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Increasing Uncertainty, Drawing out the Pain

One of the more egregious aspects of the homeowners’ bailout-plan is the provision to allow bankruptcy judges to rewrite mortgages (the bluntly named “cram down” provision). As Alan Reynolds explains:

Any plan that compels mortgage holders to reduce the amount of money they are owed must in turn reduce the value of mortgage-backed securities held by banks, insurance companies, pension funds, Fannie and Freddie, and the Fed. By injuring the balance sheets of potential lenders, a cramdown would also injure potential borrowers. The needless threat of inviting judges to rewrite mortgage contracts at whim helps explain why bank stocks generally fell on the plan’s announcement, while financial shorts rose.

It was this sort of mischief-making that candidate Barack Obama railed against Hillary Clinton for suggesting during the campaign. In a system in which lenders won’t lend, zombie banks are a major concern, and asset values are uncertain, it’s hard to imagine a worse move. (It is ironic that the U.S., which has lectured other countries about sound economies depending on the rule of law and property rights, is now flagrantly violating both willy nilly.)

Well, come to think of it, that’s really been par for the course since the waning months of the Bush administration and continuing into the present. One savvy observer writes that in addition to the mortgage rewriting rules, we have seen a dangerous pattern:

Then there’s the shapeshifting Troubled Assets Relief Program, or TARP. It was sold to the public as a means to buy toxic assets from banks that nobody else wanted to touch. Then it morphed into the Treasury buying chunks of businesses outright and receiving preferred stock in return.

President Bush initially claimed that TARP couldn’t be used for a Detroit bailout, in part because the legislation refers to “financial institutions,” but he changed his mind in December and wrote a multi-billion dollar check. Treasury Secretary Timothy Geithner announced yet another set of TARP rules on his first day in office.

Perhaps some of these measures are necessary. Perhaps they’re not. But a collection of rules that seem to be constantly in flux is no way to reassure investors already rattled by a worldwide recession that is sharp and severe. Talk of outright bank nationalization, which the New York Times reported is taking place in the Obama administration, isn’t helping.

So when the Fed declares that the recession is going to be prolonged, one might surmise there is a reason for it. We are drawing out the pain, not allowing asset values to stabilize, increasing risks for lenders, not providing any incentives for businesses to hire and invest in the private sector, and piling up more and more public debt. How could there be any good outcome to this?


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