You Ain’t Seen Nothing, Yet

Steve Pearlstein provides a view into the new reality now rising across our nation’s collective consciousness: that we’re in for a rough ride in the quarters ahead. His column doesn’t provide any new insight — for readers of HW, at least, who have known about the risks portended by the mortgage crisis for the better part of 2007 — but it does provide some concise analysis:

… let me assure you, you ain’t seen nothing, yet. What’s important to understand is that, contrary to what you heard from President Bush yesterday, this isn’t just a mortgage or housing crisis. The financial giants that originated, packaged, rated and insured all those subprime mortgages were the same ones, run by the same executives, with the same fee incentives, using the same financial technologies and risk-management systems, who originated, packaged, rated and insured home-equity loans, commercial real estate loans, credit card loans and loans to finance corporate buyouts. It is highly unlikely that these organizations did a significantly better job with those other lines of business than they did with mortgages. But the extent of those misjudgments will be revealed only once the economy has slowed, as it surely will.

Of course, the problem goes far deeper than reaching across lines of business; it extends into just how far out the securitization process has gone, even within one line of business (like mortgages). I’m talking about CDOs, CDO-squared deals, and the like here — there was so much money generated off of one dollar of secured cash flow that it literally pumped up balance sheets for anyone issuing and investing in the secondary markets to historic highs. Now that the great unwinding is here, the losses will be every bit as real as the income generated by the wind up — and that’s where our focus should be. Who takes the losses? I bring this up because, contrary to U.S. Treasury Secretary Henry Paulson’s assertions, the mortgage bailout plan now being considered most certainly involves taxpayer liability (say it with me: municipal bonds). Asking taxpayers to shoulder the cost of a bad bets made by investors and borrowers alike doesn’t just set a bad precendent; in some ways, it undermines the soul of the American economy itself. A free economy means just that — individuals are free to make choices and own the responsibility for their own choices, whether that means becoming astronomically rich or finding yourself in the poorhouse. That’s the very heart of the pursuit of life, liberty and happiness — warts and all. Asking taxpayers to bail out troubled borrowers isn’t the same thing as coming to the aid of our fellow man when a natural disaster strikes — when a hurricane hits, for example, the American ethic is that we help our brothers in need. When a tsumami decimates another country, we take the lead in providing the help that is so desperately needed. But when a free market leads those on the buy-side and those on the sell-side to play fast and loose with risk — or to decide that they have no responsibility for understanding the risks associated with their own voluntary decisions — we MUST allow those individuals to shoulder the cost of their choices. Any discussion of how to save our financial markets and prevent recession frames the issues completely wrong. A recession may be exactly what’s needed; and in these instances, the job of our fiscal and monetary policy should be to ensure that a recession doesn’t become a Depression, and to help prepare the economy for its next upward swing. Getting there means having tolerance for the idea that people are, in fact, responsible for the financial choices they make. Especially when it comes to property rights — nothing is more American than that.

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