With the intervention of the Federal Reserve into the Bear Stearns mess, Paul Krugman sees a bigger bailout of our financial system on the horizon.
As Bear goes, so will go the rest of the financial system. And if history is any guide, the coming taxpayer-financed bailout will end up costing a lot of money.
I remember the savings and loan debacle. We were supposed to have learned something at that time that would avoid such things happening again. Instead, motivated by – what else? – greed, we find ourselves about to spend taxpayer dollars to do it again.
I guess the free market works as long as government is there to bail it out when it doesn’t.
VIVIAN J. PAIGE | All Politics is Local 
Nope, the free market works when the government does not intervene. Sometimes Adam Smith’s “invisible hand of the market” needs to give some folks a good slap up side the head. That means letting investors who do foolish, greedy things suffer the consequences of their actions.
Bears’ stockholders did get punished, getting only $2 per share when Morgan bought them out (with a gov’t guarantee that they wouldn’t get hurt) Without the guarantee, Morgan would still have bought Bear, but probably at an even lower share price, which is what should have happened.
BTW, the Savings and Loan debacle was not caused by greed in the financial industry, it was caused by Jimmy Carter’s interference in the natural gas market. It just took a while for those chickens to come home to roost.
I am a free market advocate, but. The but is due to the strange contrivances we impose upon the free market. The banking industry is a good example. A bank is an arbitrary invention. Think about the fact that a bank takes our money then invests it. At same, we naively expect ALL of it to be there when we go back for it. If EVERYBODY goes back at the same time…
Hence, we have government interference to prevent the inevitable crisis in confidence that will inevitably occur when people get overconfident and too greedy.
Don – would you mind explaining how Carter’s interference in the gas market caused the S&L crisis? I must be missing the connection.
I agree with TB…please explain the connection between Carter, the gas market and the S&L crisis…your references/links would be helpful.
I am furious that the perpetrators of the current home foreclosure are being rewarded with a bail out. No discussion, no nothing. Who gave the FEDS the power to USE my taxes at their discretion. I’ve already contacted my congressional representatives and asked them to close that loophole and fast.
IF it is absolutely necessary to give some funding to the banks than the executives responsible should have to resign first AND GIVE UP THEIR GOLDEN PARACHUTES so that money can also be used to help finance the bank’s restructuring.
Personally I would prefer the money go to the victims not the perpetrators and all the folks who got greedy and created this mess by pushing for deregulation so they could make these shady deals should go down in the rubble heap. I don’t want to bail out these greedy risktakers.
buzz…buzz…
Truth be told, a little pre-emptive market intervention–not in the form of bailouts, but in the form of regulation–could probably have been helpful. Someone should have come along and said, “you know what, wait. Maybe flooding the housing market with apparently-free money financed by subprime loans with adjustable rates is actually a recipe for disaster.”
The simple fact is this market was going to fail, it’s just a matter of when and how much. Things are worse now than they had to be because we kept delaying the inevitable and exascerbating the problem by fiddling, but even if we’d let the free market do its thing, we’d be sitting here wondering how many of us are going to lose our jobs. At some point someone should have exercised the leadership necessary to say to lenders, hey, quit being stupid, you’re about to ruin a good thing for the rest of us.
The problem is the bailout. Risk loses its value if Uncle Sam will step in should the situation be sufficiently dire.
The Original Savings and Loan Scandal was said to have been the result of “under-capitalized loans” by a number of savings and loans in Colorado, Texas, OK and LA. But unlike the current fiasco, those loans were not under-capitalized when they were made, in fact, it was the opposite of the overvaluing problem we have now. My home in LA was one of them.
An $80K loan on a $100K house is a good loan, but if the price of that home falls to $50K, it is all-of-a-sudden an under-capitalized loan. If millions of homes in a restricted geographical area lose half their value in less than a year, and the homeowners lose their jobs and walk away from those homes, leaving the S&Ls with hundreds of thousands of repossessed homes and no buyers at any price, and you have an S&L scandal. So, how does that happen?
In the late 70’s there was a shortage of natural gas for heating homes in the Northeast during an unusually cold winter. Carter decided to fix that with the Fuel Use Act which forbid using natural gas as boiler fuel for generating electricity or steam for industrial processes, thinking that by not allowing NG to be “wasted” for commercial purposes, it would become available for home heating in the Northeast. Only the reason for the shortage in the NE was not lack of supply, it was the Federally controlled price of NG which was too low to support building the pipeline capacity to bring it up.
The result was that the industry in the ‘oil patch states’ that relied on natural gas as a cheap fuel was destroyed and the profitability of drilling for oil was greatly diminished. Oil and natural gas are usually found together and in many formations, you can’t produce the oil without also producing the gas. With no place to sell the gas, as it was forbidden for boiler fuel where it was available and still was priced too low to build pipelines, those fields were just closed. Still, with oil at $40 a barrel, up from $17 a few years before, the industry limped on. Then, in the eighties, Reagan broke OPEC and the price of oil fell back to $18. Congress still wouldn’t deregulate NG for a few more years, so with the oil price down and NG still unprofitable by law, the domestic petroleum industry collapsed.
That’s why I live in VA now instead of LA. My home town went from 18K pop. to 12K in a year as people left looking for work since unemployment in the oil patch was 40%. The banks owned 1/3 of the real estate in town and there were no buyers. My $110K home sold for $41K after 2 years on the market. I took the loss because I had it mostly paid for, but most people just walked away from their mortgages.
