Capital Commentary is the weekly current-affairs publication of CPJ, written to encourage the pursuit of public justice.
The Root of the Problem
September 26, 2008
Hank Paulson, secretary of the Treasury, argued last weekend that the new bailout plan he was proposing would finally go to the root of the problem. That problem, he said, is the “illiquid mortgage assets that have lost value as the housing correction has proceeded.” He wants Congress to approve a $700 billion package that would give him, on behalf of the federal government, almost unlimited authority to buy up the bad (“toxic”) assets so banks can feel confident to lend again.
But why have so many mortgage assets lost their value and become illiquid? The primary reason is that banks and investment companies irresponsibly encouraged people to take out mortgages not adequately backed by the value of the homes they were buying. Perhaps, then, that is the deeper root of the problem.
Well, not quite. Why were these sub-prime mortgages offered and accepted so irresponsibly? Because both the financial institutions and the homebuyers were betting—gambling—that home values would continue to rise and thus “produce” in the future the asset security that did not exist at the time of purchase. That, in turn, would give the financiers more time to try to make more money by means of more leveraging of more money.
Martin Wolf explains that the “aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007” (Financial Times, 8/24/08).
Yet, why were so many families and financial institutions taking on and trying to leverage so much debt? What was the root of that dangerous gamble? In part, government itself was encouraging individuals and companies to buy (or borrow) now and pay later. Government-sponsored mortgage companies Fannie Mae and Freddie Mac led the way or backed up those who were leading the way in this direction. Homebuyers trusted the banks. The banks trusted Fannie and Freddie as well as the investment companies that leveraged the mortgages. Investors trusted the market and those who rated the investments. And this circle of trust depended finally on trust in the government, whose laws and policies backed up or overlooked all this debt-mounting leveraging.
Now, however, the circle of trust has been broken—all around. As a consequence, Paulson’s narrow focus on the “liquidity problem” doesn’t begin to go to the root of the problem. Over the past few months, and particularly the last two weeks, Paulson and Federal Reserve Chairman Ben Bernanke have tried one expensive fix after another that has failed to overcome the liquidity crisis. And they, along with President Bush, now want us (and investors, and Congress) to put our trust in their last-minute bailout plan that requires additional massive public indebtedness? Why should any of us now assume that this program will work?
Clearly, the root of the problem is a lack of trust, including lack of trust in government. For after all, Congress as well as the executive branch has been complicit in the entire system that is now collapsing around us. It is a little late, then, for them to cry “emergency,” abrogate the so-called principles of free-market capitalism that the president says he still believes in, and ask the country to trust them now. This is simply the next—and an even bigger—gamble, made in the hope that prosperity can somehow be recovered without requiring any fundamental change in our habits, desires, and mind-set.
But it won’t work. Trust will not be restored until real responsibility and genuine accountability are reestablished at every point around the circle.
— James W. Skillen, President
Center for Public Justice
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Capital Commentary is a weekly current-affairs publication of the Center for Public Justice. Published since 1996, it is written to encourage the pursuit of justice. Commentaries do not necessarily represent an official position of the Center for Public Justice but are intended to help advance discussion. Articles, with attribution, may be republished according to our publishing guidelines.”