For or Against?

The bailout that is. I will grudgingly accept, for the sake of argument, the claims that Ben Bernanke and Henry Paulson looked into the abyss last week and decided it had to be done. Still, it is on balance a bad idea. (But the realist in me thinks that Sec. Paulson is thinking about this first from the point of view of Goldman Sachs and the investment-banking industry, and only secondarily as the secretary of the Treasury of the whole country.)

The most important requirement right now is to set the rules of the game once and for all. The primary reason the Great Depression was as bad as it was not that there had been a financial collapse in 1929 - those were commonplace, and a year or two later normality was always restored. The problem was the new cure for the disease - the panicked handing over of immense power to FDR, who used it arbitrarily and socialistically (in the sense of giving the state the power to set prices, change the rules of the game faced by property owners, etc.) Depending on what he had for breakfast, a bank might or might not get taken over, an industry's freedom might or might not come under the control of the NRA, a new federal agency might or might not be established.

Even if the proposed taking over and selling off of all the bad debt were overseen by a wise philosopher-king with dictatorial powers, I might be against it because of the moral-hazard problems. But we have to think about the world we live in, and the people overseeing this massive new government intrusion into the financial system will not be Platonic public servants but Barney "We are not facing any kind of crisis" Frank, George W. "I hate high taxes but I love to expand federal spending" Bush, Christopher Dodd, etc.

Already the government's behavior has been completely ad hoc - Bear Stearns and AIG get saved, Lehman doesn't. The bailout will open the door to more arbitrary changing of the rules, crippling the ability of entrepreneurs and financiers to know what the rules are. Accounting rules may be X one day, -X the next; lenders may be required to favor American borrowers one day, subsidized to invest in Israel or Southern Africa the next. And most if not all of those changes will be in the direction of greater government control of free individuals in the market - controls on executive pay, the political hammer brought to bear to force lending to favored groups (the thing, remember, that helped get us into this mess), and other things political entrepreneurs will come up with that don't even occur to me now. Painful though the current situation is, the only sensible choice if we are to hold the line against further collectivization of our economy - and hence of our freedom itself - is to endure the pain, and to tell economic actors unequivocally that there will be no bailout, so that they can get on with the dirty work of taking out the trash.

The Fruit of a Poisonous Seed

I had not heard of Peter Wallison, but he sure looks smart now. From The New York Times, Sept. 30, 1999:

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

...
In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison, a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

When politics subsidizes something, we get too much of it. Every time.