Is Congress crazy?

[cos]

Problem: A lot of banks, insurance companies, and other financial institutions are in trouble, and if a bunch of them fail the economy will suffer severely. They're in trouble through a chain of stuff that starts with a lot more mortgages failing than were expected, and a bad housing market. When someone can't make their mortgage payments they may be forced to sell the house, but in a bad housing market, their house may not be worth enough anymore to pay off the mortgage by selling it, so they can't do that. Glossing over a lot of the stuff in between, and ignoring for a moment the legal changes that let this happen, that's basically where the problem begins at the moment, yes?

Now, assuming that we decide that we can't afford to let all these financial institutions fail, and assuming we decide it's worth spending several hundred billion dollars on it right now - rather than argue the merit of those two points, let's take them as a given - assuming all of that... why would Congress even consider using that money to bail out the financial institutions directly?????

We could take the same money and spend it on bailing out homeowners who can't make their mortgage payments.

We could get more bang for the buck at first pass because we wouldn't have to buy all of the "bad" debt, only enough to make it possible for each homeowner to keep on paying, perhaps with lower payments over a longer period of time. Banks would be stronger simply because all this debt would no longer be poised to fail, and confidence in the banks would recover as soon as the plan was passed, even before actual homeownwers were bailed out, because people would know that a lot of these loans would no longer fail completely, because they'd qualify for the bailout plan. Not only would we save banks, but we'd save jobs, neighborhoods, and families. By preventing mass dislocation of people we'd be saving lots of other pieces of the economy at no extra cost.

I've heard some arguments against the "moral hazard" of bailing out people who took risks that didn't work out... every single one of those arguments applies to a much greater extent to bailing out financial institutions who took vast amounts of irresponsible risk, who risked not just themselves but everyone around them, who were paid to understand finance and to know better than to do this, who lobbied for laws to make it easier for them to do this...

In what bizarre reality does it make any sense to even consider bailing out the financial institutions instead of the homeowners in trouble?

I'm going to call my members of the House and Senate and I hope you call yours.

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Comments

[mrf-arch.livejournal.com]

In your example, the owner of the formerly $800k place has more of a "point" to staying in that place than anyone else does, so the amount of money you'd have to apply to let them stay is less than the loss that happens if you don't, and someone else buys the place. If that place is worth $500k on the market now, the homeowner already has that extra $300k of debt burden.

Sure, but if the Owner can walk away from the debt burden, then he doesn't have it any more. If I pay $800 for a suit, and I see the suit next week marked down to $500, nothing changes - I'm already out the $800. If I promise to pay $800,000 for a house, but then find out I can have the same house for $500,000, that's $300,000 worth of incentive for me to wiggle out of my current promises.

You don't make it go away by declining to help them keep the house: one way or another, that money is gone. However, if the house is worth $500k on the market, it's likely worth more to the owner, let's pretend $600k. So if they can't afford it and someone else has to buy it, it gets sold for $500k and $100k worth of value goes *poof* - nobody gets it.

While cognitive neuroscience has some fascinating things to say about the ownership effect, I think assuming it has a 20% price value for everyone is a poor basis of policy. Likewise, If we take the case of the $800,000 mortgage, I fail to even understand what you're trying to get at. Is your argument that if I write down $200,000 of that fellow's debt, that he'll stay? In that case, I haven't saved $100,000, I've lost $200,000 - unless you're presupposing I take that money away from you and me and give it to this fellow's banker? And the last $100,000 is a non-number anyway. If the fellow can sell the house for $500,000, that's its market value, regardless of how sentimental he is about the place.


If "liquidity" were the only issue, banks could just sell the securities they have no for whatever people are willing to pay for them - there are people willing to buy them cheaply.

Oh? Whom, and how cheaply, and how much?

A plan that would obviously prevent a lot of foreclosures would give all of those securities a lot more value, which is the real problem.

That's not the problem. The problem is that most of the key players are so heavily leveraged (or were, until the fed took over the last two survivors) that there's no way to unwind their positions in those securities without bringing in a new counterparty. If it was just a matter of taking a paper loss, it'd just be a balance sheet write-off, and everybody goes about business as usual, no different from when the stock market tanks. THe difference being that stock market price discovery is almost instant, and the price discovery mechanism for these securities is being written even still.

Applying the same money directly at the financial institutions can possibly solve that same problem (though I'm skeptical), but it does so without the benefits of applying the money to the root of the problem.

Just to be clear, (because I realize there are some different implications in your previous comment) how do you propose to do that? Write down the value of existing mortgages to market? Pay them off with Federal dollars? Something else?