Don’t Blame Them for Failing, Blame Them for Trying

Why government intervention failed to correct the market woes

When we were in grammar school, even if we did poorly on a project, we would often still get an “A for effort.” The lesson - even if you fail, do your best. Good lessons on life and persistence to teach a school kid, but a bad lesson for Government intervention.

The American people had been told by everyone from the President, to Congressional leaders, to the pundits that unless the $700 Billion bailout bill was passed, there would be stock market crashes, banks would fail, and a financial crisis not seen in many years – maybe since the great depression – would ensue.

So the Congress passed a pork-laden $800 billion plus bailout package to save the economy. What happened? Banks failed, world financial markets crashed, and financial crisis ensued. Should we at least give them an A for effort?

We are now told it is not enough, the government needs to do more to stabilize the markets. But the reality is, the government has already done more than enough to cause the crisis in the first place, and their quick fix bailouts and injections of capital - to the tune of $1.5 trillion dollars so far – have done little to stabilize the markets.

A quick trip down memory lane will remind us that congressional and Clinton administrations policies to ease credit policies at the Government Sponsored Entities (GSE) Fannie Mae and Freddie Mac started the snowball rolling down hill that created this mess. Well intentioned policies designed to make homeownership easier for those who were less than credit worthy created the Sub-prime mortgage that was the catalyst for the melt-down.

Government then created and championed 100% or ‘zero money down’ mortgages to again make it even easier for people who couldn’t afford to own a home to get one. The traditional 20% down used by banks for generations to insure proper collateralization was abandoned, again creating more vulnerability.

Banks then were pressured by Janet Reno and others to make more risky loans. Fannie and Freddy were all too willing to buy this worthless paper, getting banks off the hook. Add in unscrupulous commission based ‘mortgage brokers’ who trolled for subprime ‘marks’ and encouraged them to take even larger mortgages, regardless of their ability to pay them back, so that their commissions would be greater.

The most fundamental of checks and balances in the financial system is risk and reward. This government created mortgage Ponzi Scheme paid banks and mortgage brokers massive reward while removing the risk. Long before the loans defaulted, the broker had gotten his commission check and the bank had sold their bad loans to a willing Fannie and Freddie.

Things ballooned out of control in the secondary market. Fannie and Freddie bundled loans and packaged them as Mortgage Backed Securities (MBS) which it then sold to investment banks, hedge funds, and others. Again, the risk seemed negligible as these loans had an implicit backing of the ‘Full faith and credit’ of the US Government.

Those buyers then sliced and diced the MBS and resold them to other investment banks and financial managers. To make them even more attractive to buyers, even more risk was removed by offering a dubious instrument called a “Credit Default Swap” (CDS), which acted as a sort of insurance policy. Why CDS? They were unregulated.

While many people were shouting from the rooftops that this was not sustainable, and when the housing bubble created by easy credit popped would all come crashing down, Congress resisted multiple efforts by the Bush administration and Federal Reserve Chairman Alan Greenspan to investigate and regulate Fannie and Freddie.

While Congress can do many things, it can’t legislate out of existence the business cycle. When the bubble burst, as they always do, banks were left holding worthless paper. These MBS were worthless, and Lehman Brothers, AIG and others were expected to make good on the CDS. We then learned that banks had actually borrowed money to buy MBS, and, lacking the cash reserves to cover the loses, now were headed for bankruptcy.

Enter the US government. The same leaders that intervened in the market, ignoring fundamentals and creating the structural problems that caused the crisis in the first place, insisted that only Government intervention could solve the problem.

The most honest assessment of the situation came from Senate Majority Leader Harry Reed, when he candidly said, .”we don’t know what to do.” The market is far too complex and decentralized for the central planners in Washington – the same leaders that created the mess in the first place – to solve.

The government has taken it upon itself to pick winners and losers – letting Lehman Brothers fail, while backing other similar institutions. The Treasury Secretary is now given sweeping powers to dole out nearly a trillion dollars to prop up the banking system. The Federal Reserve has lowered its discount rate. And thanks to this, the crisis was averted? Well, the Dow Jones average saw its greatest one week drop in history – after the critical bailout bill passed.

Should we give the Government an A for effort? After all, Alan Greenspan and the money masters were credited with keeping the economy roaring throughout the last 20 years. Surely the booming economy had nothing to do with innovation, a growing world economy, reduced regulation, and lower tax rates.

Looking back at the crisis and its genesis, I would say the lesson is not that the government failed in the bailout, but that it should never have tried to ‘fix’ the market in the first place.

Copyright 2008 Reprint permitted with the following citation:
TJPaine
Un^Common Sense
Dedicated to the Advancement of Americanism
http://uncommonsense-tpaine.blogspot.com/