Our Financial Bailout Culture
Lee K
By ETHAN PENNER
April 11, 2008; Page A17
http://online.wsj.com/article/SB120787271551406585.html?mod=opinion_main_commentaries
Last week's congressional hearings on the Bear Stearns "non-bailout" were
fascinating, and frightening. Our leading financial regulators said the
Federal Reserve's unprecedented action was necessary to ensure the stability
of financial markets, which would have melted down had nature taken its
course.
When asked by the committee if opening the Fed borrowing window for
investment banks (which was done later) could have saved Bear, New York Fed
President Timothy Geithner responded that "We only allow sound institutions
to borrow against collateral," thus implying that Bear was not sound. That
raises the question of when Bear became unsound, especially in light of the
public statements about the company's strength by their CEO only days
earlier. If Bear was undercapitalized and overleveraged, shouldn't red flags
have gone up long before?
Sen. Jim Bunning (R., Ky.) asked the regulators how the solvency of a single
financial institution could threaten to bring the entire market to its
knees. The regulators' reply was to hang their heads and pledge more and
better oversight.
In a bear market – with losses looming for investors, homeowners, financial
services executives, homebuilders and the average stretched consumer – the
hue and cry for the government to save everyone is reaching a fevered pitch.
Even avowed capitalists who enjoyed the benefits of bull markets are now
advocating government intervention. Government officials need little
prodding to respond, and so the process of increased regulation has clearly
begun.
Every day comes news of the increasing creep of the public sector. State
governments, frustrated by the impact of the housing crisis on tax rolls,
are implementing laws to stall or impede foreclosures. The Federal Housing
Administration, granted (along with Fannie Mae and Freddie Mac) a huge
increase in its loan limit, is now close to making the increase permanent.
The unstated premise is that, with better government oversight, we would not
be suffering today's bear market and financial chaos. Of course, during the
previous outsized boom, no one was calling up his congressman to complain
that home values were appreciating too quickly. Meanwhile, they drained that
appreciation regularly through refinancings to pay for vacations, new cars
and other pleasantries, all of which created the prosperity for which
politicians were pleased to take credit.
Leverage – and the rapid creation of dollars – fueled the boom we all seemed
to love. But leverage cuts both ways, accentuating the benefits of a bull
market and the pain of a bear market. The lesson we all must take away now
is that leverage is not a one-way path to wealth with no risk of loss.
There is little doubt that if Bear were to have ended up in bankruptcy, the
ripple would have been felt wide and far. Perhaps the most extreme and best
example are the defaults that would have occurred on Bear's overnight
borrowings, whereby they pledged collateral, much of it mortgage-backed
securities (MBS), as security. Many of these loans were held by (short-term)
money market funds, funded ultimately by people like you and me, who are
legally prohibited from owning MBS with their long 30-year final maturities.
Had Bear gone bankrupt, these funds would have been compelled to seize and
immediately liquidate the collateral into an already highly distressed
market, ensuring that its investors (you and me again) would have likely
lost much of their stake. Painful? Surely. Eye-opening? Definitely.
Instead of losses spreading through the system, however, the government
stepped in. As J.P. Morgan CEO James Dimon said in the hearings, "This would
have been far more, in my opinion, expensive to taxpayers had Bear Stearns
gone bankrupt and added to the financial crisis we have today. It wouldn't
have even been close."
This is clearly true on this deal and in the short run. But as Mr. Bunning
implied, isn't it the regulators' job to ensure that we don't end up here
ever again? That is the dilemma of "moral hazard." Consequences not suffered
from bad decisions lead to lessons not learned, which leads to bigger
failings down the road.
And so we have the insidious modern trend to shirk responsibility and blame
others for our missteps. This trend, this "victim mentality," is a path
toward personal disaster.
Perhaps if the Fed had raised short-term rates more aggressively, the
excesses of the bubble could have been avoided. Maybe regulators could have
noticed that the criteria for achieving an AAA rating had weakened markedly
and inserted themselves early on. Yes, we can hope that the government takes
the appropriate steps to ensure that the regulatory system improves as a
result of this crisis. However, we citizens also need to accept our share of
the responsibility.
Homeowners must learn that there are risks to using a home as an ATM.
Investors who borrowed to flip condos must learn the downside of such risk.
Individuals who steered money from insured bank deposits into uninsured
money market accounts to pick up 1% more yield – like the institutional
investors who purchased complex securities with little due diligence – need
to know that in an efficient market, extra yield means extra risk. Those who
played the derivatives market, focusing more on computer-driven pricing
models and less on managing counterparty risk, must pay for that oversight.
And, much as it is impolitic to say, people who took money from lenders and
signed without considering how they'd repay those loans must also be held
accountable.
In one of this year's primary debates, Ron Paul said it is not the
president's job to run the economy. I'd add that it is not the government's
job either. It is each and every citizen's job to manage our own affairs,
make our own decisions, bear the fruits or painful consequences and learn
our lessons.
The free market is the essence of our society's strength and is rooted in
the Lincolnian precepts of accountability and responsibility. When decisions
are made and actions taken (or not taken), there are consequences. These
consequences are models for us to learn from and serve to stimulate social
growth and advancement.