Bankruptcy, not bailout, is the right answer

http://www.cnn.com/2008/POLITICS/09/29/miron.bailout/index.html?iref=mpstoryview

by gibsonf1 • 18 years ago

139 84 18 years ago

johnrob• 18 years ago

I agree that the solution to bad government behavior should not be more of it. The core problem is that over the past 30+ years, the government has tainted the home buying market. The gov encouraged lenders to act irrationally, pushing home prices too high. Had home prices not been able to get so high, they would not have as much room to fall. The last thing we need here is more irrational behavior from the gov - like buying worthless assets for real money.

swombat8• 18 years ago

Neither bankruptcy nor bailout are the right answer.

Compromise is the right answer.

kevTheDev• 18 years ago

Would you care to elaborate?

unalone• 18 years ago

Yeah, I want to hear this too. Usually compromise is just being wishy-washy, so unless you've got a GOOD idea for compromise...

swombat8• 18 years ago

Not particularly.

I am not enough of an economist or politician to be able to tell you in detail what the ideal compromise is in this situation, nor do I care to claim that I am.

What I do know, however, is things are not black and white. Baying for the banks' blood and shouting "liquidate!" is exactly what they did in 1929 and that kind of behaviour is even more reprehensible than the banks'.

Similarly, handing the banks a giant wad of cash with no strings attached is not right either.

The solution lies in the middle, as always.

tom_rath2• 18 years ago

What's wrong with bankruptcy?

The assets remain intact, the investors who poorly judged the risk lose their investment and those who buy up the assets (to clean things up and bring about a recovery) rightfully reap the rewards of taking on a very high risk.

Enron, to take an example, went bankrupt, but energy kept being generated and traded under new management. Former employees went on to find work at the acquiring company(ies) or took their labour elsewhere. Would things have been better if Enron were still scamming around after a bailout today?

How about the dot.com collapse? What if Pets.com and WebVan were given billions of dollars to continue on?

Bankruptcy is good. It's the market's way of flushing out bad ideas and starting fresh.

swombat8• 18 years ago

The problem with the bankrupcty solution is it encourages companies to remain secretive about their bad debts until the very last minute.

This discourages companies, particularly banks, from trusting each other.

The problem we're having now, which is also the problem that brought the Great Depression, is lack of trust. Banks won't lend to each other, or to other businesses, because they don't trust that they'll get their money back.

Saying that we should let the banks go bankrupt at their leisure is just letting this problem of trust fester for the next few years and resolve itself one bank at a time, slowly. While the problem is correcting itself, the market doesn't allocate money where it's needed because of the lack of trust, and everyone suffers. The total cost of that is much larger than a trillion dollars.

At the other extreme, you could just nationalise the whole banking system. That's a better option, but still not ideal, because governments suck at running businesses, and this would also be less efficient in allocating capital where it's needed (the primary function of banks),

So, somewhere in the middle lies the compromise. How can we get the banks to start trusting each other again and yet not nationalise them? Well, one way is to offer them a kind of "knife armistice". Bring out your knives to the police station, hand them in, and we'll let you go free. We'll even give you a water pistol as a compensation prize.

Don't be fooled into thinking that just because the bailout bill doesn't put the CEOs of banks in prison, that it will not be followed by further regulation. For better of for worse, tighter regulation will be on its way. But that's a separate debate that's not tied to the bailout. The purpose of the bailout bill is to resolve a crisis right now, not to make long term fixes to the system.

Banks are special types of companies because of their effect on the economy. You might let Enron go bust, because after all that's unlikely to cause widespread damage to the entire world economy. Let the banks go bust slowly and painfully, though, and every business pays for it. Calling for "Bankruptcy not bailout" is terribly short-sighted.

maxharris2• 18 years ago

Suppose some ostensibly "unforeseen" but avoidable* disaster befell your neighbors, and they got together to rob you and your friends in the chaos. But you don't want to part with your property. Should you (would you) be willing to "split the difference" or "compromise" with them?

