The Arizona Republic
The Bush administration’s proposal to set up a taxpayer-supported $700 billion fund to buy distressed securities is a terrible idea.
Among its worst consequences, it will inevitably trigger massive additional regulation of America’s capital markets.
Until the Bush administration’s ham-fisted response to the stress in financial markets, there was a relatively clear regulatory demarcation.
Financial institutions whose deposits were federally insured would be regulated for prudence and safety. The rest of the capital market would be regulated primarily for disclosure and not for prudence and safety.
The notion was that grown-ups should be free to invest, lend and borrow as they decide, reaping the profits from wise decisions and suffering the losses from unwise ones.
If, however, taxpayers are going to be on the hook for unwise decisions provided they are big enough, the demand for regulation that attempts to ensure that no such big unwise decisions get made will be irresistible.
That, however, is beyond the regulatory capacity of the federal government.
The capital markets are just too extensive, fast-moving and complex to be effectively regulated for prudence and safety. The attempt to do so will create stickiness and sluggishness in the capital markets, with potentially highly adverse effects on the long-term growth potential of the country for years to come.
The consequences of the Bush administration’s terrible idea will be felt in other areas as well.
The federal government now owns the country’s largest mortgage finance firms and its largest insurance company. So, would it really be such a breach in our free market system, as the Bush administration will have left it, for the federal government to own health care providers as well?
The Bush administration has been accused of having too much faith in the market. However, at times of stress, it has consistently failed to trust the self-correcting mechanisms in the market to work and intervened instead.
Bear Stearns wasn’t permitted to go into bankruptcy. Fannie Mae and Freddie Mac were seized when they still thought they could shore up their balance sheets. AIG was taken over, rather than allowing the market to revalue the debt it had guaranteed.
The Bush administration’s terrible idea was rushed to Congress when it became spooked over the stress in the short-term commercial paper market last week.
Money market withdrawals were large. Inter-bank lending rates spiked. Investors fled to short-term treasuries, bidding the interest rate for a three-month bill to zero.
The question, however, is whether such conditions would persist if government would show some forbearance. It’s highly unlikely that they would.
Investors aren’t for long going to, in essence, stuff hundreds of billions of dollars in a mattress. Rising interest rates can bring the capital back into the short-term market.
People are willing to take more risk for a 6 percent return than a 3 percent return. And they are willing to take more risk for a 9 percent return than a 6 percent return.
Higher short-term interest rates would have adverse economic effects. But the notion that the country is going to unwind from a large overinvestment in housing and excess debt in general without adverse economic consequences is fanciful.
In the meantime, the Bush administration has changed or waived virtually every financial rule except the one that would have done any good.
Mortgage-backed securities will inevitably be worth more than they are currently being traded at. After all, more than 90 percent of all mortgages are still current. Even two-thirds of subprime mortgages are still current.
Yet, when Merrill Lynch was cleaning up its balance sheet, it had to unload some of its MBSs at 22 cents on a face dollar. Accounting rules require that assets be “marked to market.”
An easing of that rule in these circumstances, when there really isn’t much of a market, would have obviated the perceived need for virtually everything else the Bush administration has done or is proposing.
All in all, this terrible idea is the Bush administration’s second worst moment. Its worst was the ad hoc flailing of Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke that preceded it.
Buying distressed paper in a nondiscriminatory way, through a reverse auction that Congress should insist on, is better than making ad hoc and arbitrary decisions about who lives and who dies, and the federal government assuming ownership of large companies.
The best that can be said about the Bush administration’s terrible idea is this: It is the least bad way of doing the wrong thing.
Robert Robb, an Arizona Republic columnist, writes about public policy and politics in Arizona. E-mail: email@example.com