new ways to growth wealth that doesn't involve government-funded inflationary bubbles
     
    korr, Sep 30, 2008 IP
  8. homebizseo

    homebizseo Peon

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    #8
    Amen brother, Amen
     
    homebizseo, Sep 30, 2008 IP