Treasury to Buy Equity in U.S. Banks
Well, it looks like what I was worried about is going to happen. The Treasury Department will be buying equity in 9 of the U.S. largest banks. What I find particularly dishonest was this line,
Therefore, the Treasury had little choice but to “jawbone them into taking the money in a coordinated fashion all at the same time.”
“These are healthy institutions, and they have taken this step for the good of the U.S. economy,” Paulson said of the financial firms.
When you have the coercive power of the the United States government backing you up, telling the public you “jawboned” them vs. “strong armed” them is contemptible.
Further, the idea here is to prevent people from learning which banks are in the most trouble and also to preserve such troubled banks–i.e. corporate welfare.
And again, this doesn’t address the problem of having politicians meddling in the home loan market. Traditionally home loans were made to people who had 20% of the selling price as a down payment, had a good credit record, and had an income that could justify the future mortgage payments. However, the result of this is that lots of people, who vote by the way, couldn’t get loans for a house of their own. So the politicians threw them a nice bone, in return for voting for the politicians in the future, of requiring lending institutions to make loans to people who didn’t have the 20%/good credit/high enough income to make the payments. Now some effort was made to make sure that people had at least the last two of the three, but it still increases the risk to the lender.
Then government sponsored entities (GSEs), Fannie Mae and Freddie Mac, got involved with securitizing mortgages. This effectively hid the risk in mortgages, it did not reduce it. To reduce it you’d have to go back to the traditional way of doing home loans and possibly even increasing borrowing requirements (higher credit score, higher income, larger down payment, etc.). So then comes along the Federal Reserve that was worried about deflation during the last recession and they dropped interest rates to a very, very low level which sets in motion both a boom in housing and a boom in home buying. Throw in the exotic mortgages that were developed to side step to an even greater extent credity and income requirements you had a the makings of a speculative bubble. Buy a second house, maybe do a few repairs/improvments then sell it 6 months later for a tiddy profit. Rinse and repeat and lots of money.
The government’s dirty handprints are all over this current crisis. Are they the sole cause of it? No. But looking back over the last serious economic crisis in U.S. (and world) history and you see similar patterns. During the 1920’s there was lots of irresponsible behavior on the part of people, but at the start of the recession the government did some really dumb things that turned a recession into a depression. Namely staying on the gold standard. This had the effect of deflating the currency massively. And what happens if you are a firm and are facing constantly declining prices? Suppose you buy $1,000 worth of inputs and produce 500 units of output. What is the price you have to charge to break even? $2. But if the price is declining when you buy the $1,000 worth of inputs you might find yourself facing a price of $1.5 meaning you have to take a loss. So economic activity slows down leading to unemployment. At the same time the gold standard meant the government had to do what it could to balance the budget so taxes were raised (in 1932). This made matters even worse. Then Smoot-Hawley comes along and doesn’t help either.
Now we aren’t making the same mistakes we did in the 1930s, but we very well might be making additional mistakes by letting the government have even more control over the economy. The government is run by politicians, who by their nature are craven and greedy (for power), and we expect this to be some sort of magic bullet? I can’t help but think it is a mistake. And in looking at the stock market right now we see it heading right back down to 8,500. Coincidence? Maybe, but I’m not at all comforted by the idea of the people who can’t even keep track of the Defesnse Deparment Budget or prevent massive amounts of Medicare fraud getting involved even deeper into another segement of our economy.