Original Proposal:
Instead of bailing out banks, the government should have used that money to help reduce the mortgages of all homes that were up for foreclosure. This could be done in a cost-neutral way by extending the life of the mortgages and allowing the home owners to eventually pay their debts off. In fact, if the risks were calculated correctly, the government could even make a profit. If the homeowners walk away, the government becomes the homeowner. The bailout approach made the government the lender of last resort. This proposal would have made the government the landlord of last resort. It is the people's land after all.
Followup Analysis:
After re-watching the Inside Job, I thought I'd re-affirm how right I was when I originally wrote "On The Mortgage Crisis" in September of 2008. Looking back, this was one month after the crisis that has still not run it's course began. Seeing the fact that to date all of the bail out money has not been repaid, seeing the fact that the crisis is still affecting the job market, I can confidently say this was the only approach we should have taken.
The part in the film that jumped out at me was the simplified explanation of Credit Default Swaps. I couldn't have explained it better if I tried. Simply put, A CDS is when someone takes out insurance on something they do not own. If the insured item breaks, the owner of the CDS makes a profit; however, as long as the insured item is solvent, the owner of the CDS must continue to pay a premium.
AIG issued numerous CDS that were in essence allowing banks to take out insurance against the successful repayment of mortgages. That is, they were betting that the predatory loans would eventually collapse and the homes would have to be foreclosed. Setting aside the discussions around the ethics and morality of the banks making these bets as they themselves sold and encouraged the issuing of these mortgages, lets take a look at the impact of each dollar spent in the bailout and how it could have been spent more effectively.
The reason AIG was at risk of insolvency was because home-foreclosures were on the rise. For every foreclosure, AIG had to pay out insurance to firms who bet against those mortgages, holders of CDSs. If instead of paying those bets out via the TARP bailout, the money was spend on buying homes to prevent defaults, each dollar spent would have gone much much further. However, this would mean that the profits GS and other banking agencies planned on booking wouldn't get booked.
The plan that was put in place was two fold: one bought junk mortgages from the banks, and the other (TARP) was a loan with strings attached to it. The amazing thing is, that after using the TARP loan to satisfy margin requirements, most banks decided that it was better to unwind and pay off the TARP loans, rather than use this capital to grow their way out of their losses. My understanding is that this was largely done due to the "bonus restrictions" placed on any company that accepted the TARP funding. Putting emotions aside, it is easy to see why execu Give of the non-morgage departments did not like this. If you are paid a 15% bonus every year you have a satisfactory job performance, you will eventually begin to expect this bonus -- for better or for worse, the executives expected their bonuses. I've tried to find out if the executives in charge of the mortgages received bonuses based on satisfactory or unsatisfactory performance; however, I could not find any media outlet that covered this with a level head.
Recap:
As I mentioned, there were at least two ways by which we helped out the banks. The TARP loan was repaired by most banks fairly quickly since they wanted to be able to pay out their annual bonuses. However, the junk mortgages and mortgage based products are still in the possession of the government. If the government were to extend the term of the mortgages as much as possible; thereby lowering the monthly payment requirement for home buyers, these buyers would be able to live in the homes until someone buys it from them. If no one buys the home, the government would continue to make enough money to pay for the interest costs -- further, since the economy would stay balanced, the country as a whole would keep out of a depression, resulting in higher tax revenues for the state. The CDSs would not pay out; however, the government would survive and everyone else would be able to continue to live in the homes they could afford and frankly, when the bets were placed, the bets should have taken into account potential government intervention.
Personal Note:
I took a very long break from writing blog entries. I felt my efforts were depressing me and had no impact. I plan to resume writing. I will finish my articles on how the market works today and how we can restructure it so that the market is incentivized to grow in a safe way.
Related Links:
- Watch the inside job. It only costs $3.99 on youtube, alternatively you can find it on the web: http://www.videoweed.com/file/0ua0illeque98. I urge you to support the film by paying for it though. We need to support the investigative documentary industry.
