Friday, October 17, 2008

Our Government Is A Contrarian Investor

I have been puzzling over our government's reaction to the credit crisis, and I have to say I feel like Hank Rearden, discovering in the unseemly behavior around him the germ of an idea, which will become understanding.

It's apparent to me that despite the panicked demands of Washington power mongers to "Act now!", the Administration's actions so far are in contradiction to the opinions of those who know what they are doing: investors and markets in general. Investors say -- and reality says -- that mortgages gone bad, and financial products based on them, are a non-value or a lesser value. A loan to a person about to enter bankruptcy court is not a good thing.

What is our government doing? It is investing in these failed products. Not because it can make money, but because others cannot, and it probably will not either. It is investing because it is not a good investment.

The banks that are in trouble are in the following situation: due to the government's incessant altruistic badgering (everyone should own a home!) and extortion (via the CRA and other means), they have shot themselves in the foot and now they can't run. The government wants to magically extract that pain and give it to us to hold for a while. This will facilitate the "liquidity" of the various feet, and running will commence again (of course what is probably happening is they are waiting for the government to give them a cab ride). Then we have to figure out what to do with a bunch of feet with bullet holes in them. After all, somebody's got to wear them and allow them to heal.

However, there are two aspects to this. Not only is the goal wrong, but the means are wrong too.

It's not as if our government has a big pile of cash lying around, with which to make investments. It has nothing. It has us.

When it uses our tax money, what happens? It prevents us from doing what we would have done with that money. What would some people have done with that money? Some would have not purchased crashed mortgage-related products. Things that are low in value are things people don't want. Therefore, the government is ultimately buying these things because people regard them as bad investments.

As for as the government's putative reasons for the bailout, they don't compute. Confidence? Liquidity? These things don't happen because governments decree they will happen, while swooping in clumsily, ignoring the market and buying things nobody else will buy. Let's be real. They happen when there are values to be traded and profits to be made. If the housing market is as saturated as we are being told, that simply is not going to happen in housing for a while unless prices fall.

As for banks, who is going to lend money to banks in trouble, and why should they? It's objectively a bad idea. The market should be frozen toward banks in trouble. Instead, the government should make an unquivocal statement to the effect that it will not intervene, and they should be allowed to fail and their valuable parts allowed to be purchased by banks that did better recently. That's liquidity.

UPDATE - A bit of validation from John Allison of BB&T about the need to make home purchases more attractive, using the excellent idea of tax credits for buyers:

The only way to solve the fundamental problem weighing down the economy, he suggested, is to clear the nation’s housing market of its inventory of unsold homes. To do that, he proposed a 10 percent tax credit for buyers on all real estate transactions for a limited period of time. The credit would apply only to houses that already existed as of a certain date.

The housing market generally remains overvalued, Allison said, so such a tax credit could move buyers into the market quickly at prices both they and sellers would accept. He suggested that would be a better use of the $750 billion Congress recently set aside to buy toxic mortgage assets from the lenders themselves.

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