Tuesday, September 23, 2008

The Bail-Out

I suspect that this bail-out of the mortgage industry is going to bail out the wrong people.

I want to start my analysis by explaining the situation in simple and personal terms.

About a year ago, the company that holds the mortgage on my house sent me an offer to refinance my home, substantially lowering my monthly payments. The advertisement showed me exactly how much money I would “save” if I switched to this new type of loan by comparing my existing payments to what my new payments would be.

In fact, the loan did not offer any savings whatsoever. In fact, it increased my interest payment. It decreased the monthly payment by eliminating any payment on the principle of the house. However, the money I pay on the principle of the house is not a “cost” to me in any accounting sense. Since I owned my house I owned all accumulated equity in my home, and money that went to principle is money that built up equity. Then, at some future date, I would have to start paying off principle, meaning that the rates will go up – up far beyond what I was currently paying on my mortgage.

What this company was going to do (if I fell for this plan) was suck interest payments out of me for a couple of years. Then, when the mortgage rates went up and I could not pay the higher rates, they would take the home, in which I had accumulated no equity (except perhaps the increase in the value of the house over those two years). They would then get the house.

The scheme was designed so that, unless I was very careful or very lucky, the mortage company would get my interest payments and my home and I would have nothing.

I was so (morally) outraged at the company for this callous manipulation that I seriously considered transferring my mortgage to another company and telling this one that their morally outrageous behavior was the reason for my decision.

Well, it turns out that the company did not do so well. Housing prices began to fall and, it turned out, the company had lent more money to the original owners than they could now get from the house. So, the company had to take a loss. When enough of these losses got added together, it drove the company into bankruptcy.

It was among the first companies to fall. It was soon followed by others – who were equally deserving.

Yet, now, as those who invested in these practices face the losses that they so richly deserve, the government steps in to bail them out.

There was no government aid for the homeowners who were losing their homes – the average working family who were swindled out of their paychecks and their homes by these companies. As foreclosure upon foreclosure piled up, the government could offer the victims nothing more than a few kind words of sympathy.

But, when the costs started to fall on those with millions and billions of dollars – when they threatened to make mere millionaires of those who were once billionaires – the government suddenly needed to step in and take over.

And what type of bail-out do they propose? They propose buying up the debt from the debt holders. The people who purchased billions of dollars worth of debt get to turn their debt over to the government, who will pay their bills for them. But the family with the outrageous mortgage (and outrageous credit card and medical bill debt to go along with it) do not get to hand their debt over to the federal government. They need to fend for themselves.

The distinction here is between debt holders and debt payers. The government appears to be stepping in to protect those people who hold (bad) debt – the people who hold the paper that other people are making payments on. It is making significantly less effort to protect the debt payers – the people who are paying money (or would be paying money if they had the money to pay) to the debt holders.

Now, what can we say about the demographic characteristics of debt holders versus debt payers. What type of person is (trying to) pay debt, and what type of person is holding the paper that the debt payers are paying? The former, of course, is your average middle class (and lower class) American. The latter are the few who are extremely wealthy – the people with money to lend.

Now, we are all, to some degree, debt holders – more so than we acknowledge. The money in our savings accounts are, effectively, leant to the bank to use in making loans. We are debt holders to the degree that we purchase CDs, treasury bills, bonds, bond mutual funds, or even stock (in a sense). If you have a retirement account, then you are not only a debt payer, but you are also a debt holders. So, it would be wrong to say that only the very rich are debt holders. However, it is still true that if the government helps the debt holder they the proportion of benefit to rich people over benefit to poor people, is significantly higher than it would be if the government had protected debt payers.

We see here where the government’s priorities are.

Independent of the need to provide some way of ending this financial crisis, the principle still stands that the people who do not deserve to benefit – the people who most deserve to lose their money and be driven into poverty – are those who invented and sold these morally outrageous mortgage packages to unsuspecting buyers.

We teach moral responsibility by holding people responsible for their own moral failings. We teach moral irresponsibility when those who do evil are allowed to get away with their moral crimes, or even profit from them. Currently, we have a situation where the government is stepping in to protect a group of people who have committed one of the worst moral outrageous in current American history.

Furthermore, the principles of capitalism hold that people should be held responsible for their decisions. They should be able to profit from their successes and suffer from their losses. If we have a system where individuals can gamble, and keep what they win while they hand the bill off to somebody off when they lose, then we can expect people to do far too much gambling, and to gamble when it is not rational for them to do so. That is to say, we can expect the same irrational and destructive results that we have gotten from the mortgage industry for the past several years, and which we can expect to happen again in the future if losers are able to use the government to force others to cover their losses.

I am not . . . repeat . . . NOT . . . saying that the bail-out should not be done. I consider myself too ill informed to make that decision. It takes somebody far more familiar with the facts of the situation than I am to make that judgment (which is true of a great majority of the people who are offering opinions on this matter). Barak Obama was right on this issue to withhold opinion until the experts among his advisors could fill him in on the facts.

I am saying that, whatever steps we take to bail the economy out, that certain people should not benefit. The government should not be in the businesses of covering the bad loans made by billionaires through which they might well become mere millionaires, when they are not covering the bad debts of average people who made bad choices in barrowing for their homes.


The Nerd said...

I personally would love to see measures taken to ensure this doesn't have to happen again.

I do know that if they really wanted to benefit the average person, things would look a lot different. Universal health care, for one. It's kind of hard to support an economy on the backs of the people who are injured or ill, and in debt because their insurance companies (if they even can afford insurance) found a loophole in the writing that lets them deny coverage.

anton said...

Now, the petty thieves serving time in prison have some new heroes to teach them how to steal. If the FBI does it job well, the inmates can attend their in the big house workshops! Oh no, I forgot! The judicial system is controlled by the same bunch! What if we first made every politician pay back every cent they received from these "desperadoes" and apply it to the bail-out? If we did that, politicians may be more reluctant to accept "contributions" again from the bad guys. Do we really care how much would be left in their "campaign coffers"?

With regard to the victims of this charade, they are, unfortunately, paying the price for their ignorance. US America, and the world, would never have been in this predicament if their worship of the Yankee Dollar didn't cloud their vision and promote their unproven faith in a corrupt system.

Does anybody still want to buy a bridge to Brooklyn?

Anonymous said...

Thanks. You explained this well-nigh incomprehensible stuff very well.

Anonymous said...

now McCain's announced he's going to suspend his presidential campaign to help sort out the financial crisis.

Hume's Ghost said...

Kevin Phillips' latest book is titled Bad Money (released earlier this year) and it anticpated that this was going to happen. I plan to read it as soon as I can get a copy at my library.

Funny thing is that if you read his 1994 book Arrogant Capital one could see this coming ... I recall a line in that book about the country being bankrupted because there is a political and business class who find it profitable to do so.

I am extremely skeptical of any bail-out bill that is going to come forth, not because I neccesarily believe that something shouldn't be done, but because the very people who caused this to happen are the political donor class which both parties get their money from.

Anonymous said...

good post. my feeling is that if there HAS to be a bail-out it should be contingent on the re-imposition of separations and restrictions on the finance sector again. in other words: the financial services modernization act of 1999 will have to be nullified by an act of congress.
if there's a bail-out without doing that, we'll be in this same place with a slightly different set of particulars 5 or 10 years from now.