Instead of bailing out banks, the government should have used that money to help reduce the mortgages of all homes that were up for foreclosure. This could be done in a cost-neutral way by extending the life of the mortgages and allowing the home owners to eventually pay their debts off. In fact, if the risks were calculated correctly, the government could even make a profit. If the homeowners walk away, the government becomes the homeowner. The bailout approach made the government the lender of last resort. This proposal would have made the government the landlord of last resort. It is the people's land after all.
Followup Analysis:
After re-watching the Inside Job, I thought I'd re-affirm how right I was when I originally wrote "On The Mortgage Crisis" in September of 2008. Looking back, this was one month after the crisis that has still not run it's course began. Seeing the fact that to date all of the bail out money has not been repaid, seeing the fact that the crisis is still affecting the job market, I can confidently say this was the only approach we should have taken.
The part in the film that jumped out at me was the simplified explanation of Credit Default Swaps. I couldn't have explained it better if I tried. Simply put, A CDS is when someone takes out insurance on something they do not own. If the insured item breaks, the owner of the CDS makes a profit; however, as long as the insured item is solvent, the owner of the CDS must continue to pay a premium.
AIG issued numerous CDS that were in essence allowing banks to take out insurance against the successful repayment of mortgages. That is, they were betting that the predatory loans would eventually collapse and the homes would have to be foreclosed. Setting aside the discussions around the ethics and morality of the banks making these bets as they themselves sold and encouraged the issuing of these mortgages, lets take a look at the impact of each dollar spent in the bailout and how it could have been spent more effectively.
The reason AIG was at risk of insolvency was because home-foreclosures were on the rise. For every foreclosure, AIG had to pay out insurance to firms who bet against those mortgages, holders of CDSs. If instead of paying those bets out via the TARP bailout, the money was spend on buying homes to prevent defaults, each dollar spent would have gone much much further. However, this would mean that the profits GS and other banking agencies planned on booking wouldn't get booked.
The plan that was put in place was two fold: one bought junk mortgages from the banks, and the other (TARP) was a loan with strings attached to it. The amazing thing is, that after using the TARP loan to satisfy margin requirements, most banks decided that it was better to unwind and pay off the TARP loans, rather than use this capital to grow their way out of their losses. My understanding is that this was largely done due to the "bonus restrictions" placed on any company that accepted the TARP funding. Putting emotions aside, it is easy to see why execu Give of the non-morgage departments did not like this. If you are paid a 15% bonus every year you have a satisfactory job performance, you will eventually begin to expect this bonus -- for better or for worse, the executives expected their bonuses. I've tried to find out if the executives in charge of the mortgages received bonuses based on satisfactory or unsatisfactory performance; however, I could not find any media outlet that covered this with a level head.
Recap:
As I mentioned, there were at least two ways by which we helped out the banks. The TARP loan was repaired by most banks fairly quickly since they wanted to be able to pay out their annual bonuses. However, the junk mortgages and mortgage based products are still in the possession of the government. If the government were to extend the term of the mortgages as much as possible; thereby lowering the monthly payment requirement for home buyers, these buyers would be able to live in the homes until someone buys it from them. If no one buys the home, the government would continue to make enough money to pay for the interest costs -- further, since the economy would stay balanced, the country as a whole would keep out of a depression, resulting in higher tax revenues for the state. The CDSs would not pay out; however, the government would survive and everyone else would be able to continue to live in the homes they could afford and frankly, when the bets were placed, the bets should have taken into account potential government intervention.
Personal Note:
I took a very long break from writing blog entries. I felt my efforts were depressing me and had no impact. I plan to resume writing. I will finish my articles on how the market works today and how we can restructure it so that the market is incentivized to grow in a safe way.
Related Links:
- Watch the inside job. It only costs $3.99 on youtube, alternatively you can find it on the web: http://www.videoweed.com/file/0ua0illeque98. I urge you to support the film by paying for it though. We need to support the investigative documentary industry.
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