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Posts Tagged ‘Moral Hazard’

Federal Reserve’s Secret Loans

Posted by Steve Markowitz on August 25, 2011

In October 2008 the United States and much of the world was in the midst of a financial crisis caused by the downturn in the US housing market and the related subprime mortgage mess.  This led to the Lehman Brothers bankruptcy that set off worldwide panic and the possibility of a meltdown of other financial institutions.

In an effort to contain the crisis, the Bush Administration came up with TARP (Troubled Asset Relief Program that would allow the US government to purchase up to $700 billion worth of troubled assets.  There was a great deal of debate concerning this proposal that amounted to a huge bailout of private financial institutions with taxpayer funds.

TARP was approved by Congress and implemented, but the jury is still out as to its long-term effects.  While the program helped stabilize financial institutions in the short-run, it has caused other imbalances in the economy and negatively impacted the moral hazard.  The bailed out banks got into trouble because they made imprudent loans.  Te government’s main excuse for the bailouts was that they were too big to fail.  However, soon after the bailouts banks were back to similar poor business practices that included huge bonuses for their executives.

While the argument can be made that TARP stopped a financial panic, there can be no justification as to why these banks’ shareholders and bondholders were not heavily penalized for investing in poorly managed companies.

As troubling as the TARP bailouts were, at least that program was vetted by Congress and in a somewhat transparent manner.  It has been disclosed that an even larger bailout occurred through the Federal Reserve in secret and without oversight or Congressional approval.  The scope of this program recently became public, the result of a Freedom of Information Act lawsuit filed by Bloomberg that went all the way to the US Supreme Court.  After reviewing over 29,000 Fed supplied documents, Bloomberg concluded the following:

  • The Fed bailouts that occurred between August 2007 and April 2010 involved $1.2 trillion in loans to 400 financial institutions and companies.
  • About one half of the banks that received these Fed loans were not U.S. based.
  • In the fall of 2008, US investment bank Morgan Stanley was near insolvency and barrowed $107 billion from the Fed, nearly three times its total profits during the previous ten years.
  • In 2007, Goldman Sachs was the most profitable firm in Wall Street history.  Yet in 2008 it barrowed $69 billion from the Fed.
  • Other companies that were not primarily financial based also barrowed money from the Fed.  This included Ford taking about $7 billion and Toyota getting $4.6 billion.  Even General Electric, who was highly profitable in 2010 but paid no U.S. income tax, received about $16 billion from the Fed.

The size of the Fed’s program is staggering.  The secret loans were 20 times larger than any previous Fed’s lending program, which occurred shortly after 9/11.  However, the most troubling part of the program is the fact that it was hidden from the American public.  In justifying its secrecy the Fed claimed that making the loans public would have caused investors to lose confidence in the receiving banks.  Since the release of this information and the lack of panic, this claim has been proven bogus.  But even more important, so what if there was panic?  The public has the right to know what the Fed does with its money.  The public also has the right to know the true financial conditions of companies that it might bank with or invest in.

Bailouts by the government and Fed were used for the advantage of some companies and citizens over others.  This has no place in capitalism or a free society, nor is allowed under the US Constitution.  The government and Fed have spent significant taxpayer funds without transparency or the required Congressional approvals, willful circumvention of the law and Constitution.

Many, especially on the Left, ignore the dangerous slippery slope that the Country is traveling.  Their fears are mistakenly focused on those attempting to stop the wild and special-interest spending in Washington.  That has allowed the Federal Reserve to debase the U.S. currency, a surreptitious way of increasing the taxes on all Americans.


Posted in Bailouts, Federal Reserve | Tagged: , , , , , , , , , , , , , , , , , | 1 Comment »

It’s Back: Risky Loans Again Growing

Posted by Steve Markowitz on July 18, 2010

It hasn’t been two years since the financial meltdown that included the Lehman Brothers’ failure and risky loans are already coming back.

It is generally agreed that the worse financial disaster since the Great Depression was caused by greed and imprudent investments, especially those related to debt financing.  Perhaps the biggest example is Wall Street’s use of collateralization to sliced and dice bad mortgages and then selling them to investors as quality investments.  This led to an overheating of the housing market, then the popping of the housing bubble, and finally the sup-prime mortgage catastrophe.  The rest is history.  The world’s financial system was in danger of a systemic breakdown, which caused governments to bail out banks and other intuitions.

While we will never know if the bailouts actually saved us from Armageddon, we do know that they saved many banks and investors from imprudent behavior.  This reality has consequences, such as damaging the “moral hazard”.  Banks and investors learned that if they bet big enough so as their failure has huge consequences to society, governments will come to their rescue.