We can live without these incompetent fly-by-night money men. Bailing them out sustains and rewards their incompetence.

* There were honest banks like BB&T that /chose/ not to get involved in these shady deals

swombat8• 18 years ago

If I have a choice between compromising with them or seeing my neighbourhood turn into a ghetto, I think I'll choose compromise. Won't you?

Remember in this case we're not looking at one isolated element - this is just one big global neighbourhood. If it turns into a ghetto, we're all still living there.

gills2• 18 years ago

They're going to try to ram it through again on Thursday, so if you agree with this economist call your reps. (Sorry for the politics, but I've been on the phone all week about this. I probably deserve some mods down, so pile on!)

davidw3• 18 years ago

I think the best commentary I've seen so far is this:

http://www.marginalrevolution.com/marginalrevolution/2008/10...

cedsav• 18 years ago

counterpoint: http://www.businessweek.com/investing/insights/blog/archives...

msb• 18 years ago

However, non-CRA lenders did pressure CRA regulated banks. From the reference:

"Many of these companies are like the one in which my next-door neighbor is employed: they are middlemen who arrange mortgage loans for borrowers including "subprime" borrowers with banks, including CRA-regulated banks"

http://mises.org/story/2963

lpgauth• 18 years ago

The crash is only indirectly based on the fact that getting a loan was joke. The real problem is the financial institution which bundle these bad loans in short term currency and starting selling them. It was all good while the housing market was still going up as if the loan wasn't getting paid to could just take back the house, but when it went down these short term bonds where without any value.

hendler• 18 years ago

We need a new economy.

Tech guys create jobs, and save money for old companies with ease. I mean, what's the utility of some of these idiots? Seems like the next phase of obsoletes are just raping the system before they're noticed as completely useless.

jmtame3• 18 years ago

I find it entertaining that Aaron Pressman (author of the counterpoint argument listed by someone else on this thread), who holds a B.S. in History from Columbia, is calling Jeffrey Miron a "know-nothing," who has a Ph.D. in Economics from MIT and is Senior Lecturer and Economist at Harvard University, in addition to the 166 academic economists who were against this bailout. Who else said the CRA is responsible for our current crisis? What's that, Ron Paul?

Sounds like these guys just know a whole lot of nothing...

Just to expand on this topic a little bit: http://jtame05.wordpress.com/2008/09/30/we-dont-need-a-bailo...

bilbo0s2• 18 years ago

The problem is rampant misuse of CDS, CDO and derivatives in general. ie - Mortgages that were improperly secured. That is at the root of what is threatening the financial system. As a former quant I am well acquainted with the top end of the issue. My problem is understanding the bottom end.

The bottom end is a secondary problem, people defaulting on mortgages. Which the system would be able to tolerate in a market place where mortgages are properly secured. That is, a marketplace where people on the top end do their jobs right. This problem is caused only in part by CRA, AND in a manner different than Ron Paul argues. CRA encouraged a large number of middle class people to move back into the city cores around the country. Poor people moved out, hip, young, creative class moved in. All funded by CRA allowances. Gentrification and all that. Basically, Fannie and Freddie were moving 'good' people in, while Ginnie moved 'bad' people out. Problem was, according to the auditors, these "gentrifiers" are defaulting in droves. To the point where Fannie and Freddie collapsed. And, to add insult to injury, Ginnie is fine. The problems it does have it acquired in government attempts to rescue Fannie and Freddie.

I, frankly, find this state of affairs difficult to believe. If we were redeveloping the city cores, and then letting the same people who lived there before buy the redeveloped housing, then I could see a high level of defaults. But the people in those neighborhoods now are actually pretty solid. That is one of the most perplexing facets of this entire mess to me. I understand the bad risk assessment at the top end, I think ANYONE generally assigns a higher risk to people in poverty, and a lower one to people in higher socio-economic classes. I would have gotten that risk assessment wrong as well if I was judging that market. So how can so many solid home buyers be hitting the skids at the same time? I would like to think there is something more going on here. I am simply unable to find it.

joshwa• 18 years ago

Well, all those 'gentrifiers' took out interest-only or teaser loans, with the expectation that real-estate prices would only ever rise. When the time came for the re-fi, the market had tanked, so they now had negative equity in their assets, and couldn't refi based on the value of the asset. Hence, default. Many of the so-called 'gentrifiers,' in the true American Spirit, were 'strivers' without the cash reserves to take the loss and keep their homes.

