So, the Dodd bill—great improvement over the Paulson bill, perhaps because as a friend quipped, "that wasn’t a bill, that was an ultimatum. Make me dictator, or the economy gets it." However as it stands the Dodd bill won’t actually bail out the economy or the financial sector.
Why? Well, first of all it’s paying too much for mortgages. 15% off current prices is less than most properties are going to drop. I know folks don’t want to hear that, but a return to trend is more than that. 30% would be a reasonable number, but the proper way to do it is to figure out what housing prices in an area would have been without a bubble and pay slightly less than that, though that’s slightly punitive. But then, why not be slightly punitive? No reason why the government shouldn’t make a bit of a profit on bailing out banks. They already booked their profits and gave them to their executives, after all.
To work, a bill has to establish a reasonable floor for house prices. If it doesn’t 700 billion won’t be enough, there are trillions of dollars of securities based on mortgages out there, and as prices continue to decline, they will go under and have to be bought. Either the government blinks and refuses to borrow and spend trillions to do it, in which case all the 700 billion did is buy a bit of time and bail some CEOs out, or it goes all in and winds up borrowing trillions. Not only does this money go straight to oil inflation and probably general inflation, and crash the dollar, but if it succeeds in holding housing prices higher than they really should be it leaves the US with a cost structure that is too high, and thus not competitive. Ie., expect offshoring to resume, and get ready for that vacuum cleaner to suck your job overseas.
On top of that since every dollar of spare money is being used for nothing but holding up housing prices, there will be no money for business borrowing by real businesses (those that make things), which means there will be no job recovery and no real export recovery. There will also be less and less credit for consumer spending, which will reduce demand (though, what the hell, you won’t have any money anyway.)
The way a housing bubble works is a reversal of the historical norm, along with an overshoot. That’s what the US government should be paying – pay for a mortgage what it would have been worth if there’d never been a bubble, minus about 10%. That’s a fair price when you’re buying what amounts to distressed property and it means you are setting a real floor that allows for a bounce afterwards so that the government gets its money worth and the housing market can operate naturally again without having to be kept on permanent life support at the cost of hundreds of billions of dollars every 6 months to a year. It also goes a long way to making Americans competitive again.
Dodd’s offering too high a price because he wants to dampen the pain; to not take away too much. But this is a tough love situation. If he offers more than properties are worth, he’s perpetuating the problem. The government is stepping in because markets have failed. Its job is to reset markets back to the point where they can work again without being constantly kept on government life support. That means setting real prices.
It also means some other things, like managing oil costs, re-instituting regulation and regulating and insuring pension funds, mutual funds, money market funds in the right way. Dodd’s half way there on some of this stuff, like insuring money market funds, but doing it half right is almost as bad as doing it entirely wrong.
More on that in my next piece. For now – the way the bill determines how much it pays for assets needs to be changed. Badly. Right now this bill is a bailout which won’t actually bail out either the financial industry or the economy. But with a bit of work, it can do both.