01 April 2008
Sub Prime Mortgage Cleanup
The U.S. Treasury and the Federal Reserve rescued the country’s financial system from the consequences of a collapse of Bear Stearns with a guarantee of $30 billion of its assets to its selected buyer, J.P. Morgan Chase. The immediate beneficiaries of this emergency measure were other investment banks whose operations depend on the availability of credit from their trading partners around the world. Ultimately, the entire financial system of the country was believed to have escaped a meltdown for lack of the mutual trust of trading partners on which it depends.
The emergency action was taken to preserve the lubricant, credit, that allows large financial institutions to conduct their business with each other. This was an operational challenge. Secretary of Treasury Paulson characterized it as facing the systemic risk. It had arisen from nervousness about the value of one class of assets underlying a small part of the global money market—real estate. It did not correct the valuation errors that led to the credit crunch, nor did it address the personal tragedies of those home buyers whose mortgage loans exceed the deteriorating value of their homes.
We have indeed gone through another bubble-bursting, and there are many different losers. Some deserve what they got, having invested capital in a wildly inflated real estate boom. A few, however, saw their personal savings destroyed by the collapse of foolish dreams sold to them by fast-talking con-artists.
Perhaps an argument can be made for rescuing those victims of the real estate debacle. No one believed that investors in the stock market deserved a bailout, even those whose retirement nest eggs were crushed, deserved rescuing in 1987 or following the Internet Bubble. However, investment in one’s home is encouraged officially by the Income Tax code as well as culturally by the American mythology of self-reliance. Based on that, a federal rescue plan for home owners who took ill-advised mortgages could reasonably be offered new loans on realistic terms, at the expense of the investors who bought debt obligations collateralized by the original sub prime mortgages involved.
An important part of the new federal credit regulation plan proposed by Secretary Paulson, the Mortgage Origination Commission, should be implemented strongly in order to demonstrate to foreign investors the conscientiousness of federal regulators. Although foreign investors were possibly imprudent to have invested in CDOs backed in part by sub prime mortgages, their confidence in the transparency of the U.S. financial system is critical for assuring the availability of their capital to finance American private enterprise and public entitlement programs. The aphorism, “Fool me once, shame on me; fool me twice, shame on you,” packs a lesson that Americans must abide by if we wish to continue enjoying a way of life we cannot afford without monetary liquidity provided by willing institutional investors from abroad.
The U.S. Treasury and the Federal Reserve rescued the country’s financial system from the consequences of a collapse of Bear Stearns with a guarantee of $30 billion of its assets to its selected buyer, J.P. Morgan Chase. The immediate beneficiaries of this emergency measure were other investment banks whose operations depend on the availability of credit from their trading partners around the world. Ultimately, the entire financial system of the country was believed to have escaped a meltdown for lack of the mutual trust of trading partners on which it depends.
The emergency action was taken to preserve the lubricant, credit, that allows large financial institutions to conduct their business with each other. This was an operational challenge. Secretary of Treasury Paulson characterized it as facing the systemic risk. It had arisen from nervousness about the value of one class of assets underlying a small part of the global money market—real estate. It did not correct the valuation errors that led to the credit crunch, nor did it address the personal tragedies of those home buyers whose mortgage loans exceed the deteriorating value of their homes.
We have indeed gone through another bubble-bursting, and there are many different losers. Some deserve what they got, having invested capital in a wildly inflated real estate boom. A few, however, saw their personal savings destroyed by the collapse of foolish dreams sold to them by fast-talking con-artists.
Perhaps an argument can be made for rescuing those victims of the real estate debacle. No one believed that investors in the stock market deserved a bailout, even those whose retirement nest eggs were crushed, deserved rescuing in 1987 or following the Internet Bubble. However, investment in one’s home is encouraged officially by the Income Tax code as well as culturally by the American mythology of self-reliance. Based on that, a federal rescue plan for home owners who took ill-advised mortgages could reasonably be offered new loans on realistic terms, at the expense of the investors who bought debt obligations collateralized by the original sub prime mortgages involved.
An important part of the new federal credit regulation plan proposed by Secretary Paulson, the Mortgage Origination Commission, should be implemented strongly in order to demonstrate to foreign investors the conscientiousness of federal regulators. Although foreign investors were possibly imprudent to have invested in CDOs backed in part by sub prime mortgages, their confidence in the transparency of the U.S. financial system is critical for assuring the availability of their capital to finance American private enterprise and public entitlement programs. The aphorism, “Fool me once, shame on me; fool me twice, shame on you,” packs a lesson that Americans must abide by if we wish to continue enjoying a way of life we cannot afford without monetary liquidity provided by willing institutional investors from abroad.
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