Friday, September 19, 2008

Massive federal bailout of bad loans proposed: what woud be the downstream consequences for individuals?

The media has multiple reports this morning of a massive bailout by Congress, involving the government’s somehow taking over “toxic loans”. It was unclear if this involved setting up something like a Resolution Trust Corporation of the 1990s, and the government’s buying bad loans. This sounds like Jim Cramer’s (“Mad Money”) proposal that the government pick up failed loans at 30 cents on the dollar.

The latest fear, as noted yesterday, was a “run” on uninsured money market funds, and the unwillingness of financial institutions to lend to one another and to consumers.

It sounds as though government worldwide may do the same.

Short selling is likely to be reformed and much of it slowed or curtailed considerably. (One would wonder about the tricky technique of “shorting against the box,” which is short selling stocks that one already owns).

Some stories suggested that the government would need to act quickly, within a week.

This sounds like “getting something for nothing” and it probably will not turn out that way. Individual borrowers may have to meet higher credit score minimums and down payment requirements could increase. On NBC, one financial advisor said that one needs a credit score of 740 today to have the equivalent of 700 last week. There could be a other changes in what is expected of individuals in a lot of circumstances.


PM said...

This is a time for cool reasoning and the long term view from our elected officials and regulators, not emotional response and panic.

We must create liquidity while respecting moral hazard.

The only way a bailout as imagined here can work -- and not cause far greater harm and a repeat of this same scenario in the long term -- is to structure something that respects moral hazard.

Bad loans the government takes over should be tracked and any losses incurred should be transferred back to the institutions responsible for them in the form of taxes on future profits and/or penalties.

Otherwise we are rewarding and encouraging the behavior that led up to this. Our nation deserves better than Ponzi Scheme Economics. Real changes are required to our economic system to get on track for sustainable and robust long-term economic growth -- this crisis is a rare opportunity and catalyst -- we must not sacrifice it in the name of panic and short term relief.

Bill Boushka said...

I like the idea of holding institutions responsible retrospectively. What happens when we apply the same kind of "moral hazard" thinking to individuals and families?

media kingdom said...

from a historical point of view, it's hard to object to the government's mass bailouts since similar debt-producing methods were used to bring the U.S. out of the Depression... our economy has been supported and driven by debt ever since