The media have the country cheering the efforts by Bernanke and the Fed to stabilize the financial markets. They have convinced the public that Wall Street is the home team and that we all will benefit if the banks can be kept solvent and the financial turmoil of recent weeks comes to a halt. That is not true. The main reason that the financial markets are in turmoil is that banks, hedge funds, and other financial institutions hold trillions of dollars in bad debt. Much of this debt is backed by mortgages that exceed the value of the homes against which they were issued, the result of an unprecedented run-up of house prices. What is happening now is that the banks and funds, after being oblivious to risk for the last five years, suddenly noticed that much of the debt they hold is not very creditworthy. They desperately want to dump this debt and exchange it for safer assets. The Wall Street crew wants the Fed to lower interest rates, which will reduce the cost of carrying this debt, and thereby give them more time to find some suckers on whom to dump it. There is no general public interest in having the government assist the Wall Street crew in their efforts to dump their debt on less informed investors. They profited on the upside, they absolutely deserve the losses that stem from their failure to exercise good judgment in their investment decisions. On the other side, the core problem is that house prices have become hugely over-valued. While the rate of home sales is down more than 20 percent from its 2005 peaks, there are still more than 100,000 people buying a home every week. In many cases, these people are buying homes in bubble-inflated markets that may be over-valued by 50 percent or more. Imagine a hypothetical middle income family. Say, a factory worker who is married to a retail clerk. They have a combined income of $50,000 a year. They saved enough for a reasonable downpayment and now want to purchase a $300,000 home in one of the bubble areas. Since the market is currently hugely over-valued, the house price eventually falls back by one-third (in real terms) to $200,000, costing this family $100,000. There are millions of families who look like this. Every week that the housing bubble persists, more of them will make an enormous financial mistake that may impose a serious hardship on them for the rest of their lives. Bernanke and the Fed will not be bailing them out. Middle class families have to live with the consequences of their mistakes. It is not the Fed’s job to protect the financial industry from its own mistakes. As Greenspan and Bernanke said repeatedly in response to questions raised about first the stock bubble and now the housing bubble, the Fed can deal with the consequences of the collapse of financial bubbles. I’m skeptical about how well it will be able to deal with the consequences of the collapse of the housing bubble, but the Fed certainly has no business deliberately propping up financial bubbles so that more informed investors can recover from their mistakes. (In this respect, the Fed’s decision to encourage the use of mortgage backed securities as collateral on loans was completely improper. It should not have been giving its seal of approval to bad debt – I take back my earlier more benign view of this action.) After having largely neglected to report on the growth of the housing bubble over the last five years, the media should start reporting on the losers in this bailout story. If the Fed can give the big Wall Street boys the opportunity to save themselves by unloading bad debt, then it just means that others will be the ones to eventually pay the price. The media should make it clear that bailing out Wall Street is not win-win; it is a win for Wall Street where some sucker down the road takes the hit.
--Dean Baker
