Wednesday, October 1, 2008

Thoughts on the Financial Crisis

A surprising number of people have emailed me to post something of length on the financial crisis and bailout plan. I thought I had.

Anyway, this crisis didn't appear overnight. It's been going on since August of 2007. I still stick by my statement from January:
Bernanke announced that the Fed is going to take substantial additional action, which means, in Fed-speak, that interest rates are going to be cut.

Basically, we are delaying a probably mild recession in 2008 for a worse recession in 2009. At least that is my off the cuff analysis.

The credit crunch has been bubbling since August of 2007. Unfortunately, actions taken by the Fed at that time that were meant to stabilize the market not only stabilized the market, but also signaled to banks that the party was still on. I understand the Fed's motivation. Nobody wants to be the person to tell everybody to go home, but it would have been much better to have done it late last year or early this year. Back then people were going to be hungover. Now, the place is so trashed the entire building might fall over.

I'm not entirely comfortable with the Paulson plan, but its logic makes sense. The government will buy up the cancerous loans. This will get them off the banks' balance sheets and give them cold, hard cash instead. Do not believe the argument that the government might make money off the deal. While technically possible, this is unlikely. The entire point of the government buying these loans is that they are going to OVERPAY for them to shore up the prices of other loans. It will most likely work.

I also worry about the long-term consequences of an intervention this large. As I have said before, government intervention is invaluable during a crisis situation whether that crisis is real or financial. However, many on the left will use this to justify persistent intervention by the government in the markets. I am less sanguine about their ideas on those fronts.

The finger pointing has already begun. Democrats argue that financial deregulation and weakened oversight allowed the worse excesses of evil capitalism to run amok. Oh, it's President Bush's fault, too. The right has begun blaming liberal policies such as the Community Reinvestment Act and the quasi-public nature of the GSEs. There is blame to go around for everybody.

The fundamental problem is a misunderstanding of the American Dream. Everybody believes that home ownership is a Good in and of itself. Both liberals and conservatives jump all over themselves to support home ownership. Homeowners are wealthier than non-homeowners. Homeowners are more responsible and stable than non-homeowners. These stable homeowners form the backbone of every community. Therefore, encouraging homeownership will make people both more responsible, give us stronger communities, and offer a route to build wealth among the less-well-off.

The problem is that the causation reversed. Homeowners are not more responsible, stable, and wealthy because they own a home. They own a home and are wealthier because they are more responsible and stable. Giving a house to somebody, which is what a 100% loan basically seems like, does not make them responsible.

Previously we had a means to determine who was responsible and stable. It was called a downpayment. I don't know that 20% was the magic number to determine who was responsible or not, but a person who can save that much is.

Both liberals and conservatives were content to allow the homeownership wave to keep rising. People were happy their houses were worth so much. New homeowners were entering the market. Responsible, stable people and communities created every minute, or so they thought.

The government, both parties, banks, mortgage companies, and homeowners are all to blame. They wanted to believe the American Dream could exist without hard work. They wanted to believe that more homeownership was the key to a more equal or responsible, depending on your political predilections, society. Homeownership is a Good.

I'm not happy with the mess. I'm not happy the Fed let the party go on so long. I'm not happy with the proposed solutions. I'm not happy we will have to borrow $700 billion to fix it. I'm not happy we are going to have a deeper recession than we should have had. I'm not happy House Republicans think that spending $700 billion is worse than the potential collapse of our financial system. I'm not happy Democrats exacerbate the problem by using class warfare rhetoric. I'm not happy Nancy Pelosi decided to score petty political points instead of leading. I'm not happy the Republicans blamed her speech for their No votes to deflect from their stupidity. I'm not happy that the eventual bill will be far larger in scope and repercussions, if not in dollars. However...

This is not the end of Wall Street. This is not the end of globalization. This is not the end of the dollar as the world's reserve currency. This is not the end of America. This is not the end of life as we know it.

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