A Trillion Here, A Trillion There and Pretty Soon We're Talking Real Money

There are two, ever so very vocal camps on the issue of financial bailouts. There is the Paulson-Bernanke Camp, which is throwing money around like so much confetti and there is the Everyone-Else -Outside-Washington Camp that is watching its tax dollars go down the black hole that is Washington politics. Now, after about a trillion dollars worth of various bailout and stimulus packages, the Fed is pledging more than $7.4 trillion dollars to get credit flowing once again.

What $7.4 Trillion Looks Like

To give you some perspective on the numbers under discussion, according to Bloomberg: “The money that’s been pledged is equivalent to $24,000 for every man, woman and child in the country. It’s nine times what the U.S. has spent so far on wars in Iraq and Afghanistan, according to Congressional Budget Office figures. It could pay off more than half the country’s mortgages.”

This is a Hail Mary pass, a desperation move since nothing else—that is, none of the other money they have thrown at the problem—seems to have worked. It is the something that they feel they have to do to help the problem. According to the Bloomberg article, “The worst financial crisis in two generations has erased $23 trillion, or 38 percent, of the value of the world’s companies and brought down three of the biggest Wall Street firms.” With those kinds of numbers, you can see why the government is feeling the heat to do something to contain the damage. When he was testifying before Congress for the first $700 billion bailout, Paulson identified the following as rationale for his proposal:

  • Stabilize the economy

  • Improve liquidity

  • Comprehensive strategy

  • Immediate and significant

  • Broad impact

  • Investor confidence

  • Impact on Economy and GDP

It is certain that these same issues are at work today, especially the need to stabilize the economy and improve liquidity. However, it is hard to say whether the Fed will be empowered to make these loans. Lawmakers still feel burned by the changes to the Troubled Assets Relief Program (TARP) and the utter lack of transparency in the way Treasury is handling the money that Congress has already approved. What is not so hard to say is that what we have seen from the existing bailout and stimulus efforts does not inspire a great deal of confidence that throwing more money at the problem will be any more effective today than it was yesterday.

Changing the Culture

The problem is that nothing is being done to change the culture of the companies involved. The politicians railed against the arrogance of the automaker CEOs and their private jets, yet their bailout is still on the table; AIG received billions and still threw luxury trips for its executives, the money that the banks have already received has, in great measure, gone to purchase other banks. Still, the greatest example of business as usual has to be the continuation of the one practice that started the whole avalanche—sub-prime mortgage lending!

Surprised? I bet you thought the sub-prime mortgage was a thing of the past, right? Like any reasonable person, you assumed that the primary cause of our economic meltdown would be the first thing to be eliminated as we try to rebuild, right?

Wrong. Think back, have you heard a word about ending the practice? You might have heard pundits calling for a halt, or the odd politician saying that these must be stopped, but you have not heard of any concrete proposal, executive order or piece of legislation to put an end to sub-prime mortgage lending. The market took care of that, destroying the value of the bad paper, but according to BusinessWeek, that hasn't stopped the people who were peddling that bad paper from continuing to sell mortgages.

Thousands of subprime mortgage lenders and brokers—many of them the very sorts of firms that helped create the current financial crisis—are going strong. Their new strategy: taking advantage of a long-standing federal program designed to encourage homeownership by insuring mortgages for buyers of modest means.

You read that correctly. Some of the same people who propelled us toward the housing market calamity are now seeking to profit by exploiting billions in federally insured mortgages. Washington, meanwhile, has vastly expanded the availability of such taxpayer-backed loans as part of the emergency campaign to rescue the country's swooning economy.

Now, there were (and are) many sub-prime lenders that acted with honor and an ethical business model. These are not the problem. Credit scores are not the sum total of a borrower's experience and many times those with poor credit had the means to deal with a sub-prime mortgage. The problem was the predatory lenders, the legal loan sharks that put people into homes they could not afford on the premise that either the value of the house would rise or the loan would be sold and so the near-certain default would be someone else's problem. The risk this poses to what is left of the economy is inestimable.

Gary E. Lacefield, a former federal mortgage investigator who now runs Risk Mitigation Group, a consultancy in Arlington, Tex., told BusinessWeek: "Within the next 12 to 18 months, there is going to be FHA-insurance Armageddon." That, of course, would mean another massive bailout, something on the order of $100 billion over the next five years if the numbers from Inside Mortgage Finance, a research and newsletter firm in Bethesda, Maryland, are correct. That is over and above the already approved $700 billion that is currently in the pipe.

The Bottom Line

The fact that these lenders can now cash in on more government-backed mortgages is bad. The fact that the government thinks that allowing them access to the FHA is a good way to help the economy is worse. It forces you to question the judgment of the people running this whole show, which brings us back to the Fed's pledge of $7.4 trillion.

As long as the prevailing culture in America's board rooms mirrors AIG and the auto industry, then the government can throw all the money it likes at the problem and nothing will change. Nothing will improve and we will be treated to an endless parade of millionaire executives mounting the steps of Capital Hill, hat in hand, to beg for more and more taxpayer money. How does this help us? How does it make things easier for small businesses? How does this save the economy?

It doesn't, it doesn't and it doesn't, and yet no one in government seems perturbed by that little fact. There are two ways of proceeding as far as I can see it. We can allow our government to continue along this path, which will quickly move to buying up assets as history begins to repeat itself, or we should allow the market to correct itself, accept the pain and the lesson that goes along with it. One way and the government controls the economy and we know what that is called. The other way, the economy takes care of itself and comes out stronger. Either way, people will be hurt. It is merely a question of how badly and for how long. If you let the economy right itself, the pain will be intense but short, like a bad shot. Let the government run things, its like an untreated toothache, not as intense but long lasting.

I prefer the shot, and I would prefer it from someone who actually has an educated plan and a little creativity where it comes to fixing the economy.

Oh, and if they go ahead with the $7.4 trillion, then I would like my $24,000 in gold. You never know.