Thoughts on the Bailout

On the Bailout

How did we get into this mess? Well, it started when Adam and Eve decided to go against God… Okay this may be taking things a bit too far back, but it really is about choosing selfishness over prudence; of choosing to create a new reality apart from the Truth. This fallen world tries to accommodate us in our prelest (as St. Paul writes, it “groans in sin”), but consequences of poor choices can only be put off for so long.

We got into this mess first, because we made borrowing too easy. It, rather than saving, became the foundation of our economy. This manifested itself in many ways, but it prepared the way for all kinds of nastiness while decreasing our ability to deal “ride out” difficult times (to jump ahead, if you rely on credit as an “emergency fund”, and the “emergency” is that credit has dried up, then you have a problem).

Reliance on credit combined with lender-greed (i.e. seeking out new markets to tap) and a sense that everyone should be able to buy a house to create an entire market in “sub-prime” loans. More risk-averse lenders saw their competitors making money (in commissions and the hope of fulfilled/paid-back loans) and joined in the fun. For a while it was a win-win situation; everyone got a bigger home than they could otherwise afford; housing values soared; and lenders cashed in big time. This would have corrected itself somewhat as folks defaulted and banks regained their natural conservatism had it not been for what came next: geniuses packaged sub-prime loans and traded them. Then more geniuses bought them and based a huge proportion of their company holdings on them and the high returns they promised. Now they are worth NOTHING on the market, companies can’t get rid of them, and credit has “frozen”. As our economy is now based on credit, we have a problem.

But it is important to remember that the loans themselves are not worthless: they are based on property. And while they are “risky” in the sense that the people who have them may have to default on their loans (because they bought more house than they could afford), the loans themselves are still “guaranteed” by real property. Even though this property has probably depreciated (because there is less demand for housing now than before… the “bubble” has “burst”), even a foreclosure would bring some return. The problem is that the companies holding the bundled loans have to account for them based on the bundle’s market value, which is next to nothing. This makes it impossible for companies to borrow money (because their assets are worthless and they have to have a certain proportion of real assets to borrow money).

The Solution?

If I understand it correctly, the proposed “$700 billion bailout” would create a government bureaucracy (under Paulson) that would buy the loan bundles. Because the loans themselves are actually worth money, the actual cost would be much less. It would also free companies up to borrow and lend money, thus alleviating the immediate consequences of our stupidity. While I think this will work, I DON”T LIKE IT.

I don’t like it because I do not trust the government to handle this well. First, bureaucracies are inefficient. Companies that are inefficient lose profits to more efficient competitors. Inefficient bureaucracies just grow. Second, it does not have the right incentive structure and could be diverted to serve other purposes (like wealth redistribution, continuing the tradition of getting people into houses they cannot afford, etc.). This is fine if you think socialism (i.e. gov’t control of the “commanding heights” of the economy) over capitalism (a well-regulated free market); but I don’t.

I like the solution my personal financial advisor, Dave Ramsey, endorsed (along with real economists etc.): let the government “guarantee” some of the risky loans while temporarily relaxing the accounting rules that force companies to mark their bundled loans based on market (rather than real or expected) value. This will free up credit, thus alleviating the immediate consequences of our stupidity. I don’t like this either (guaranteeing bad loans can, without proper regulation, distort the market and allow more such loans to be made – yuck!), but at least it minimizes the government footprint.

Back to the Fall

I wrote above that even in this fallen world of our own design, we can only avoid the consequences of bad decisions for so long. The sub-prime loan crisis is an example of this (Judgement Day is the ultimate example). Houses cost money to build. In a capitalist economy, supply and demand determine the costs (supply factors in the cost of land, supplies, labor, etc.). If you can afford the cost, then you can buy it. If not, you don’t (and hope that the market provides alternatives, which it does). The best way to provide affordable housing would be to figure out a way to make them cheaper (e.g. modular homes, cheap labor, doublewides, making more land livable). We tried a shortcut: we basically pretended that everyone had more money than they really did. Ironically, this increased demand which made the houses cost even more! But our charade is over. We have been forced to admit (I hope) that you can only buy what you can afford to pay for.

There are other ways to provide affordable housing. We do this a little with our “housing projects”, but it was almost the only way to get a place to live in the Soviet Union. The idea was that everyone has a right to a nice place to live. So the government builds a lot of places and doles them out to all the people. Sounds great, right? But you can’t pretend that law of supply and demand (or the equally irresistible “Law of Unintended Consequences”, “Murphy’s Law” and “Law of Governmental Inefficiency and Incompetence”) are not real. But rather than solving the problem, it created new ones: waiting lists, poor quality construction, bloated bureaucracies, and corruption. Like I said, we have a small glimpse of this in our projects, but I fear we may head there on a much greater scale if 1) we do the bailout and 2) we continue to vote for irresponsible politicians who like government solutions.

It’s wonderful that (almost) everyone can vote. It’s wonderful that (almost) everyone can run for office. But can’t we require them all to take Economics 101? Or at least listen to Dave Ramsey?

PS Special shout out to my (only) reader, Mark. Thanks for letting me know there is someone looking at this stuff!

PPS Sorry about the long delay between posts. I got swamped with a lot of things at once. I am almost caught up and back to the normal frenetic (but generally maintainable) pace.