I don't claim to be an economic expert, but the more that I learn about the administration's proposed $700 billion solution to the mortgage crisis, the more I find myself thinking that this is a poorly conceived idea.
I am liberal on social issues, a bit more moderate on economic ones. But it's clear to me that government's role is to regulate capitalism, not to wade in to the markets in this fashion. What the administration is proposing is rife with risks, the most significant being that it may not actually resolve the situation. But as it's currently envisioned, it carries substantial risk to today's taxpayers as well as for the long term viability of the American economy. And it also appears to offer ample opportunity for someone other than the American taxpayer to benefit, and that's irregardless of whether the proposal succeeds in reviving our credit markets.
I make that last point because Treasury Secretary Paulson has proposed having private entities administer the government's portfolio of mortgage securities, and with a portfolio valued in the hundreds of billions of dollars, you're going to have a hard time convincing me that there won't be an incredible temptation for those private entities to make decisions that aren't necessarily in the public's interest.
If this is the best plan for America, the taxpayers need to be told why that's the case and why alternative, less draconian solutions are inadequate. Here's one example of
another approach:
Raghuram Rajan and Luigi Zingales of the University of Chicago suggest ways to force the banks to raise capital without tapping the taxpayers. First, the government should tell banks to cancel all dividend payments. Banks don't do that on their own because it would signal weakness; if everyone knows the dividend has been canceled because of a government rule, the signaling issue would be removed. Second, the government should tell all healthy banks to issue new equity. Again, banks resist doing this because they don't want to signal weakness and they don't want to dilute existing shareholders. A government order could cut through these obstacles.
Meanwhile, Charles Calomiris of Columbia University and Douglas Elmendorf of the Brookings Institution have offered versions of another idea. The government should help not by buying banks' bad loans but by buying equity stakes in the banks themselves. Whereas it's horribly complicated to value bad loans, banks have share prices you can look up in seconds, so government could inject capital into banks quickly and at a fair level. The share prices of banks that recovered would rise, compensating taxpayers for losses on their stakes in the banks that eventually went under.
THINK ABOUT THE SITUATION AGAIN: the administration is proposing that Congress pass legislation
by next Friday that authorizes the greatest single expenditure in the history of the world, some $700 billion. What are the chances that they're going to get this wrong? If the banks and other financial institutions don't have any idea how much these assets are worth, how is the government going to possibly make that determination and avoid overpaying with taxpayer money?
Joe Nocera at the
New York Times has this to say:
Most of the assets in the [late 1980s] S.& L. crisis were real estate — which are always going to have value. And the government didn’t have to acquire them; it simply took them over and, over time, sold them. This time, the assets are complex derivatives of uncertain value that the big firms will actually be selling to the government.
But how is the government going to assess these securities — and what price will it pay for them? In many cases, these securities aren’t being sold because they are still overvalued on a firms’ books. That is, their mark-to-market price is unrealistically high. Will the government buy it at the too-high price? If it does, the firms won’t have to take additional write-downs — but it will constitute a huge, unjustified bailout of Wall Street. (More moral hazard.)
But what if the government drives a hard bargain, and gets the securities for what they are really worth — 20 cents on the dollar, say, instead of 50 cents? In that case, the firms would have to take yet more enormous write-offs, which would further damage their balance sheets, and they would have to raise billions more in capital. Maybe the removal of these bad assets would allow the firms to raise the capital. But maybe not — meaning one or more could conceivably have to file for bankruptcy, creating yet another spasm of financial turmoil. It’s a huge roll of the dice by the government.
Finally, there is the question of how much it will ultimately cost. “Institutions so far have written down $550 billion globally of bad debt,” said Daniel Alpert, managing director of Westwood Capital. “We think that when you add up all the problems in the residential housing market still to come — further erosion of housing prices, mortgage foreclosures and so on — we are going to need another $1 trillion of write-downs.”
WHATEVER THE CASE, the current financial crisis has to be understood as a wake-up call to the American people. If something is too good to be true, it is. If it doesn't seem like it can go on forever, it can't. We have lived too long thinking that we can simply borrow our way to prosperity. You can only live beyond your means for so long. We are learning that as a nation with respect to our economy. Recent years have also begun to tell us that this is true in terms of the finite resources available to us on this planet. We ignore these facts at our own peril, as well as that of future generations.
At dinner tonight, a metaphor occurred to me as Victor and I discussed the economy and our addiction to cheap money. To the fish living in a fish bowl, the limitations of that environment seem to simply be
the way things are. You swim in a circle, stop, swim the other direction. Occasionally some food appears. Sometimes the water gets stagnant, only to mysteriously improve. Life goes on.
But a fish that was able to pop his or her head up above the surface for a moment would realize that that world wasn't designed for the benefit of the fish.
