September 30, 2008

Academic Concerns II

In my post of 27 September I discussed the initiative of the American scholars / economists to send a letter to Congress arguing against the proposed bill for the bank bailout. The story appears in an interview to CNN titled “Bankruptcy, not bailout, is the right answer” presenting the motives of one of the signatories for signing the letter. He said the following about the credit meltdown:
“….Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared. This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle…”
I fully agree with the analysis and I respect the colleague's reasoning of not supporting the Bill. However I can’t help wondering again, as in my previous post, why no protest was heard from anyone all these years when the “wholesale abandonment of reasonable lending practices” (I think this is rather mildly put) was actually unfolding. This rather unorthodox process was feeding the insatiable appetite of the American consumer for subprime lending building up enormous debts that “ the government implicitly promised …it would make good…” (using taxpayer money of course).

Why no one raised the red flag when subprime lenders transformed their debt into shaky financial products? An obvious answer is the fact that those bonds were AAA rated by overenthusiastic Rating Agencies. These structured financial by-products were taken out of the accounts of promoting banks which sold them – making a hefty profit – to a great number of institutions and individuals around the globe.

But the party came to an end as soon as the promoting banks and investment houses were forced to “eat their own food” when investors declined to supply their cash in exchange to such “structured” products. This led the world financial system to the results we see around us these days.

While many Americans are allergic to everything sounding “socialist” I would argue that socialist tactics of the Administration lay behind the problem: an overvalued(?) house for everyone, even if most people couldn’t afford it; a situation that did not raise any opposition, unlike the “socialist” tactics to bailout the bankrupt banks. Given the sentiment against anything “socialist” one would expect some kind of action much earlier. Why this did not happen I am not sure. Any explanation is welcome.