Arnold Kling  

The House Republicans

Why Did Financial Markets Like... Hold a Hearing...

They propose that all holders of private mortgage securities get together and form an insurance fund to guarantee their values.

Treasury Department can design a system to charge premiums to the holders of MBS to fully finance this insurance.

As I say in my AP stats class, "I appreciate that you raised your hand and tried to answer, but no. Anyone else?"

I am to the right of the House Republicans. I think that everybody is focused on the wrong thing--the mortgage securities. Mortgage securities are a rent-seeking issue, not a public-benefit issue. What puzzles me the most about Ben Bernanke's behavior is that he doesn't see through this.

Greg Mankiw writes,

If I were a member of Congress, I would sit down with Ben, privately, to get his candid view. If he thinks this is the right thing to do, I would put my qualms aside and follow his advice.

I agree, and I would love to be a fly on the wall at such a meeting. I really would like to see Ben lay his cards on the table, and not just issue vague threats of doom and destruction. A lot of people, not just from the far left or libertarian fringe, are drawing the analogy between the push for the bailout and the run-up to the Iraq war. Personally, I think that this is being unfair to the Iraq war, which by comparison was debated longer with more information provided to Congress and to the public.

I see the bailout as the latest grab from of the GSE-Wall Street industrial complex.

The whole history of Freddie Mac and Fannie Mae (the GSE's) is that Wall Street loved them because they generated humongous trading profits in their securities, and Congress loved them because they could be manipulated to steer mortgage funds toward favored constituents. Any regulator who dared tried to stand in their way got crushed by one of the best lobbying machines in Washington.

Barney Frank is one of the last people on earth who thinks that the GSE model is ideal. He loves the basic idea of the Paulson plan. Moreover, with Paulson literally going on bended knee to Nancy Pelosi to get this passed, the Democrats are in a position to "fix" the plan any way they want without fear of Presidential veto.

The bailout idea is really nothing new for the GSE-Wall Street complex. It's the same old rent-seeking--the folks who make a living in mortgage securities are just going for a lot more than usual in terms of tax dollars.

To the extent that the banking system (as opposed to the nonbank sector of financial services) is clogged by bad mortgage securities, taxpayers already face risk. The FDIC insures deposits at banks, which means that taxpayers could end up owning the mortgage securities, anyway. But better to own a few from failed banks than own a lot from both banks and non-banks.

If a bank has lost so much in mortgage securities that it is insolvent, it will have to closed by the FDIC. At that point, the mortgage securities transfer from the bank to the FDIC. The FDIC can then hold the mortgage securities (if we're in the mode of thinking that the market undervalues them) or sell them right away. If the FDIC insurance fund runs out, then you tap the Treasury.

It's ugly, but it's not Armageddon.

My advice is to focus on the banks, and forget trying to revive mortgage securities markets. Let those limp along as best they can without government help.

The benefits of the bailout will be almost entirely private. They will go to the shareholders and executives of institutions that made unwise decisions. On the other hand, the financial system, in the sense of banks that can make loans to qualified borrowers, can be saved using other tools. Again, I recommend lowering capital requirements for new bank loans going forward.

The problem with lowering capital requirements is that the benefits are broad-based. There is little or no rent-seeking traction to be gained in lobbying for them.

Comments and Sharing

COMMENTS (9 to date)
Frejus writes:

The only group that looks worse than politicians in this crisis are economists--and the field of economics in general.

A deeply troubled field.

aaron writes:

I don't get the Iraq war analogies. The Iraq war was a no brainer. Saddam had been a threat to the region which prevented growth and development throughout, he used the implied threat to bully neighboring countries, al qaeda types and other small minded anti-americans saw allowing Saddam's aparent (real or not) transgressions as taking face from America, and Saddam's large army and the uncertainty of WMD made taking on Iran impractical.

We had pocket Aces, the flop was two Aces and a King. Saddam was bidding up the pot and bullying his neighbors suggesting he had a full house. What are supposed to do, fold? We have 4 aces, it doesn't matter whether or not Saddam has the boat. If he wants to go all in, you take him all in.

Josh Lyle writes:

Great analogy, aaron, the problem is "who's we, white man?" In both cases, the fat cats playing "America's hand" are sitting behind chips that don't belong to them but still get to collect the pot.

David Thomson writes:

The Democrats are mostly to blame for this mess. Why is this being ignored? Why are so many of you nonchalant? You know darn well the Democrats are going to severely damage our nation's economy. Do you truly hate the Republicans that much because of the cultural war issues?

aaron writes:

That's the other thing, we had a stagnant economy at the time and people willing to lend to us at or below inflation.

Ok, I don't think I understand this proposal. The authors state that "Currently the federal government insures approximately half of all mortgage securities.". This is news to me. Do they mean that Fannie & Freddie are insuring these securities against loss of value? Or has the government been running some other huge program to sell insurance, of which I was unaware?

In any case, I'd think that it'd be at least as hard for the Treasury to properly price insurance on illiquid securities as it would be to price the securities themselves (and buy them, as Paulson suggests).

And the subtitle, "Common Sense Plan...", is amusing.

DanM writes:

I believe the current system can solve this problem without the bailout's astronomical cost to taxpayers. Capitalism is about creative destruction. The unwise institutions that invested in these securities will be destroyed. The depositors will be protected by the FDIC. The government will obtain the toxic securities without paying for them. The government will then go about establishing a clearing price for the securities which ultimately will unclog the credit markets. The analogy to the Great Depression is overdone because the FDIC did not exist and the RTC government asset sale model had not been created.

Frank Manziano writes:

This crisis is, as was pointed out, not so much about the value of the mortgage securities as it is about enabling banks to continue to lend. And the way to do that is to make sure they meet their capital requirements. And the easiest way to do that is let them (1) identify their troubled securities (2) submit to a fed program that allows to carry them at par / cost (as held to maturity securities, ie don't mark to market) in consideration for (3) all future interest payments go TO the fed, to form a pool they can use to (a) buy distressed securities if/as they might see necessary and (b) to start up a derivatives clearinghouse that all financial institutions would have to use to transparently offer, buy and sell their CDOs/swaps (like the options clearinghouse). This could get the system working again, without any tax payer dollars. Banks would go for it even though they lose the interest since they get protection and can go back to gearing without needing to raise new capital...

DanM writes:

A solution that improves the flow of credit without a huge taxpayer investment makes sense to me. My concern with the current plan is that once again we are kicking the can down the road for future generations to deal with. The deficit created by the bailout will not cause inflation in the short run because of the contraction in credit and the slow down in world wide demand. The increase in inflation will occur in the future when my generation is attempting to live on a fixed income and my children are attempting to educate and feed my, as of yet, unborn grandchildren. This really strikes me as a pay me now or pay me later scenario. We are the ones who screwed this up and we are the ones who should pay the price.

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