We, in turn, live in a world dedicated to consumption, even if that requires borrowing. It certainly isn't a world designed for our benefit. And if it's not clear to you who is actually benefiting, ponder that question the next time you are paying your credit cards, mortgage loan, and other bills.
HERE'S THE
TEXT OF THE LEGISLATION that the administration is proposing. I've added a few comments in italics:
LEGISLATIVE PROPOSAL FOR TREASURY AUTHORITY TO PURCHASE MORTGAGE-RELATED ASSETS
Section 1. Short Title. This Act may be cited as ____________________.
Sec. 2. Purchases of Mortgage-Related Assets.
(a) Authority to Purchase. The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.
(b) Necessary Actions. The Secretary is authorized to take such actions as the Secretary deems necessary to carry out the authorities in this Act, including, without limitation:
(1) appointing such employees as may be required to carry out the authorities in this Act and defining their duties;
Who are these deputies? Why wouldn't this function be carried out by a department or agency of the federal government? Isn't this introducing a huge potential for decisions to be made that benefit someone other than the citizens of the U.S.?
(2) entering into contracts, including contracts for services authorized by section 3109 of title 5, United States Code, without regard to any other provision of law regarding public contracts;
What laws are being circumvented here? Why does this have the ring of "no-bid" contracts?
(3) designating financial institutions as financial agents of the Government, and they shall perform all such reasonable duties related to this Act as financial agents of the Government as may be required of them;
(4) establishing vehicles that are authorized, subject to supervision by the Secretary, to purchase mortgage-related assets and issue obligations; and
(5) issuing such regulations and other guidance as may be necessary or appropriate to define terms or carry out the authorities of this Act.
Sec. 3. Considerations.
In exercising the authorities granted in this Act, the Secretary shall take into consideration means for—
(1) providing stability or preventing disruption to the financial markets or banking system; and
(2) protecting the taxpayer.
Take into consideration? If these are not the primary and only objectives of this legislation, then why aren't any others explicitly stated?
Sec. 4. Reports to Congress.
Within three months of the first exercise of the authority granted in section 2(a), and semiannually thereafter, the Secretary shall report to the Committees on the Budget, Financial Services, and Ways and Means of the House of Representatives and the Committees on the Budget, Finance, and Banking, Housing, and Urban Affairs of the Senate with respect to the authorities exercised under this Act and the considerations required by section 3.
Semi-annual reports to Congress? That's it? No other oversight? After a lack of adequate regulation got us into this mess, it's imperative that Congress has a much stronger watchdog role. We're talking about $700 billion here!
Sec. 5. Rights; Management; Sale of Mortgage-Related Assets.
(a) Exercise of Rights. The Secretary may, at any time, exercise any rights received in connection with mortgage-related assets purchased under this Act.
(b) Management of Mortgage-Related Assets. The Secretary shall have authority to manage mortgage-related assets purchased under this Act, including revenues and portfolio risks therefrom.
(c) Sale of Mortgage-Related Assets. The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any mortgage-related asset purchased under this Act.
(d) Application of Sunset to Mortgage-Related Assets. The authority of the Secretary to hold any mortgage-related asset purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a mortgage-related asset under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.
Sec. 6. Maximum Amount of Authorized Purchases.
The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time Sec. 7. Funding.
For the purpose of the authorities granted in this Act, and for the costs of administering those authorities, the Secretary may use the proceeds of the sale of any securities issued under chapter 31 of title 31, United States Code, and the purposes for which securities may be issued under chapter 31 of title 31, United States Code, are extended to include actions authorized by this Act, including the payment of administrative expenses. Any funds expended for actions authorized by this Act, including the payment of administrative expenses, shall be deemed appropriated at the time of such expenditure. Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
The decisions of the Secretary of the Treasury are "non-reviewable" by any court of law? We're throwing out the whole notion of checks and balances upon which our government was founded?
Sec. 9. Termination of Authority.
The authorities under this Act, with the exception of authorities granted in sections 2(b)(5), 5 and 7, shall terminate two years from the date of enactment of this Act. Sec. 10. Increase in Statutory Limit on the Public Debt.
Subsection (b) of section 3101 of title 31, United States Code, is amended by striking out the dollar limitation contained in such subsection and inserting in lieu thereof $11,315,000,000,000. Sec. 11. Credit Reform.
The costs of purchases of mortgage-related assets made under section 2(a) of this Act shall be determined as provided under the Federal Credit Reform Act of 1990, as applicable. Sec. 12. Definitions.
For purposes of this section, the following definitions shall apply:
(1) Mortgage-Related Assets. The term “mortgage-related assets” means residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before September 17, 2008.
(2) Secretary. The term “Secretary” means the Secretary of the Treasury.
(3) United States. The term “United States” means the States, territories, and possessions of the United States and the District of Columbia.
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