You are here

Bailout Threatens Economy, Shreds Constitution, Rips Off Taxpayers

The stock market sank as the Bush Administration capitulated to liberal demands that its proposed $700 billion bailout of the financial system be expanded to add more costly give-aways, like "systematic” limits on foreclosure, that would allow irresponsible borrowers to remain in their homes at taxpayer expense.   The bailout is so extreme that it is unconstitutional.

Because of rigid federal accounting regulations that require Enron-style "mark-to-market accounting," the bailout could actually deepen the financial crisis.  The bailout will reduce economic growth over the long run, and is logically inconsistent.

The bailout rips off people who lived within their means to pay their debts.  I can pay my mortgage, because I was frugal, and bought a little two-bedroom house on a fixed rate mortgage.  But reckless people in my region can't pay their mortgage, because they bought big houses on adjustable interest-rate loans with low teaser rates.  Now that their introductory low rates have expired,  they can't afford their payments.  The government is going to bail them out, at our expense.  While many defaulting borrowers have been living it up, buying fancy Lexus cars and eating expensive restaurant meals, I've been going through recycling bins on weekends searching for coupons.  (I found over $100 in baby food coupons that way).

There is no reason to believe government officials who claim their sweeping bailout will fix what ails the economy, since it was their incompetence that spawned the crisis.  John Lott, Jonah Goldberg, and the Wall Street Journal explain how redlining regulationsfederal affordable housing mandates, and the Community Reinvestment Act encouraged lenders to make risky loans to irresponsible people who never saved any money and now are defaulting.  Financial expert John Steele Gordon describes how the government-backed mortgage giants Fannie Mae and Freddie Mac spawned the mortgage crisis, in the New York Times.

Congressman Barney Frank and other bailout supporters are relying on blatant lies to pass the bill.   Barney Frank spawned the mortgage crisis by defending the corrupt management of the Government-Sponsored Enterprises, Fannie Mae and Freddie Mac, which gave him and his liberal allies enormous campaign contributions, bullied political opponents, and encouraged lenders like Countrywide Financial to make risky loans in the name of affordable housing.  He ridiculed whistleblowers like Greg Mankiw, chairman of the Council of Economic Advisers, whom he mocked for being  “worried about the tiny little matter of safety and soundness rather than” the liberal goal of promoting affordable housing.  Frank and his allies repeatedly blocked critically-needed reforms of Fannie Mae.

Now, Frank he claims that he and other government officials are blameless.  "The private sector got us into this mess," he said, "The government has to get us out of it."  Never mind that the federal government, through the Department of Housing & Urban Development, played a key role in causing the proliferation of risky mortgage loans, as even the liberal Village Voice has chronicled.

Scholarly reaction to the bailout is so hostile that Walter Olson calls it a “hail of dead cats."

John Berlau, Holman Jenkins, Newt Gingrich, and former FDIC Chairman William Isaac argue that federal accounting regulations aggravated the financial crisis.  (Iain Murray describes how strange those "mark-to-market” accounting rules, which Enron used, can be).  If that's so, then relaxing the regulations might go a long way towards eliminating the need for a bailout, as John and I have noted.

The bailout plan gives Treasury Secretary Hank Paulson extraordinarily broad powers to buy bad loans throughout the economy, without any meaningful standards, barring any judicial oversight of even patent misconduct, to a degree that is unconstitutional.  Sweeping grants of authority are only permitted when government officials are subject to judicial review to prevent arbitrary or capricious acts.  President's Nixon's price controls were upheld in the Amalgamated Meat Cutters case only because they incorporated judicial oversight.

News reporters question Paulson's possible conflict of interest in pushing the sweeping bailout, since he himself is a wealthy former Wall Street executive whose firm stands to benefit from taxpayers, rather than Wall Street, picking up the tab for bad loans.

No matter what strategy the government uses to buy bad loans, it will place the economy in profound jeopardy.  Sources say that if the Paulson plan goes forward Paulson will buy risky mortgage-based securities at a value somewhat greater than they are worth intentionally. The effect will be that taxpayers are guaranteed to lose money and that the crisis will just be pushed down the road to a later deflationary event.  He has powerful incentives to do so, not just political, but also economic, despite the devastating effect it will have on taxpayers.  One reason is because of the chain-reaction effect described by John Berlau here and in the Wall Street Journal.  Under rigid federal "mark-to-market” accounting rules, if a mortgage is sold by one bank for a low price, other banks have to revalue their mortgages downward to reflect that price (even if few of their own mortgages have ever defaulted).  So if Paulson buys up a mortgage security for a low price, it may cause banks that hold similar mortgages to default.  So he has an incentive to overpay for mortgages, even if taxpayers get ripped off in the process.  If he underpays, by contrast, it wipes out banks' assets as defined by federal accounting regulations, putting them in jeopardy of violating their reserve requirements.

Enron famously used "mark-to-market" accounting to inflate the value of its assets and conceal its financial problems until it went bankrupt and wiped out thousands of people's life savings.  But Paulson has avidly defended federal accounting regulations mandating this controversial practice.

The Fed's inflationary easy-money policy, and a government-enforced credit-ratings oligopoly, also contributed to the mortgage crisis, something long chronicled here and in the Wall Street Journal.