Posted on 09/21/2008 5:50:25 PM PDT by mathprof
Bush is seeking $700 billion to buy “bad mortgages” in the largest bailout in history. The proposal attempts to bail out the entire financial system, rather than individual banks. This sweeping federal intervention will turn out to be either excessively costly, or unnecessary. Defenders of this bailout, like Treasury Secretary Hank Paulson, claim it is needed because the mortgage meltdown and ensuing panic have led to mortgages having a market value of far less than they are truly worth, drying up markets for mortgages and resulting in “frozen” credit markets.
But even if this is true, it’s no reason for a bailout. There are two possibilities, neither of which justifies a bailout. Either the mortgages are just as worthless as their current market price suggests, in which case the banks that hold them, rather than taxpayers, should pick up the tab (and any insolvent banks should be closed, so that they cannot gamble with depositors’ and taxpayers’ money in the future).
Or, the mortgages are worth much more than they are currently valued — their current value being set under federal “mark-to-market“ accounting regulations, which require that assets like mortgages be conservatively valued at what they can currently be sold for at the moment, rather than what they would be worth if held to maturity. If that’s the case, then federal accounting regulations need to be immediately relaxed by federal agencies like the SEC that enforce them — as John Berlau argues today in the Wall Street Journal, and as former FDIC Chairman William M. Isaac urged yesterday in a Journal editorial attacking the federally-enforced Fair Value Accounting Rules and Basel II capital rules. (This would also be a good time to revisit the truly senseless accounting regulations imposed by the Public Company Accounting Oversight Board, which cost the U.S. economy over $35 billion per year, and were used by sub-prime mortgage lender Countrywide Financial as a smokescreen to hide its risky business practices).
As John Berlau and Holman Jenkins have noted in the Wall Street Journal, if it were not for federal accounting regulations, the federal bailout of AIG might never have been necessary. And banks, rather than dumping their own sub-prime mortgages at fire-sale prices to meet reserve and regulatory requirements, might instead have been willing and able to purchase or make loans to troubled financial institutions that now will have to be bailed out by the taxpayer.
As we noted yesterday, federal regulation contributed to the mortgage bubble and meltdown, as regulators encouraged and promoted risky lending, rather than curbing it. Laws that pressure banks to engage in risky lending, like the Community Reinvestment Act, remain in full force, and the government-backed mortgage giants Fannie Mae and Freddie Mac, which failed and were taken over by the federal government, are now buying even more risky mortgage loans. “Affordable housing” mandates continue to encourage risky lending.
But politicians, seeking to avoid any responsibility for causing this mess, are blaming the mortgage meltdown entirely on the free market and an alleged lack of regulation. And journalists who recently (and belatedly) admitted the role of federal affordable housing mandates in causing the mortgage crisis, like the Washington Post’s Steven Pearlstein, a long-time cheerleader for Fannie Mae against its critics, are now back to their long-time role of cheerleading for more federal involvement in lending, and claiming that the massive federal bailout proposal shows the need for still more regulation of financial markets.
John Lott explains how regulators helped spawn the mortgage crisis by eroding lending standards here and here.
"Defenders of this bailout, like Treasury Secretary Hank Paulson, claim it is needed because the mortgage meltdown and ensuing panic have led to mortgages having a market value of far less than they are truly worth, drying up markets for mortgages and resulting in “frozen” credit markets. But even if this is true, it’s no reason for a bailout."
Isn't the true value of something its market value?
Great post. Thanks.
Thanks for posting. I am looking forward to reading the comments.
You are welcome. I think that McCain should oppose this, especially if the dems add pork and class warfare to it. I predict that the dems will overplay their hand as usual.
I like Bush a lot, but I think he’s made mistakes by rushing to judgement. I think that this might be another one.
We were very close to a financial collapse. Thank goodness Paulson acted.
If the bailout is delayed, we are in deep stuff but 70% of America thinks its a diabolical plot to steal the nation. We are so screwed.
http://www.nypost.com/seven/09212008/business/almost_armageddon_130110.htm
That’s going to take some time to digest. Thanks for the hard work.
If people panic and all withdraw everything from their money funds on the same day, there aren't any banks.
Isn't any money, either.
This is more of the same ignorant moralizing nonsense, that assumes there is any kind of finance that is so "sound" that it can stand up in a full blown money panic. There simply isn't, hasn't been since the dawn of mankind, and never will be.
No. That is merely its price. Its *value* is the discounted present value of all its future cash flows, as those actually occur.
Whenever people are wrong about what those cash flows will be, their price is also wrong. And if they are wrong about the interest rates that will prevail over the whole period of time those cash flows come in, then they will discount them at the wrong rates, and again their price will be wrong.
Sometimes dollar bills sell for 40 cents because people can't do math. Or are too scared to bother trying, only thinking "maybe it is worth more than this really, but it could be worth even less next week - I'll wait until then just in case it drops even further".
Value investing consists of an objective appraisal of the true value of anything, and a comparison of that objective value with the current quoted price. The current quoted prices are frequently quite irrational. They usually don't stay that way forever, and have some tendency to fluctuate through, if not to settle around, the true value, over long enough periods of time.