Not surprisingly, banks are now going back to similar risky behavior that caused the original meltdown.  The Wall Street Journal has reported the following examples:

  • A 66-year-old retired phone-company worker in Brooklyn, NY is $33,000 in debt, earns $2,414 a month and filed for bankruptcy in June.  Shortly before the filing, she received an offer from Capital One for a credit card even though they sued her in 2006 to recover $4,470 she owed them on a different card.  The Capital One offer told the retiree: “At some point we lost you as a customer and we’d like to have you back.”
  • An Illinois couple received six credit card offers since emerging from bankruptcy in June even though they still $73,000 in student loans.
  • Credit-card issuers offered 84.8 million cards to subprime borrowers in the first half of 2010, almost double last year’s rate.
  • 8% of new car loans in the latest quarter were to borrowers with the lowest credit scores, up from 6.2% in the previous year.
  • AmeriCredit, a Subprime auto lender, informed investors that loan originations could be $900 million in the fourth quarter, over four-times the previous year’s volume.
  • Fannie Mae, perhaps the largest villain in the subprime mortgage meltdown, is also back at it.  Fannie was seized by the U.S. government in 2008 to avert failure.  Fannie launched an initiative in January that allows some first-time home buyers to get a mortgage with as little as $1,000 down.

While it is too early to determine if increased loan activities to those with questionable credit worthiness will lead to another meltdown, it doesn’t feel right.  The government intervened in markets and saved investors who made poor decisions from paying the bill.  Now those same people are back with similar behavior.  It doesn’t take a PhD in economics to know this is not good.

An appropriate closing paragraph to this posting is Fannie Mae’s response to questions about their $1,000 down mortgage offering.  There justification for these mortgages is that Fannie faces limited risk because these mortgages then go through state agencies that have solid histories.  This justification sounds suspiciously similar to the pitch that Wall Street gave for the collateralized mortgages that were then highly rated by bond rating agencies.

Posted in Bailouts, Fannie Mae, Moral Hazard | Tagged: , , , , , , , , , , , , , | Leave a Comment »

Bailouts for Mortgagees: Here We Go Again

Posted by Steve Markowitz on March 25, 2010

When the President signed the healthcare reform bill this week he instituted historic changes to America’s healthcare system, about one sixth of the Country’s economy.  Anyone who thought that Obama and his Progressive friends in Congress were finished were dead-wrong.  Even before the ink was dry on the bill they are on to the next major realignment of capitalism.

The New York Times just reported that the Obama Administration will introduce a major initiative offering substantial assistance to those behind on their mortgages or even if they are merely underwater, owing more on the mortgages than the current value of the homes.  According to the Times, the program will include:

1. The government encouraging lenders to write down the loans.

2. The government repackaging millions of loans for borrowers whose home values have gone below the amounts owed on the mortgages.

3. Holders of the affected mortgages will be asked to take losses, but less than if foreclosures were forced to occur on the homes.  The newly repackaged loans will then be insured by the Federal Housing Administration; i.e. taxpayer guaranteed.

4. Lenders will be cajoled into reducing payments for unemployed workers for some period of time.

The Obama Administration’s wading into the mortage market with what is another bailout is a further march down a path that is destroying capitalism.  First, we bailed out the banks that created this mess in the first place.  Then we rewarded auto companies who produced cars that consumers did not want with a bailout.  And now we will bail out people who barrowed too much for houses they could not afford; yes others who helped create the housing bubble.

The bailouts are all justified by Progressives as saving us from far worse disasters.  This argument has proven fallacious by the fact that each bailout is succeeded by yet another one.  We are traveling down a slippery slope of never ending bailouts.  But, they will be forced to end at some time, unless you believe in perpetual motion.

When the government gives a bailout it can be funded in two ways.  Taxes can be used in which case the government charges the people who do not receive bailouts.  In other words the government taxes those who used prudent behavior to pay for those that were imprudent.  The alternative is to barrow funds and charge the next generation for this generation’s foolish behavior.  Neither choice can be morally or economically justified.

Capitalism, while imperfect, is the most efficient system for regulating a complex and dynamic economy.  It accomplishes efficiency by rewarding individuals who produce things of value; i.e. goods and services, better than others.  However, it is equally important that capitalism punish those that make poor decisions that are not productive, often referred to as the moral hazard.  Bailouts remove or lessen the punishment for bad decisions, leading not only to inefficiencies in the economy, but more significantly to more imprudent behavior by capitalist as the fear of the consequences of failure fades.  Without punishment, capitalism will not work, period.

President Obama is fully aware of the negative consequences of bailouts.  His continuance down the bailout trail can only be because of: 1) a lack of political courage to correct our economic problems that will require pain, or 2) because this trail leads to socialism, the Holy Grail for the Progressive movement.

Let us recall the words of Peggy Joseph shortly after Barrack Obama was elected (video below).  This was the young lady that with tears in her eyes said “I won’t have to worry about paying my mortgage” referring to the result of Obama’s election.  It seems Ms. Joseph understood the President-elect better than many who voted for him.

Posted in Bailouts, Business, Capitalism, Mortgages, Progressives | Tagged: , , , , , , , , , , , , | Leave a Comment »