Retric2• 18 years ago

Hypothetically, as a 28 year old in 2005 I would have little problem getting an interest only loan on a 400k home. If the market drops 100k within a year or two I might as well default and rent for a while or move in with a girlfriend and who could then buy back in at the bottom.

Note: I am not alone and I am not stupid.

nostrademons• 18 years ago

I'd like to read more about the majority of defaults being middle-class, gentrified buyers. Are there public sources available? It's very much at odds with the "common wisdom" portrayed by the media.

As for how it could happen - my cubemate bought a house in the South End of Boston in 2006, right next to downtown. He's a well-established professional, solid skills, solid resume, and I believe makes over 6 figures. But he bought the house with a $500k interest only mortgage. His banker told him that nearly everything they wrote these days is interest-only, and he should buy the biggest home he could afford. So if housing prices fall, he has every incentive to walk away. It hasn't happened yet (he got promoted to CTO, and prices are still rising in the South End), but I could imagine there're many people who took out similar terms but don't have the same wherewithal to pay them.

jonny_noog• 18 years ago

Could there also possibly be some knock on effect from the rising cost of fuel prices, leading on to rising costs of food, home heating/cooling and other essentials for these "gentrifiers"?

Goladus• 18 years ago

I think the problem people have when the CRA is brought up is that there's no way the stated purpose of the CRA would have "pressured" banks to lending to unqualified applicants. The purpose of the CRA was to get banks to lend to equally qualified applicants within their lending range. It's point is to break down institutional racism and discrimination.

I don't know enough about the details to know what Miron was talking about, though. He didn't say in the article.

maxharris2• 18 years ago

Exactly. The government ultimately has to print the money that it uses to bail out these guys (who deserve to fail anyway) - the consequence of this printing is that the dollars in your pocket can't buy as much as they could before.

Taxes are not the only way to tax people.

* Yes, the government has been playing this game for around a century. But does that make it right to tack on another trillion in the theft?

aschobel• 18 years ago

Fascinating video from the Newshouur with Jim Lehrer: http://www.pbs.org/newshour/bb/business/july-dec08/bailoutta...

We do need some kind of government intervention, but the current form stinks.

timr• 18 years ago

This is a good article, and I generally agree, but...there's a danger in calling this particular bailout plan "more government", and then arguing against it by saying that more government is always bad.

The problem here isn't "more government" -- it's that the government is showing a willingness to prop up an unsustainable system. If the proposed legislation was a package of hard-nosed reform and regulation, plus some money to bail out the most critical banks to our economy, it would make much more sense. However, in its current state, the bill oinks and waddles just like congressional pork.

We got where we are through a lack of government (regulation), and the solution to the problem almost certainly involves more of it; it just has to be the right type.

Prrometheus3• 18 years ago

>We got where we are through a lack of government (regulation)

I hear this a lot, but what particular regulation do you think would have mitigated the crisis? I can't think of any, except restricting subprime lending - which would be directly contrary to the Government's other goal of more home ownership.

Meg Mcardle had a good discussion of possible regulation:

http://meganmcardle.theatlantic.com/archives/2008/09/hindsig...

RobertL• 18 years ago

Agreed Prrometheus. More regulation is just going to push more of the business overseas. If Congress screws this one up they could create a situation where there will be no investment capital industry in the United States in the near future.

gills2• 18 years ago

The problem with the goal of "more home ownership" is that it was a tagline from the GSE's for "increase our deal flow", as they had somewhat of a golden goose with throughput being the only limit. It was and still is political suicide to oppose it. Stroke of genius, if you ask me.