That is reality. Ideology often tries to pretend otherwise, but is pure fantasy when it does.
Lurking on these “bailout” threads to try to figure out if the President’s proposal is a good thing or not.
Agree that intervention seemed absolutely necessary.
My “beef” is that none of the crooks at Fannie Mae and Freddie Mac where this nightmare really hit the fan - are paying for their CRIMES unlike the Enron execs and the Worldcom execs who cooked THEIR books - and got bonuses.
I think the American people expect and deserve JUSTICE for the crimes that have been committed over at Fmac and Fmae - for starters.
Then, if desired, they can indict all of Congress who ignored the warnings that have been going out since the early 2000’s = while instead majoring on BDS issues.
Isn't any money, either.
Pray tell Oh Great Financial Genius what would be depositors withdraw. Turnips?
L
If the mark to market accounting rules were suspended the banks could hold the bonds until the market settled down and none of this would be taking place. The bondholders would, in effect, be “whistling past the graveyard” until the bond performance is known and then adjust their portfolios in an orderly fashion. Much easier on the global financial system.
It's not necessary. The only people being 'bailed out' are a bunch of crooks, thieves, grifters, and con artists.
Let 'em fail. Then indict the lot of 'em. Anyone speaking in favor of this monstrosity has a vested interest in it.
That includes a lot of Freepers to my mind.
L
“Isn’t the true value of something its market value? “
One can make this argument semantically. I do not think it is always correct, especially in cases where external pressures distort the pricing mechanism of the market. This is such a case. It is certainly possible that an entity with the financial ability to simply buy and hold them would make a very large return vs. current market value.
The problem here is that no one has the spare capital to do this, and in fact the losses being marked on them are large enough to wipe out entire corporations, thus the endless death spiral on pricing.
Thursday was bad, apparently most if not all the 300bn put into the markets by central banks that day ended up in mmfunds, and the financial system was at serious risk.
I think the American people expect and deserve JUSTICE for the crimes that have been committed over at Fmac and Fmae - for starters.
Then, if desired, they can indict all of Congress who ignored the warnings that have been going out since the early 2000’s = while instead majoring on BDS issues.
BTTT!
The article advocates just letting all banks fail if they can't make it through any crisis the markets throw at them unscatched on their own. This completely ignores the actual structure and intended operations of our banking system, the Fed, the FDIC, etc. It amounts to saying, "first we will demand that the patient's heart stop, because the heart is not allowed to intervene in this, and then we will command him to rise up off the table out of sheer faith. If he can't, he wasn't healthy, let him die."
The Fed is *supposed* to intervene in a money panic. All the other banks turned over to it when it was founded specific roles they had exercised themselves, before it existed. Waiting for a general money panic and then saying, "oh no, the Fed can't interfer, that would be wrong!", is demanding the patient's heart be removed.
And no bank would survive the procedure. Nor any other form of financial wealth.
BS.
The article advocates just letting all banks fail
The article says no such thing. It advocates letting the banks that were stupid enough to make NINJA loans 60+% of their 'assets' fail. I agree.
The Fed is *supposed* to intervene in a money panic.
Except this isn't one. This is the largest theft in the history of the world, and it's about to be made even bigger by Paulson, Bush, and Congress.
Have you actually read this monstrosity? It wants to give Paulson unlimited and unreviewable authority and access to taxpayer money.
He should be fired and then drawn and quartered for even suggesting such a thing.
What's your vested interest in all this? I'm willing to bet you're a banker or 'financial services' type.
Screw the lot of you. You caused this. Now you live with the consequences.
Maybe when we see mobs hunting the crooks who caused this down with dogs you'll learn your lesson.
L
Not necessarily. One problem is defining the period of time over which the market value is determined. If you pick a very short time, then there is a lot of noise in the price - because the market may not even be operating. So for example, you may live in a house "worth" $400,000 but if you need to sell in in 30 days the selling price you get from the four or five buyers that come by might only be $300,000. If you need to sell it by tomorrow afternoon the only buyer may offer just $200,000, or there might not be any buyers at all. So is your house suddenly worth nothing? No, you just have an illiquid asset over that time interval.
I suspect we're seeing some assets underpriced by the market right now due to uncertainty as to their value by people who would normally trade the assets and provide liquidity. I also suspect that there are also a lot of assets that were and probably still are tremendously overvalued --the consequence of a giant credit and real estate bubble. Figuring out which is which isn't always easy.
It also appears to me that the existing schemes used to rate and value a lot of investments are pure BS -- which is why collections of worthless mortgages were "packaged" and sold as A grade investments. Once the market participants lose the ability or confidence to rely on 3rd party data to assess the value of an asset, transactions take much longer to happen, if they happen at all. If everybody in the market is forced to value their assets at the market, but the market falls apart - even temporarily - then a chaotic situation ensues. Like the one we have right now.
I wish I didn’t, but I sure do understand what you are saying.
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.