Economist Miron: Bail on the Bailout
Nick Gillespie | September 30, 2008, 2:39pm
Via Drudge comes this CNN.com column by economist Jeffrey Miron. After detailing the government's role in fueling the subprime mortgage crisis, which is at the heart of the current "crisis," he concludes:
So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.
The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.
Miron notes that, among other things, Wall Street is now engaging in "strategic behavior" in anticipation of a bailout. He argues that the current credit freeze, such as it is, is largely a function of firms waiting to see what's coming out of Washington. The whole piece is well worth reading.
Miron participated in our recent forum, "The Great Bailout Brouhaha." His contribution:
Jeffrey A. Miron
1. How bad is the current market situation?
The current situation is serious, but not so much because the economic conditions are especially bad. The situation is serious because policymakers seem poised to undertake an enormous intervention that will have huge adverse effects and may well exacerbate the very kind of problem the intervention is meant to fix.
2. How bad are the current proposed bailout plans?
See #1. The bailout is a terrible idea. It transfers a huge amount of wealth to people who do not deserve it. It will generate enormous incentives for creative bookkeeping as the investment houses and banks try to rid themselves of any assets they do not want. The bailout fails to eliminate the crucial policies that contributed to and caused the current situation, such as the Community Reinvestment Act, the creation of Fannie Mae and Freddie Mac, and so on. Last but hardly least, the bailout sets a terrible precedent: If you take huge risks and become too big to fail, the government will bail you out.
3. What's the one thing we should be doing that we're not?
The only things we should be doing are eliminating the underlying policy causes of the current situation; see #2.
Jeffrey A. Miron is senior lecturer and director of undergraduate studies in the Department of Economics at Harvard University.
More here.
Amakudari | September 30, 2008, 4:42pm | #
You know, that whole "of a positive correlation between CRA loans and the defaults that fed the current mess" thing. That's the part I missed.
There's a reason no one's done that perfectly: it's
impossible. Simply because a loan is considered CRA does not make it
caused by the CRA. It's only the marginal loans, those that would not exist otherwise, that should count. Moreover, the best scenario for banks was getting CRA credit by issuing subprime loans to applicants who were eligible for prime, so there are CRA loans that should be
excluded.
As someone who works in a bank and deals with our mortgage operations frequently, I can tell you that on a practical level the CRA was a big deal. We would negotiate with community groups (we even gave some 6- and 7-digit sums indirectly) for lower lending standards and a new branch to get into the more profitable prime mortgage areas. At that point, it was a tax. When the US allowed the securitization of CRA loans, bad lending practices and lax oversight were pretty much encouraged by the government.
Bad banks that played along should fail, and good banks shouldn't be subject to grand social engineering plans. Lending based exclusively on risk = good. If otherwise deserving neighborhoods actually get "redlined" I hereby commit myself to stepping in and making mad profit.
The banks that maintained the old business model of taking deposits and lending the money to their customers are doing just fine.
Wachovia bought Golden West, a portfolio lender. Their ARMs kept Golden West's proprietary loan indices and therefore
couldn't be bundled. In a flat or positive home price appreciation scenario, Golden West actually matched assets and liabilities and got rid of a lot of interest rate risk through normal operations (whereas most banks are liability-sensitive, or less profitable when interest rates rise). Yet, Wachovia fell victim. I'd say it's the supermarket model that's been the most successful, unfortunately.
But the lender doesn't necessarily lose much, they get the mortgage that was paid, plus the house back in the foreclosure. I have no problem with that.
Lenders typically have loss severity of 20-40% (loss net of fees divided by unpaid principal as of foreclosure). The number gets big quickly.
It reduces the amount of the loss to the bank by the amount of the check.
Potential loss. By the way, the absolute best way to stem foreclosures (that is, Keep People in Their Homes) is to take the worst subset of borrowers and pay off a huge portion of their loans. Paying off half the principal on subprime ARMs would cost $420 billion ($12 trillion in outstanding mortgages, 7% is subprime ARMs, 50%). Since we get absolutely none of that back, it may actually be an 11 on your scale.
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