Even worse than non-enforcement has been the active encouragement by the legislature of lots of this stuff. Tightening up the lobbying and revolving doors might help cool off some of that, but I don't really know.

Some of the regulation concepts being floated (not my ideas) are to ban off-balance-sheet vehicles, tighten definitions of what can be put in Level III/model-priced assets, and require that CDSs and other derivatives/wraps be traded on real exchanges so that a market-maker acts as central counterparty).

I'm not a financial expert, just trying to learn about this stuff. Maybe someone more knowledgeable will chime in.

Flemlord2• 18 years ago

Not getting rid of the Glass-Steagall Act would have limited the scope of the crisis. The act was put in place in 1933 to prevent the "too big to fail" problem with banks that led to the Great Depression. In general, we've had a Republican congress for the last 8-10 years that has been slowly deregulating the financial services industry.

Staying on a gold standard would have prevented the crisis. The gold standard was eliminated by Nixon in the 70's. In general, there were many checks and balances in place that had to be removed for us to get to where we are now. All in the name of political expediency.

bilbo0s2• 18 years ago

I am still a little confused as to what exactly is causing this crisis. I looked into the whole sub prime Fannie and Freddie thing and I found some surprising things. The first thing I found was that poor people get home loans through mechanisms other than sub prime lending. They go through the whole Ginnie Mae umbrella, where all the inner city HUD and FHA stuff is handled, along with rural housing, housing for native americans and there is also a special allowance for veterans of the military to cover them under Ginnie. All of these groups use mechanisms OTHER THAN SUB PRIME! Or rather, sub prime or not, these people have loans that are guaranteed EXPLICITLY by the government, unlike the loans backed by Fannie and Freddie which had IMPLICIT guarantees. How can Ginnie Mae be sound and Fannie and Freddie be such basket cases? Even if 100% of the poor people defaulted, Fannie and Freddie would be untouched. Another question is, who, exactly, was using these sub prime mechanisms that Fannie and Freddie ended up backing? The auditors are claiming that they were primarily used by people making between $40000 and $150000 to afford mortgages that they would otherwise be denied. But something is out of place. Why would the middle class be defaulting at such a high rate? There is some money missing here. I have yet to get a really complete understanding of what went on exactly. After reading through all of the financial info, I am left even more confused.

Is there an economist on Hacker News somewhere that can explain these inconsistencies to us? The only thing I could come up with is that these people wanted to live beyond their means. My quandary is that I have either severely underestimated the number of middle class Americans who want to live beyond their means, or overestimated my capacity for financial analysis.

And yes . . . it could be both.

ojbyrne• 18 years ago

In Canada, the average Debt-to-Equity ratio for banks is 3:1. We only have a few. Large, heavily regulated, safe as hell.

jmtame3• 18 years ago

Government intervention is the corporation's way of unfairly messing with free markets and competition. It only costs $8 million per quarter (see AT&T) to hire a team of lobbyists and Senators to unfairly block your competition out of the game and take over an entire industry (see network neutrality).

I agree with you; government regulation is good, meddling is bad.

anamax2• 18 years ago

How do you get from

> It only costs $8 million per quarter (see AT&T) to hire a team of lobbyists and Senators to unfairly block your competition out of the game and take over an entire industry (see network neutrality).

> I agree with you; government regulation is good, meddling is bad.

Is "unfairly block" and "takes over" good?

Surely you're not suggesting that we can have good govt regulation if only we believed in Tinkerbelle.

TrevorJ• 18 years ago

In one sense, the current situation is a product of too little government enforcement of antitrust laws. The whole point of keeping the marketplace free of monopolies is so that one or tow companies can fail catastrophically in any given sector without collapsing the sector as a whole.

jsmcgd• 18 years ago

I totally agree. Government in generally is very good at introducing new laws whilst being not very good at enforcing the laws they've already introduced.

