Monday, September 22, 2008
"The Fed and the US Government will ultimately put together some sort of bail out plan for the $300 billion in subprime bad debt. The amount is smaller than the S&L bailout in the late 1980s, and it is the only way to keep the real estate market from being a drag on the economy for years to come." Rising Dividend Blog March 25, 2008. This is a quote from my March 25, 2008 blog entitled Tough Questions, Controversial Answers. I was wrong by 60%, but right in principle that the US Government would eventually be forced to buy the bad mortgage debts from the banks to end the mortgage crisis. I heard many negative comments about that blog. I heard about free markets, moral hazards, and a host of other issues that didn’t mean a twiddle. I heard them, and I listened patiently, but I knew where this subprime debacle was heading. Now we are here at a figure of $700 billion instead of my $300 billion. Could the number have been smaller had Ben Bernanke and Henry Paulson moved faster? No, they have moved as fast as they could. Politicos cannot move much faster than the populace, and the people were not ready for a government bailout until recently. The following is a paraphrase of the last question of the March 24 blog. Question: What about the precedent of bailing out people and institutions who made unwise investments? Answer: It is not the Fed's job to impose moral judgment on society. It is their job to maximize sustainable economic growth and minimize inflation. One could just as easily use the argument about the moral hazard of people in the US who live directly in hurricane alley, or tornado alley, or wildfire alley, or earthquake alley, or any other dangerous alley in the country. Why should the rest of us have to pay when Katrina rips away New Orleans or Houston, or a tornado tears through a city in Kansas. These people all built homes or bought homes in harms' way. Shouldn't we just leave it to them to clean up their own piles of trash? No, that is not the way our country works. There is no hiding place from the storms of life -- physical or financial. Our country has stepped forth time and again to calm the storms and solve the problems in one economic sector or region of our country so that the troubles of that area do not spread to other areas and take us all down. Of course, there were egregious lapses of judgment on Wall Street, but they are paying for it in the hundreds of billions of dollars in write offs they have taken, bankruptcies they have filed, and in the tens of thousands of jobs that they have lost since the beginning of the subprime debacle. I don't like bailouts any better than most of our readers, but some bailouts are necessary when the foolishness of one group imperils the general populace. I believe the subprime-real estate crisis rises to that level. Had the government not bailed out the S&Ls in the late 1980s, the S&L problems would have lasted a decade, cost hundreds of billions of dollars, and slowed overall economic growth to a crawl. As it was, the Resolution Trust Corp. cleaned up the majority of the mess in only a few years at a fraction of the $500 billion at stake. In almost all economic crises, the death knell is the freezing up of valuable assets behind fear and risk aversion. In essence, when the government steps in, they act as an icebreaker by breaking apart the frozen assets and keeping them flowing, then putting the assets up for sale in an orderly basis. That is what happened in the S&L crisis. That is what I predict will happen in the subprime crisis. So, now we long-term investors wait and watch the politicians as they wrangle their political advantage out of the bail out package. While they spout and speak of things they know and care very little about, the markets will dangle in a cloud of unknowing, and as a result, will swing with the wind. When the package is delivered to the President for his signature, if it is along the lines of Secretary Paulson’s proposal, the markets will calm and the seeds of trust and confidence will sprout. If it includes tag-ons like more “bridges to nowhere,” the market will see through it like a cheap suit, and we will have more weeks of rough weather until the politicians get it right. I am not worried about the future because in a crisis US politicians usually get it right. Politicians are pawns of political pressure. Political pressure is beholden to the will of the public. The will of the public is not as far from the truth as many in the media elite would have us believe. The public are figuratively in the streets chanting for a stop to the financial carnage. They know that much of New Orleans is under sea level, but they reach out to New Orleanians as the storm surges over their seawalls anyway. That’s what’s so great about America. We are a nation that forgives and forgets and moves on. You say things have changed and it won’t happen this time. History says you’re wrong.