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The End of American Hegemony
By Paul Craig Roberts (about the author) Page 3 of 3 page(s)
This is not a picture of an economy that a bailout of financial institution balance sheets will revive. As the Paulson bailout does not address the mortgage problem per se, defaults and foreclosures are likely to rise, thus undermining the Treasury's estimate that 90% of the mortgages backing the troubled instruments are good.
Moreover, one consequence of the ongoing financial crisis is financial concentration. It is not inconceivable that the US will end up with four giant banks: J.P. Morgan Chase, Citicorp, Bank of America, and Wachovia Wells Fargo. If defaulting credit card debt then assaults these banks' balance sheets, who is there to take them over? Would the Treasury be able to borrow the money for another Paulson bailout?
During the Great Depression of the 1930s, the Home Owners' Loan Corporation refinanced one million home mortgages in order to prevent foreclosures. The refinancing apparently succeeded, and HOLC returned a profit. The problem then, as now, was not "deadbeats" who wouldn't pay their mortgages, and the HOLC refinancing did not discourage others from paying their mortgages. Market purists who claim the only solution is for housing prices to fall to prior levels overlook that rising inventories can push prices below prior levels, thus causing more distress. They also overlook the role of interest rates. If a worsening credit crisis dries up mortgage lending and pushes mortgage interest rates higher, the rise in interest rates could offset the fall in home prices, and mortgages would remain unaffordable even in a falling housing market.
Some commentators are blaming the current mortgage problem on the pressure that the US government put on banks to lend to unqualified borrowers. The proliferation of privilege that bureaucrats pulled out of the Civil Rights Act led in 1993 to Shawmut National Corporation's acquisition plans being blocked by federal regulators until its subsidiary entered into a consent agreement with the US Department of Justice to racially norm its mortgage lending. This agreement was quickly incorporated into the growing body of regulations. Next, Chevy Chase Federal Savings Bank was forced by the DOJ to open new branches in "majority African-American census tracts." Chevy Chase had to provide below-market loans to preferred minorities at interest rates "at either one percent less than the prevailing rate or one-half percent below the market rate combined with a grant to be applied to the down payment requirement." In 1995 the DOJ forced American Family Mutual Insurance Company to sell property insurance to preferred minorities on uneconomic terms. [See Roberts and Stratton, The New Color Line]
Thus, it is true that it was the federal government that forced financial institutions to abandon prudent behavior. However, these breaches of prudence only affected the earnings of individual institutions. They did not threaten the financial system. The current crisis required more than bad loans. It required securitization and its leverage. It required Fed chairman Alan Greenspan's inappropriate low interest rates, which created a real estate boom. Rapidly rising real estate prices quickly created home equity to justify 100 percent mortgages. Wall Street analysts pushed financial companies to improve their bottom lines, which they did by extreme leveraging. The full story goes far beyond the propaganda videos put out by Republicans blaming Democrats.
An alternative to refinancing troubled mortgages would be to attempt to separate the bad mortgages from the good ones and revalue the mortgage-backed securities accordingly. If there are no further defaults, this approach would not require massive write-offs that threaten the solvency of financial institutions. However, if defaults continue, write-downs would be an ongoing enterprise.
Clearly, all Secretary Paulson thought about was getting troubled assets off the books of financial institutions.
The same reckless leadership that gave us expensive wars based on false premises has now concocted an expensive bailout that does not address the problem, which will fester and become worse.
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