Even if the "rescue" bill does become law, it could just add to the confusion and lack of confidence that's the real root of the financial world's problems.
Many say instead that the root of the problem is the declining housing market. Indeed, the first goal of the bailout bill is to "protect home values." Yet that's the first way in which the proposal could add to confusionbecause houses in much of the country are likely still overvalued, perhaps wildly so.
Sure, the government can try to keep prices up, by buying bad mortgages and deferring principal or interest payments on them so people who bought at inflated prices don't have to sell. But if potential lenders think prices still have far to fall, and that the government is interfering with an inevitable process, they'll hold back on lending against the overinflated value of those houses.
Theoretically, even companies like Fannie Mae and Freddie Mac should hold back on such new lendinglest they stick taxpayers with a higher bill from fresh bad loans. Lenders of other types of consumer creditfrom credit-card companies to auto-finance firmswill also hold back if they think that Americans are still struggling to make payments on over-inflated home values.
New lenders, needed to replace all the old ones that have gone (or should go) bust, won't start lending again until they think home prices have fallen enough so as to be affordable over the long term for middle-class people. Anything the government does to interfere with this painful process will delay recovery.
There is just no way that housing prices can stay as overvalued as they are without having a worse impact on the economy than their deflation. Overvalued housing prices are impossible to sustain permanentlyand, in the meantime, they suck money out of more productive areas of the economy.
The second problem is that the declining housing market is only the symptom of the problem. One reason house and other asset prices rose so much between 2000 and 2006 was because some (not all) financial institutions had gone crazy, ginning up the credit that led to those price increases.
Wall Street firms seemed to think that any and all lending risk could be structured away via inscrutable securitization techniques and by adding derivative on top of derivative to what were once plain-vanilla mortgage-backed securities.
Because of almost unimaginable management and risk-control errors, nobody can figure out what these securities are worth now. But, since they're based (in the end) on inflated home prices, they're possibly not worth much.
And there's yet a deeper problem: Potential lenders and shareholders have no faith in these financial institutions' ability to manage their future business. Taking bad assets off banks' books, as the Treasury wants to do, won't fix that.
In fact, it could make it worse. How? Government subsidy for certain institutionsgiving them good money for their bad debtwill allow some bad actors to hobble on into the future in their current form.
Potential investors won't know if a given institution has learned its lessonor if, just as bad, the lesson it has learned is that the government will bail it out if it's big enough and if its decisions were bad enough.
The good financial institutions leftwhich really should be rebuilding America's credit infrastructurewill have to compete with these bad ones.
And competing with bad institutions may make good ones careless, too. Consider how Fannie and Freddie (with their implicit government guarantees) long distorted the private mortgage-lending marketand you can see the implications of this risk.
Lastly, unless the government buys all the bad mortgage-related assets out theresomething that $700 billion won't coverthis bill could delay recovery in another way.
The markets need private "vulture" investors to buy bad assets from financial institutions at fair prices - but the vultures may not do so if they have to worry about how long the government will try to prop up prices in this market.
Whether or not the "rescue" bill passes, the future could be very painful for the US economy. Nobody knows which way is worse.
The bill has one potentially huge benefit: It would mandate that the Treasury department quickly report to the public the types of assets it buys from financial institutions as well as the prices it pays for those assets. If executed well, this provision would shine some badly needed light on what remains a dark, opaque market.
But the rest of the bill is such a muddle that there's there's no compelling reason to believe that it's better than the immediate alternative. Namely, for the government to continue 1) lending aggressively to surviving financial institutions, 2) approving good mortgages (via Fannie and Freddie) for people who can pay them, 3) offering to guarantee money-market funds and 4) quickly working on future, rational market regulationsin hopes that the credit markets open slowly and soon to good-quality borrowers.
And any new bill should offer a way for debtholders to bad companies to take a severe haircut in return for government money.
Original Source: http://www.nypost.com/seven/09302008/postopinion/opedcolumnists/the_uncertainty_act_of_2008_131362.htm?&page=1