US Government Bailout of the Financial Crisis of 08

I still don't have all the details of the current financial meltdown, or the US government bailout plan. I am not sure anyone does actually. From what i have gathered, there are two main components to this crisis. Firstly a lot of it has to do with bad debt. People were given loans at interests rate that was bound to go up to a point they cannot afford unless the value of their house continues to rise and rise. When the housing market bubble burst, many people were left with loans they cannot pay or can recuperate with sales of the house. Now had the loans been held with the local banks, perhaps arrangement could have been made for refinancing. But a lot of local banks that made the original home loan collected the loans and packaged them for resale (naturally before the housing bubble burst that made these loans worth less). Those that bought the home loan packages themselves repackaged them as investment portfolio for investors. The big investment firms then had a huge loss of value when they held so much of the home loans.

While it might be "a who cares" if large investment banks lost money, the lost money means the write offs are no longer available for other economic endeavors. And continued fear of further credit loss means even good available money are being held onto rather than lent out. Once bitten twice shy. Thus the second element of the meltdown is a loss of financial confidence and credit. Once this reaches a certain scale, continued economic function is threatened.

Why not a fan, partly because i do not know how dire things actually was, i do understand that there comes a certain time when the government does have to step in and halt the meltdown. Currently it appears that at the core of the bailout is the US government will buy these bad loans. The real question then is at what price the US will have to pay for the loan packages and what terms will the US government set in exchange for buying the loans.

What i would like to see is the US government buying these loans at basement-bottom prices. I want these financial companies to take a financial hit to some degree. I do not want the bailout to be bailing out Wall Street; I want the bail out Main Street. Not that I want to punish the financial houses of Wall Street, but investment carry intrinsic risks and they should understand that the role of the government is not to minimize their investment risks. By Main Street i mean the US government should trace back the loans to the original home buyer and refinance the terms of the loans so that those people who bought homes to live in should be able to keep their homes. Once these loans have been rewritten, i am fine with the government holding on to them for the full terms, or sell them to local banks. In this way the government does not own any financial commercial entities and may recuperate some of the cost when, or if, the housing market picks back up. Thus the US would be less likely to become a socialist state.

Regarding the terms of the US intervention, i do not want the US government to significantly increase oversight and regulation of the financial markets. The government may have the money to bailout Wall Street, but the US government does not have the smarts to do better than a de-regulated economy. Sure certain steps and procedures need to be enacted and placed so that this will not happen again. I am just not sure how that would work just yet.

As to limiting the pay of CEOs, on paper it may seem feasible to restrict CEO salary, either to the profit margin of the company or in proportion to its lowest paid employed, I don't think it will be too long before loopholes are discovered and make this attempt useless and potentially harmful. Think of it in terms of professional athletes, as long as the team can afford stars, they should be able to pay them as much as they are deemed valuable and profitable. What might work is to stipulate that all CEO faces "re-election" every so many years by stockholders.


More on the cause of the meltdown from Bloomberg

It is easy to identify the historical turning point that marked the beginning of the end.

Back in 2005, Fannie and Freddie were, after years of dominating Washington, on the ropes. They were enmeshed in accounting scandals that led to turnover at the top. At one telling moment in late 2004, captured in an article by my American Enterprise Institute colleague Peter Wallison, the Securities and Exchange Comiission's chief accountant told disgraced Fannie Mae chief Franklin Raines that Fannie's position on the relevant accounting issue was not even ``on the page'' of allowable interpretations.

Then legislative momentum emerged for an attempt to create a ``world-class regulator'' that would oversee the pair more like banks, imposing strict requirements on their ability to take excessive risks. Politicians who previously had associated themselves proudly with the two accounting miscreants were less eager to be associated with them. The time was ripe.

Greenspan's Warning

The clear gravity of the situation pushed the legislation forward. Some might say the current mess couldn't be foreseen, yet in 2005 Alan Greenspan told Congress how urgent it was for it to act in the clearest possible terms: If Fannie and Freddie ``continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road,'' he said. ``We are placing the total financial system of the future at a substantial risk.''

What happened next was extraordinary. For the first time in history, a serious Fannie and Freddie reform bill was passed by the Senate Banking Committee. The bill gave a regulator power to crack down, and would have required the companies to eliminate their investments in risky assets.

Different World

If that bill had become law, then the world today would be different. In 2005, 2006 and 2007, a blizzard of terrible mortgage paper fluttered out of the Fannie and Freddie clouds, burying many of our oldest and most venerable institutions. Without their checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed.

But the bill didn't become law, for a simple reason: Democrats opposed it on a party-line vote in the committee, signaling that this would be a partisan issue. Republicans, tied in knots by the tight Democratic opposition, couldn't even get the Senate to vote on the matter.

Here is the video: