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The $700-Billion Bailout – The Saving Grace or a Train Wreck?

bailout.jpgThe number one question posed to me by clients and the media alike in recent days was, “What do you think of the bailout?”

As best I can figure, the foundation of the most recent problem came in 1999 when the Clinton administration wanted to increase the percentage of Americans owning homes. The reason more Americans didn’t own homes was that they could not qualify for home loans. The government pushed lenders to lower credit standards and decrease down-payment requirements. The Federal Reserve lowered interest rates and kept them low. All this resulted in risky, sub-prime loans going on the books of lending institutions nationwide. Many of these loans were sold on the secondary market.

Two quasi-government companies, Fannie Mae and Freddie Mac, purchased many of these loans. These companies pooled the mortgages into a securitized product called mortgage-backed securities and sold them to investors like Lehman Brothers and other investment banks. This allowed billions of dollars to flow into the housing market.

This easy money and new demand for housing was like putting gasoline on a fire. It caused prices to soar to incredible heights because of the increased demand. Predictably, the party eventually ended. Even with easier credit, lower interest rates, and no down payments, many sub-prime borrowers could not afford their mortgages, defaulted on the payments, and forced lenders to foreclose. Housing prices collapsed and lenders suffered enormous losses.

Now government policymakers are finding out that increasing homeownership by lowering lending standards didn’t work so well. What a surprise! The heart of the argument is now who will pay the tab for this failed government policy: the borrowers, the lenders, or the taxpayers? Probably the answer is all three.puzzled.jpg

I find a number of factors surrounding the current situation very puzzling. Those supporting the bailout are, at least on the surface, a pretty astute and politically diverse group. This includes President George Bush, Presidential candidates Barrack Obama and John McCain, Secretary of the Treasury Hank Paulsen, the Chairman of the Federal Reserve, Ben Bernanke and the House and Senate leadership. The only folks in government that seem to be opposing the bailout are a handful of renegade Republican and Democratic representatives.

Conversely, the American people soundly oppose the bailout, and that opposition appears to be bipartisan. According to a September 28 Rasmussen poll, 50% of all Americans opposed the bailout, 25% supported it, and 25% had no opinion.

Much to the surprise of the leadership in Washington, the House defeated the initial bailout bill. The Dow promptly fell 777 points, the largest point drop in history but nowhere near the largest percentage drop in history.

Frankly, I am amazed the markets are doing as well as they are. Government leaders promised us the markets would collapse and the whole banking system seize up if the bailout didn’t pass. I guess we’ll get the chance to see how accurate their prognostication was.

skunk-saying-this-stinks.jpgOne of my peers in New York told me after reading the initial bill, “It stinks.” From the little information I was able to read about it, I tend to agree. My guess is that the bailout would probably cause more pain than it cured.

This belief isn’t based so much on the particulars of the current economic situation or the bailout bill, which I am convinced are really unknown to even the insiders. It is based on my core economic belief that the more governments meddle in free markets, the greater unintended consequences they create.

I have a hunch we will see some type of bailout bill passed before this is over. Stay tuned.

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