Over the weekend, President Bush asked Congress to grant the United States Treasury Department the authority to purchase $700 billion in assets from troubled financial companies. The government would create a corporation, like 1933’s Home Owners’ Loan Corporation, to buy mortgage-backed securities at a discount and sell them later for a profit.
This is by any measure the biggest government intervention in an economy ever. So much for “free market.”
Do these financial companies deserve to be bailed out? They created, marketed, and sold risky mortgages. The market has determined that the bundles that the financial companies created to market these mortgages to investors are worth nothing. That is, the supply of these mortgage securities is high while the demand does not exist. If you can’t sell a product, it is “worth” $0.
Through the bailout, the government is saying that they’ll pay a certain amount for the securities the market has determined are worthless. In addition, the government believes that they will make money throughout this process. That is, in the future, either someone else will buy the securities or the rate of default on the mortgages will improve.
The default rates won’t improve unless conditions improve for homeowners. This plan does not address the homeowners, only the financial industry.
It’s unfortunate that greedy companies and greedy people, as well as homeowners who were led to believe they could afford their mortgages, won’t be forced to suffer the full consequences of the creation and purchase of risky mortgages. This sends the message that corporations and homeowners are encouraged to lie, cheat, and steal: Once the situation gets bad enough, all past sins will be forgiven.
Nevertheless, a bailout of this size is most likely necessary to help stabilize the economy, and without it, the world’s economies might experience a devastating collapse in a manner never experienced before.
Is a $700 billion bailout the right course of action? Should failing companies and defaulting homeowners be saved? What is needed for the global economy to move in the right direction?
Updated January 16, 2010 and originally published September 22, 2008.