Market Report: August 2008

Is Deregulation Finished?

After months of ideological posturing and hand wringing, there is at last a comprehensive plan in place to shore up the beleaguered housing industry. The President did an abrupt u-turn and was joined by enough Republicans and conservative Democrats to get this historic bill passed. With the election looming and three-fourths of Americans dissatisfied with the economy, the free-marketeers had to run up the white flag. Not since the New Deal has the government waded so deeply into the affairs of the private sector, freely throwing life rings to several sinking banks and consumers. When the public learns the total cost for fixing the run-amok mortgage world, Congress will have to take a hard look at re-regulating America's banking system. You can be sure next year there will be legislative open season on the culture of deregulation.

The bill complements the earlier bold and necessary initiatives from the Treasury Secretary; using tax dollars to shore up several investment banks and Freddie Mac and Fannie Mae. The latter have also been invited to sup at the Federal trough and have been given a do-over for their past fiscal sins. While distasteful for some, the benefits of supporting F&F go beyond the obvious relief for their respective stockholders. These quasi-government corporations are also major players in the securitized mortgage market and as such their survival is in everyone's best interest. By writing blank checks to lenders and borrowers alike, Washington has acknowledged that the effects of the crisis must be mitigated and that if needed, more tax dollars are waiting in the pipeline. Judging from the unknown size of the ultimate bill, I would argue the expense of the current schemes is just the first installment.

Free market thinkers argue that the various bailouts are nothing more than rewarding foolish economic behavior. While this is a tidy ideological argument, the practical reality is that the collateral damage from such a ritualistic bloodletting would not be easily contained. One is never quite sure who will get hurt when you roll a hand grenade into the room. Globalization has linked the fates of the advanced economies and of most individuals. Housing prices are falling everywhere in the industrialized world, not just in the United States. Like the Depression, this problem is too big for a private sector solution. John Gregory Dunne is still right.

The New Safety Net

For these rescue efforts to succeed, Fannie Mae and Freddie Mac and their banking pals will have to hold up their end of the bargain. The purpose of the aid package is not to fatten their respective stock prices; the intent is for F&F to gain the economic muscle that will allow them to sharply increase the current volume of residential loans. The retail lenders who originate loans, and subsequently sell them to Fannie and Freddie and others in the secondary market, need to immediately underwrite new mortgages and modify existing loans for those in financial need. They will by nature be reluctant to help out their former co-conspirators, conveniently forgetting how they fervently they embraced 'liars loans' and questionable borrowers. They were like bartenders hustling cheap booze for customers already blowing a .15. Since the Feds are now the lenders of last resort, there is no reason not to open the credit spigot.

It accomplishes little to argue about who will benefit from these bold legislative and administrative actions. We can wag collective fingers at the legions of financial miscreants and free-booters but that solves nothing. The public's expectations are for effective governmental action and their economic gloominess portends electoral retribution if the cruel mechanisms of the free market end up resolving this crisis.

American Exceptionalism

I do not think these stimulus plans, however laudable, will match the striking success of Franklin Roosevelt's HOLC. During the Depression this Federal agency purchased defaulted mortgages directly from banks and changed the individual loan terms so that a foreclosure was avoided. Money owed was not forgiven but deferred. By the time the agency was terminated, there was no cost to the taxpayers but rather a small profit. A newer version of this plan would have been a far preferable option but the concept gained little traction on the Hill or in the White House. It is clear no one in Washington learned anything from the last housing recession and the RTC debacle. No one had the courage or the wisdom to attack the problem at the source, the bottom of the economic pecking order. As a result the taxpayers are paying the foxes to fix the chicken coop, enlisting the help of precisely the same people who created the mess.

This is uniquely American: faith in the second chance. The bailout is not throwing good money after bad, but a powerful affirmation of our Frontier mythology. We always adapt just enough to make our national contradiction relevant and ongoing; the enduring conflict between rugged individualism and collectivism.

Click here to see Jim's past Market Reports.

> Send me complementary, custom MLS listings
> Contact Jim Scott for more information or with comments at jimscott@sqre.com