| The Bush administration says it was doing only what bankers would have done anyway in corralling the biggies in the home mortgage field and having them agree to provide relief to a million or so subprime borrowers in one of three ways: refinance an existing loan into a new private mortgage, move them into an FHASecure loan or freeze teaser rates for five years. If that were the case, who needed Uncle Sam’s arm-twisting?
A critical, oft-underappreciated principle of free markets is property rights and the sanctity of contracts. It’s one thing if both parties sit down and renegotiate terms, quite another when the government comes in and says (in this case) to the bankers: “Do it or we’ll break your arms.” Argentina and other perpetually underperforming countries routinely abrogate agreements when it’s politically convenient to do so. During the 20th century Argentina tumbled from being one of the richest economies in the world to the chronically troubled, submediocre state it is today.
Treasury Chief Henry Paulson’s decision follows bad precedents made during the Great Depression. Both the Hoover and Roosevelt administrations took high-handed actions that precipitated and then deepened and prolonged the economic crisis that was battering both the U.S. and the rest of the world and made possible the rise of Nazism and the advent of World War II.
In particular, Paulson’s powwow in December was reminiscent of one of President Herbert Hoover’s moves in the fall of 1929, following the stock market crash. Hoover convened a meeting of the leaders of many large companies and had them promise not to cut wages or lay off workers. Amazingly these corporate chieftains largely stuck to the agreement for more than a year, until sickening economic conditions forced them to slash payrolls and salaries in order to stay afloat.
Amity Shlaes’ The Forgotten Man: A New History of the Great Depression reveals that Hoover’s seemingly humane actions perversely worsened the crisis. As sales plummeted, these companies had to tighten expenses, which forced suppliers to slash prices. In turn, suppliers had no choice but to engage in massive layoffs on their own workforces. The large companies, by keeping all their workers on their payrolls and salaries artificially high, ended up creating far more joblessness in the rest of the economy.
Today the real problem is that we still don’t know where all the bad paper is. As with tainted spinach or lettuce – and even though, as a proportion of the whole, only a minuscule amount may be bad – no one will buy any of it until it’s known where the bad produce is.
What an activist-minded Treasury chief and the SEC should do is make sure that bank regulators and the accounting profession don’t over-react. During the savings-and-loan crisis of the 1980s, bank regulators lurched from laxity to zealotry. Hundreds of banks were needlessly destroyed.
Banks should be graded on how well they keep lines of credit open to solvent borrowers, as well as on their willingness to boost lines of credit to small and medium-size businesses that have sound plans for expansion.
It’s no surprise that accountants are haunted by the specter of Arthur Andersen, a firm annihilated by an indictment that was subsequently thrown out by the courts. Fearful of prosecutors and trial lawyers, the accounting profession is already aggressively pressuring companies to massively write down the value of securities with sub-prime mortgages or other consumer receivables, such as auto loans and credit cards. Sine there’s no market for much of this stuff, valuations are arbitrary. The SEC should be telling the profession that there will be no writedowns until there has been an actual loss. This would prevent any more money market panics of the kind that recently gripped local governments in Florida, which had a run on a state-managed money market fund that had some questionable securities.
Another thing Washington should do but is currently incapable of doing is to substantially cut individual and corporate income tax rates and eliminate the alternative minimum tax. Such moves would quickly swing the economy back into high gear.
Remember, the size of the losses from “sub-prime slime” is easily absorbable in an economy in which consumers have assets of more than $50 trillion. The financial net worth of consumer households in this country has reached a record-level $31 trillion.
This article is reprinted with the permission of Forbes Inc.
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