No Kid-Gloved Bailouts

Stop the stampede.  Conservatives objecting to the president’s kid-gloves bailout of the financial companies that have brought our credit market to the brink are the last defense of free-market capitalism.

But as they must limit what the president’s staff calls an “extremely interventionist” proposal, the congressional conservatives should act as a filter, not an impenetrable barrier.

President Bush has asked for urgent action on his proposal that would, for two years, enable the Secretary of the Treasury to contract for, purchase and resell up to $700 billion of “…mortgage-related assets from any financial institution having its headquarters in the United States.”

Last night, the president said that this financial crisis has frozen the credit markets and threatens our economy with a long and painful recession.  He said that our entire economy was in danger, that more banks would fail unless Congress acts now.  

The president also said that he expects much if not all of the money to be paid back to the treasury.

But in congressional testimony earlier yesterday, Federal Reserve Chairman Ben Bernanke said, “We don’t really know what the long-term cost or benefit may be.”  

There are many problems with the president’s proposal, but the one substantive problem Bernanke admitted overshadows all political issues. If we don’t know if it will work, shouldn’t less drastic measures be taken? Conservatives need to limit the government’s action and give the markets a chance to heal themselves.  

Today a deal may be made on the president’s bill.  In meetings this morning — to be attended by both presidential candidates — the economic freedom of our nation may well be decided.

As I wrote on Monday, there are enormous dangers in the president’s proposal to bail out the financial industry.  First among them is the one I stated three days ago: that the government will interfere too much in our market economy, the “solutions” to short-term problems creating larger long-term problems that will institutionalize instability in our financial system.  

In the congressional negotiations, conservatives should demand minimization.  It’s quite likely that if $700 billion would bail out all the bad investments, half of that could do the same while still imposing the some economic penalty on the investors who brought this about.

One appropriate step might be to cut the president’s proposal in half: instead of $700 billion over two years, why not half of that over twice as much time?  If stability can be bought, why not at $350 billion — or less — over three or four years?  If that isn’t enough, Congress can do more later, even if they have to suffer the loss of a couple of vacation weeks to do it.  

The urgency of a bailout seems to be fading because the market is beginning to react as it should.  Warren E. Buffett, one of the nation’s most prominent investors, announced he would invest $5 billion in Goldman Sachs, one of the largest investment houses threatened by the crisis.  Buffett has taken part of the heat off the crisis and by doing so will encourage other investors to take aggressive action to restore the credit markets’ function.

Buffett must be confident of some recovery.  If he is, why aren’t the president and Congress?

The panic President Bush described is real.  According to Chuck Blahous, Deputy Director of the National Economic Council, there was a domino effect in our economy.  Banks began to refuse to lend to each other. The London Interbank Offered Rate — LIBOR — spiked to World War 2 levels as banks refused to invest in each other, freezing the credit market.  The interest rate on Treasury bills — supposedly the safest investment in the world — went to zero and then below: by buying negative-interest T-bills, investors were exhibiting a level of desperation we’ve not seen in our lifetimes. Companies became unable to obtain normal credit.

The gobbling up of credit by the sub-prime mortgage market (and the securities based on the mortgages) turned every aspect of lending into a huge risk when the securities became less valuable than the mortgages they represented.  

These mortgages and securities violated the prime directive of the free market: they were “moral hazard” risks. Those are risks that are knowingly taken despite the fact that they are obviously unreasonable banking — in this case literally — on the idea that if the decision proves wrong someone else will, ultimately, have to suffer the loss.  It’s a bet on a bailout, and this is just what President Bush’s team is proposing.

The administration says it’s goal is to stabilize the financial market and protect the taxpayer.  The first half is true, but — as Bernancke said — no one really knows if it the proposal will work. The second is obviously false.

Taxpayers are being asked to don kid gloves to bail out the moral hazard market.   Treasury Secretary Paulson said in a Tuesday Senate Hearing, he wants to make the bailout attractive enough for the banks to willingly participate.  He said, “If they have problems, they are our problems.”  Why coddle these people?

Why should the banks and investment houses — and the people who run them — be protected from the market results of their own malfeasance?  

The kid-gloves bailout will make it possible for others to profit like the 10,000 members of the New York staff of Lehman Brothers who — with their shareholders and investors left to suffer billions of dollars in losses — reportedly walked out the soon-to-be-boarded-up doors of their brokerage with about $2.5 billion in bonuses.  Does Paulson believe that the other bankers and brokers who produced this disaster should be similarly rewarded?

To prevent this outcome, there must not be any kid-glove bailouts. The banking and investment companies who brought about this disaster by risking moral hazards have to bear as much of the burden as can be imposed on them without destroying the market. No matter how many brokerages and banks close, others will quickly replace them if the credit market is secure.  

The government can’t bring this about.  People such as Warren Buffett can and will, unless government interventionism blocks their path.

The only mechanism that can bring long-term stability back to the credit market is the market itself.  That the sub-prime mortgages and securities have gobbled up too much credit to allow the rest to flow requires a short-term solution, not nationalization of the credit markets.   

Democrats — normally the party of economic intervention — are proposing the creation of a government-controlled financial market that will be as successful as a Soviet Five-Year Plan.

Senate Banking Committee Chairman Chris Dodd (D-Ct) has a draft bill that effectively nationializes the credit market under an “Office of Financial Stability” and an “Emergency Oversight Board”.  Dodd’s bill would end free market capitalism in America.

Rather than the recession that Paulson and Wall Street fear, Dodd would create a depression.  

Conservatives have to fight to make the government use only those measures that will free up American capital, not let it be mired in bad investments here or abroad.  

Congress planned to recess this week for the election.  As Cong. Jeb Hensarling (R-Tx) said at a press conference Tuesday, “Congress should stay in session through election day if that’s what it takes to get this right.”  

Hensarling is right.  Congress should stay as long as necessary to do this right, not just fast.

Free market capitalism is the only basis for economic recovery and prosperity.  Those who forget that basic principle endanger us all.