TJP

Bailing out Wall Street Fat Cats will not solve the Credit Crunch

By Byron A. Ellis-September 24, 2008

Last week, the Treasury Department offered government insurance to money market funds and the Security and Exchange Commission banned short-selling of financial stocks. Apparently neither agency put a lot of thought in their actions. As a result, they had to rapidly backtrack.

The unintended consequences of insuring the money market funds would cause funds to flow from low interest bank funds to higher interest money market funds. Likewise, the SEC amended its band on short selling (betting that the stock will loose value), since curtailing short selling should only occur when publicly traded firms are a particular crisis, such as a mind disaster.

The Treasury and the SEC are the same agencies poised to engineer the Bush administration bailout that they claim have to occur before Friday, September 26, 2008. The speed and lack of transparency of the bailout is the administration’s version of financial shock and awe. 

Shock and awe during the Iraq invasion, however, was a mirage. And, like the Iraq war, to date the administration has given the public no good reason for a taxpayer-funded bailout. All they are telling the public is that if a bailout does not occur quickly the economy will collapse because of the mortgage crisis. But, what is the mortgage crisis?

They failed to tell the taxpayers the percentage of mortgages in default. Hence, the public has no real information to validate or invalidate the government assessment of the so-called mortgage crisis.

According to the Federal Reserve (Fed), mortgage debt outstanding for all holders in the first quarter of 2007 was $13,549,040,000,000 and for “1 to four family residences” was $10,426,630,000,000, or 77 percent of all mortgages. The table below documents outstanding mortgage debt between 2003 and 2007.

Source Federal Reserve (June 2007)

Sub prime mortgages are blamed for the mortgage crisis. However, the Fed indicated that of the 3.3 million active sub prime loans in 2007, 3 million loans were owner occupied with and average outstanding loan balance of $180,000, or a total amount of outstanding residential sub prime loans of $540,000,000,000. Thus, sub prime loans are about 5 percent of residential loans, and not all are in default.

The implausible argument is that less than 5 percent of residential sub prime loans caused a credit crisis. From the above, it appears that the cause of the crisis cannot be sub prime mortgages.

The more likely culprit is high-energy prices that decrease consumers’ disposable income and transfer payments energy payments to foreigners. However, to acknowledge that the root cause of the crisis is high energy prices would reignite analysis on the consequences of the Iraq invasion. The invasion created uncertainties in crude oil supplies, which cause speculators to bid up crude oil prices.

Failure to properly diagnose the root cause of the crisis has led to improper remedies, such as ineffective fiscal and monetary responses; and now the bailout scheme. The bailout like all previous remedies will not affect the price of crude oil. Thus, bailing out Wall Street “fat cats,” is unlikely to solve the credit crunch, except if the price of crude oil recedes below $75 per barrel.

The solution to the credit crunch is Middle East stability, which would reduce speculation and stabilize the crude oil market.

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