That’s what caused the S&L scandal. Carter’s interference destroyed the domestic petroleum industry, which caused a mass migration from those areas that were dependent on oil exploration, crashing the housing market in those areas at a time when it was booming everywhere else. From outside those areas, it may have looked like the S&L’s were making bad loans, but in reality, they were good loans to good people who were just destroyed by a localized depression caused by a meddling fool with no understanding of economics.
Oh, now I remember. I think Ashton Kutcher made a movie about it.
Brian, for pete’s sake, that was so stupid I had to put my hand to my ear and see if blood was squirting out.
If you’re in the middle of the ocean, and you’re constantly bailing water out of your boat, the problem isn’t the energy you’re wasting bailing–the problem is that you’re sinking. Likewise if you think the problem was JP Morgan’s fed-backed bailout of Bear Stearns because it takes the flavor out of risk, you’re ignoring the larger question of why a bailout was necessary in the first place.
Seems like I remember the S and L crisis as including commercial properties, and a good deal of raw land as well. I lived in Denver, where the failed Silverado Savings and Loan went under to the tune of about $1b.
Bill Walters, who later would give everything to his wife to avoid bankruptcy, had 20-30 buildings at least that were empty and no market with which to fill them. There were hundreds of empty buildings (some in the Denver Tech Center). Silverado (thanks Neil Bush!) was only one of a group of S&L’s that went under. John McCain was involved and was one of the ‘Keating Five’.
It rocked Denver pretty severely. On top of years of bust in the boom and bust cycle (mostly due to oil this time), they could ill afford a huge inventory of buildings that would sit empty for years.
When you use the term “bail out,” keep in mind who got bailed out. The people who got “bailed out” did not own Bear Stearns. The people using Bear Stearns as an investment bank got bailed out. Bear Stearns’ stockholders lost almost all the value of their investments. The “value” of risk has been preserved.
anon,
How about thinking before you post – is that so much to ask?
I am ignoring nothing. I’m saying that if the government eliminates risk from the financial world, then we are going to see more stupid actions and then the expectation that the taxpayers will foot the bil for them.
Read that over slowly a couple times and even you might understand it.
Oh noes! Your so right! The biggerer concern’s got to be the psychology of serious investors who purposefully bet against the market in order to lose money because obviously there are tons of those people out there. Whatever will we do?
Oh wait. No, it turns out the fact that one out of 557 homes was in foreclosure last month and unemployment is climbing over 5% is still the bigger problem in America today. Haha, whew, that was close, I thought we were going to face a serious crisis of investor psychology. Thank goodness it’s mundane stuff like stagflation, foreclosure, runaway debt and unemployment that we have to deal with, because how much beta a Wall Street investor is willing to keep in his porfolio is some pretty scary stuff.
Will Rogers warned us that you can’t cheat an honest man. I would add that the marketplace does not injure an informed, honest man either.
Everyone who will be hurt by the shakeout of the financial meltdown has, at some point, sought to gain at the expense of others through deception or willful ignorance.
That includes the homeowner who borrowed against fantasy equity to buy luxuries or to finance risky investments, the home buyer who took an ARM on a house he knew was beyond his means at normal interest rates, the loan company that arraigned the loans and resold them to investment houses knowing that when rates went up, the buyer would default, and the investment houses who sought high returns from those buyers by trapping them in an ARM with no upper limits. Everyone of them has earned the hardship they will endure.
That includes me, BTW, I failed to do due diligence when my financial adviser recommend a real estate trust because of its high yields during the housing boom and I have lost several thousand dollars of my investment because I did not check to see how heavily that trust was into speculative investments. Serves me right for being lazy.
But it is only when government intervenes that honest taxpayers and others who did not create the problem are injured.
I’ll take my lumps for being an overly trusting investor, but I object to my taxes bailing out the truly dishonest and greedy manipulators of the banking system.
“That’s what caused the S&L scandal. Carter’s interference destroyed the domestic petroleum industry”
Don – thank you for explaining your point.
However, you’ve provided an oversimplified, inaccurate version of history. For one thing financial crises are never cause by one single event. To say that Carter’s policy and the fallout in the petro industry caused the S&L scandal is misleading. With respect to the destruction of the oil industry – OPEC’s oil embargo against the U.S. caused the initial shortage…. not one, unusually cold winter.
Further, the glut in the oil industry, while it certainly devastated real estate markets in “oil patch states” was not the sole cause of the S&L crisis either, as you imply. If this were possible why didn’t the nation experience financial crises when real estate markets in Michigan suffered the loss of auto manufacturing jobs or when real estate in SC bottomed out after the loss of textile mills? Because you’ve overlooked the key elements that drove a national S&L crisis: (1) the deregulation (in the 80’s) of the S&L industry (2) the Fed’s effort to reduce inflation by raising short-term interest rates ….at a time when most of S&L’s asset holdings included low, fixed-rate mortgages, (3) the junk bond offerings of Milken and friends, and (4) the investment of oil profits earned by OPEC during the oil crisis that were invested in dollar-denominated assets held outside U.S. banks.
Looking at the entire economic and financial environment leading up to both crises, I have to agree with Vivian’s original post – “We were supposed to have learned something at that time that would avoid such things happening again.”
By the way, Adam Smith believed the banking industry to be an exception to free-market principles.