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As Treasury Sows, So Shall It Reap

posted by Elizabeth Warren

Once the Treasury bailed out Bear Stearns with government guarantees, the next buyer of a major US financial institution might expect similar help. Barclay's was the last likely buyer of Lehman Brothers.  Minutes ago, it announced that without the US taxpayers putting their money on the line, Barclay's isn't interested in buying

We can debate whether the government should have bailed out Bear Stearns, but surely the current mess tells us one thing we should not have done:  Bail out Bear Stearns and then return to business-as-usual.  So long as the only tool the government seems to have to halt this crisis is a bailout, then we are in trouble.  More bailouts will be needed, and, at some point, even the American taxpayer can't handle it. 

Bailouts will not put a stop to the underlying problem:  we can't find a bottom in the housing market.  Until that happens, the value of financial instruments based on those mortgage obligations will keep falling, and the worldwide market will keep sliding toward collapse.

Worse yet, so long as the government uses bailouts, the financial institutions have an incentive to sit on the sidelines in dealing with homeowners.  There's less reason for them to take their hits for bad mortgage investments if they believe that the government may bail them out. 

What will it take to put a bottom in the housing market? We have a lot of evidence now that the foreclosure approach isn't going to do it, and the voluntary rewrite-the-mortgage approach won't either.  Instead, we need a serious program to write down mortgages to an affordable level, and sort out which families can afford to stay in the homes and which families need to move out.  Whether we do that with a change in the bankruptcy laws or through another program, that is the only way we will find the bottom on the market and get this crisis behind us.

Bailouts--without serious changes designed to deal with the problem that are causing the collapse--won't work. I hope the Treasury and the Federal Reserve won't give in. If they do, they will reap the bitter harvest of an ever-worsening financial crisis.

It is time to plant different seeds.   


The situation includes, but is broader than housing alone. And, so, a suggested rewrite your comment:

"Bailouts will not put a stop to the underlying problem: We can't find a bottom in the securitization market."

"Free markets" -- as in markets entirely and totally 'free' of regulation -- produced rampant securitization that included, but went well beyond, housing (credit cards, auto finance e.g.). And, also well beyond primary lending against assets to cancerous derivatives (e.g. CDOs). All of which has produced huge amounts of insolvency, opaqueness instead of transparency, and, of course, a toothless government lacking skills and authority to overcome either insolvency or transparency.

So far, Bernanke and Paulson have chosen to respond to the shell game with a shell game of their own: a game that defers/postpones any bottom in the securitization market.

Certainly not good news to wake up to and maybe the movie line "Greed is good" may mean as long as the American taxpayer keeps paying for the seed time and harvest. However both will keep growing but the produce will not be worthy of eating.

Well, there was good talk about re-drafting the bankruptcy laws to deal with the mortgage crisis, but it failed at the time due to strong opposition from mortgage lenders who feared the long term consequences for themselves. Unfortunately, they might have been better off agreeing to a bankruptcy law change to permit modification of home mortgages, as a way of stabilizing their losses. Too bad that moment was lost.

I agree imclark.

They got a bailout instead. Maybe thats what they wanted.. ?? ..
Still not too late for us regular folk though.

Today Barclays came back and bid for some of the Lehman assets, now that Lehman has filed Chapter 11. You're going to see a lot of that in the next few months. There is no incentive to pay the shareholders of these firms a thing when you can wait for Chapter 11 and then buy the assets at a lower price. (I don't feel sorry for the shareholders at all.)

And interestingly enough, that tactic well only further depress asset values, leading to a further downward spiral in the availability of credit -- at least until the vultures eventually establish the "floor."

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