Prrometheus3• 18 years ago

There were hundreds of mortgage lenders 18 months ago - not exactly a consolidated industry. The problem occurred when they all went under.

webwright• 18 years ago

Actually, we got here through the WRONG regulation... The whole area is thoroughly regulated (probably largely by well-meaning people).

There's a very good read on the the regulation that got us here: http://myslu.stlawu.edu/~shorwitz/open_letter.htm

kingkongrevenge• 18 years ago

> The problem here isn't "more government"

The problem is government -- period. This whole situation is the result of government manipulation of credit and a long running policy to deliberately inflate the housing market.

How could anyone be so naive as to think the current problem is lack of government involvement? The housing inflation was deliberate policy. Also, it's a deliberate policy that has blown up before!

http://www.scoop.co.nz/stories/HL0709/S00238.htm

Read that link and tell me it's remotely possibly to expect the federal government to affect better outcomes in markets. It's about how exactly the same shit that's going down now in the lower end of the housing markets ran in the 80s, because of criminal government enterprises.

davidw3• 18 years ago

The right answer is: some other site.

known2• 18 years ago

Bankruptcy leads to more business opportunities and jobs.

jsvaughan• 18 years ago

You should read up on the great depression.

nsimpson2• 18 years ago

I don't know why this was modded down ... it's a fascinating subject. http://en.wikipedia.org/wiki/Great_Depression

Every entrepreneur knows that those who choose to ignore history are doomed to repeat it.

jamiequint• 18 years ago

I disagree.

Take a midsize bank market cap of $5B and multiply it by 25-50 for the number of banks that might fail. That is a total loss of around $125B-$250B for which shareholders and employees of these companies bear the losses. Also should these banks fail, the government will have to step in via FDIC. The problem with this is that assuming an average balance of $10000 per depositor $700B covers 70 Million accounts. While this is probably sufficient for average individual depositors, what is to happen to the small businesses that have greater than $100k in assets? Also, what happens to the availability of credit with so many banks in default?

Bankruptcy actually seems more risky, as the people who would lose are small businesses and those with over $100k in the bank, people who would never have recourse to get their money back. Rather than socialized losses (through inflation), its losses for an unlucky few. The bailout plan, however, which involves taking warrants in the companies we are giving money to seems to have a good chance of repaying at least a significant portion of what it costs overall.

Thoughts?

michaelneale3• 18 years ago

OK so how long will this all take to go to shit (one way or another), I am impatient.

nsimpson2• 18 years ago

For people seeking an informed and academic perspective, you may find this PDF on Liquidation Cycles during the Great Depression to be of interest: http://econ161.berkeley.edu/pdf_files/Liquidation_Cycles.pdf

lasthemy1• 18 years ago

Since no one seems to have mentioned leverage and credit default swaps, here's the first summary I could find: http://www.nakedcapitalism.com/2008/04/credit-default-swaps-...

There are many better if anyone cares to look; the mortgages defaulting lend themselves to a house of cards analogy. Banks were so heavily leveraged that they may not even be able to handle even a small number of defaulting loans on property that decreased in value.

cbrinker• 18 years ago

Yes this is the root problem with the credit markets; bad mortgages.

However, this doesn't account for the root financial problem of our country that has plagued us since 1913; the federal reserve. These crooks sway the entire economy and have exponentially inflated our currency. The dollar is worthless today. It is worth $0.02 to the dollar of the beginning of the 20th century.

We went off the gold standard, we decided fractional reserve banking was a good thing, and we put in charge idiots and crooks to create a lesse faire market that only benefits them.

Don't believe me?

http://en.wikipedia.org/wiki/Image:USACPI1800.svg

Usury, fraction reserve banking, and crooks.

known2• 18 years ago

bailout is a lose-lose proposition

wschroter• 18 years ago

Why not just give the $700b to healthy banks so that they can lend to businesses and credit worthy consumers?

If we have $700b to give, why use it to buy up toxic debt? I understand wanting to keep the markets moving, so why not address the problem there?

Bankruptcy, not bailout, is the right answer

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