BailoutWatch: I Can't Even Keep Up
By Rich Toscano
Wednesday, April 23, 2008 | When I wrote the first installment of BailoutWatch this January, I intended to post occasional updates to keep readers apprised of the ongoing housing bailout efforts. Well, the truth is that I haven't even been able to keep up.
That column wasn't even the first on the subject -- it had followed hot on the heels of this one. Since the January post, the bailout attempts have been coming fast and furious. They've also been getting progressively more irresponsible and transparent in their attempts to reward the very institutions that enabled the housing bubble in the first place.
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| Rich Toscano |
Let's go through a selection of recent bailout-related developments.
Of course, everyone heard about the Federal Reserve's offer to guarantee $29 billion of investment bank Bear Stearns' debt. "Debt," here, includes the questionable and probably worthless mortgage-backed securities of exactly the type that brought Bear Stearns to the very edge of bankruptcy. This was nothing less than a public bailout of the reckless and overleveraged Wall Street firms that for years had pulled in huge profits by feeding the real estate mania.
This action was deemed necessary by our fearless leaders to prevent a financial market panic that might have occurred if Bear couldn't pay off its creditors or counterparties, the latter being the term for the folks on the other side of a derivatives trade. Now, more established Nerd's Eye Viewers may recall that I wrote a piece back in 2006 describing the risks that buyers of credit default swaps, which are derivatives that insure their buyers against loan defaults, might not get paid back in the event of default because of the flawed models employed by default swap issuers. Many others were warning of this risk as well, but we were pretty much collectively ignored.
Well, the Bear Stearns bankruptcy was it -- a huge derivative counterparty failure. Instead of allowing it to happen, however, the Fed (one of the main parties doing the ignoring back in 2006) bailed out Wall Street by taking on the risk for itself.
"Itself," here, means the taxpayers, who are of course the ultimate source of funding for the Federal Reserve. Enjoy Bear's worthless mortgage-backed securities, because you are now effectively their proud owner.
The Fed also invoked an emergency provision in order to start lending directly to investment banks, many of which are now suffering due to their heavy involvement in the mortgage-backed securitization boom about which I wrote in detail a while back. Go ahead and read that article and then ask yourself whether these companies really deserve to be lent public funds to make things easier for them after they took such huge and obvious risks (and made a killing doing so, at least for a while).
This is all serious stuff. None other than former Federal Reserve chairman Paul Volcker recently expressed concern that the Fed's actions "extended to the very edge of its lawful and implied power, transcending certain long-embedded central banking principles and practices."
Volcker was presumably referring to the Bear deal and the lending to investment banks. His statement didn't even address the fact that the Fed's target rate has been forced down well below the rate of inflation, so that savers across the nation can watch the real purchasing power of their savings disappear for the benefit of the housing bubble participants.
The Fed is certainly breaking out the big artillery, but other members of our government are hard at work on the bailout as well. In addition to raising the limit on conforming mortgages underwritten by Fannie Mae and Freddie Mac, regulators gave those two enormously leveraged operations the green light to go further into debt. (As I explained in the January installment, U.S. taxpayers are the implicit guarantors of this now-increased debt).
Also, the Federal Home Loan Bank system, a somewhat obscure quasi-government agency that was created during the Depression, has been lending billions (and has been cleared to lend a lot more) into the mortgage market. The FHLB, like Fannie and Freddie, isn't explicitly guaranteed by the government. But if said government won't even allow a private enterprise like Bear Stearns to fail, do you really think they will let a huge government-sponsored entity fail? The point being that the taxpayers are almost certainly on the hook for this money as well.
Finally, we have the "Foreclosure Prevention Act," or as I like to call it, the "Keep Homes Unaffordable Act," or possibly the "Give Taxpayer Money Directly to the Exact People That Caused The Problem Act." This legislation was already passed in the Senate. It includes, among others, the following fantastic ideas:
- Over $25 billion in tax breaks for home building companies.
- $4 billion for communities to buy up foreclosed homes.
- A $7,000 tax credit for anyone who buys a foreclosed home.
I hope it's clear that most of these bailouts benefit not struggling homeowners, but the housing and financial industry companies that were big and hugely profitable players in the boom.
In general, trying to keep far-underwater homeowners in their homes is often of little help to them. People who owe significantly more than their homes are worth would in many cases be better off walking away and freeing themselves from a potential lifetime of overindebtedness. Keeping them locked into their unreasonably huge mortgages benefits the lenders more than the homeowners.
But much of the Foreclosure Prevention Act is even more blatant in that it targets taxpayer money directly at the homebuilders and lenders. The first item noted above, the tax break for homebuilders, is pretty self-explanatory. And the second two, the subsidies for buying foreclosures, increase the demand for foreclosed homes and thus help the lending institutions that own those homes get a better price. As an added bonus, this artificial demand also keeps foreclosed homes from returning to price levels that people would be able to afford without government subsidies.
I try to stay off the soapbox but this is getting a bit out of hand. I am astonished at the level of complacency on display as responsible people's earnings and savings are plundered with the express purpose of keeping homes unaffordable and rewarding the institutions that both contributed to and profited enormously from the housing bubble.
If you think this is all as ridiculous as I do, write your Congresscritters and let them know you don't want any part of it. I promise it will be off the soapbox and back to the charts after this.
Rich Toscano hosts the Nerd's Eye View on voiceofsandiego.org. He is a financial advisor with Pacific Capital Associates*; he also writes about San Diego real estate at Piggington's Econo-Almanac. Contact him at rtoscano@pcasd.com.
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