Bankers pay for their greed

October 9, 2008 — by Uttara Sivaram

Some bankers are generous to a vault.

We can’t help but see a grain of truth under the humor. A year ago, banks across the nation were trading deposits and dishing out cash to anyone stepping into their air-conditioned offices. Although many of these lucky beneficiaries dragged behind them a history of irresponsible spending and laundry lists of unpaid loans, the banks told them that as long as they used the loaned money to buy or invest in a house, everything would be fine.

Any doubts the credit agencies should have had disappeared the collective reasoning that loans could be paid off by foreclosing on houses that rose in value every year. This house of cards soon collapsed. As soon as that small dip in the line graph was spotted, investors went crazy, attempting to sell houses far below their previous market value in order to rid themselves of dangerous investments. The numbers added up, and soon red ink and pink slips were becoming the latest trend in Wall Street. The only ones who remained were stubborn optimists who continued to believe in a failing economy.

Our current economic crisis is similar to the one from nearly a century ago—The Great Depression. And in order to skirt around that kind of inconvenience, the government brainstormed their idea of a quick fix: the Emergency Economic Stabilization Act of 2008, fondly nicknamed the “Bailout Bill.” This Congress-approved bill entails the purchase of high-risk MBS (Mortgage Backed Securities) loans by the U.S. government.

MBS’s are actually home mortgages bundled, sliced and diced together into unrecognizable entities, whose value is nebulous and whose risk was largely ignored. They had been snapped up by investment banks and hedge funds during the housing bubble, and fueled rampant speculation. Today, such MBS’s are selling at bargain basement prices because of the jittery state of the market. The government proposes to take the weight off the now-shamefaced investment banks by buying MBS’s through reverse auctions.

It is unfair to bail out these institutions after the countless number of subprime loans they bought. Legislations should not have to take upon themselves the role of fixing Wall Street’s feckless blunders by throwing taxpayers’ money at the problem. National finances will continue to nose-dive, but we should let the investment banks find a timely solution to this problem instead of waving fists at the government to pass a myopic bill.

Economist Robert Shimer argues that MBS-holders are unduly empowered by this bill since they will inevitably sell off their holdings at inflated prices. The government is hoping to get the lowest deal they can for these useless and risky securities and ensure that the value of the mortgages will no longer fluctuate under government control. The debtors want to sell their MBS’s to the government at the highest price they can manage. Both sides face an infuriatingly tricky set of conflict of interests.

The Bailout Bill is effectively eroding the independence of the U.S. government and giving Wall Street a sweet deal to rebuild themselves and their finances. If the government is willing to bail out the agencies that acted so irresponsibly, there is no guarantee that such behavior will not be repeated. If this crisis is to be solved, it should be solved in a manner that eliminates the problem instead of cutting corners just to finish the job quickly.

The United States government should not become the babysitter of these infantile financial institutions that have created, but refuse to solve their own problems. Credit agencies and investment banks must undertake serious reforms when it comes to high-risk loans so that the government and tax payer are not left with the sticky job of cleaning up Wall Street’s sorry mess.

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