Bankruptcy

As Treasury Sows, So Shall It Reap

By Elizabeth Warren

Once the Treasury bailed out Bear Stearns with government guarantees, the next buyer of a major US financial institution might expect similar help. Barclay's was the last likely buyer of Lehman Brothers.  Minutes ago, it announced that without the US taxpayers putting their money on the line, Barclay's isn't interested in buying. 

We can debate whether the government should have bailed out Bear Stearns, but surely the current mess tells us one thing we should not have done:  Bail out Bear Stearns and then return to business-as-usual.  So long as the only tool the government seems to have to halt this crisis is a bailout, then we are in trouble.  More bailouts will be needed, and, at some point, even the American taxpayer can't handle it. 

Bailouts will not put a stop to the underlying problem:  we can't find a bottom in the housing market.  Until that happens, the value of financial instruments based on those mortgage obligations will keep falling, and the worldwide market will keep sliding toward collapse.

Worse yet, so long as the government uses bailouts, the financial institutions have an incentive to sit on the sidelines in dealing with homeowners.  There's less reason for them to take their hits for bad mortgage investments if they believe that the government may bail them out. 

What will it take to put a bottom in the housing market? We have a lot of evidence now that the foreclosure approach isn't going to do it, and the voluntary rewrite-the-mortgage approach won't either.  Instead, we need a serious program to write down mortgages to an affordable level, and sort out which families can afford to stay in the homes and which families need to move out.  Whether we do that with a change in the bankruptcy laws or through another program, that is the only way we will find the bottom on the market and get this crisis behind us.

Bailouts--without serious changes designed to deal with the problem that are causing the collapse--won't work. I hope the Treasury and the Federal Reserve won't give in. If they do, they will reap the bitter harvest of an ever-worsening financial crisis.

It is time to plant different seeds.   

Full post as published by Credit Slips on September 14, 2008 (boomark / email).