Tuesday, September 23, 2008

American People Must Stop The Bailout

The current proposal to bail out portions of the banking industry will be a disaster for the American people, and we must act immediately to prevent it from becoming law.

The plan does not do anything to address the structural economic problems we face; in fact, it exacerbates them. It does, however, transfer massive amounts of wealth from taxpayers and savers to those who made poor investment and business decisions, many of whom count themselves among the wealthiest of Americans.

Here are some important things to keep in mind when considering this plan:

1) The absence of an overt tax increase does not mean you are not being taxed. A $700 billion expenditure is a $700 billion tax. We don’t yet know how it will be collected, but it will be collected. Options include direct tax increases in the very near future or an increase in inflation which devalues savings accounts, bonds, money market accounts, social security payments, hourly wages, and salaries. The inflation tax will disproportionately hurt the elderly and those who have little bargaining power with employers.

2) The devaluation of the dollar makes it much more likely that foreign holders of U.S. dollars and dollar-denominated assets will flee the U.S currency. Foreign investors may also pull back on investments in the U.S. economy. Our system is highly dependent on foreign credit and foreign investment and a sudden massive decrease in foreign participation is a much greater risk, with much more dire consequences, than large bank failures.

3) On the subject of bank failures, there is no evidence that the losses of banks will cause economic disaster. Our policy officials and the banking executives have repeatedly claimed that the consequences of inaction would be severe, yet not one has offered any justification for this prediction. Henry Paulson even walked away in silence rather than answer a reporter’s question about this issue.

4) It is a myth that this, or any other bailout plan, will increase the value of homes or stop any declines in home prices. Real home value is a function of the stream of benefits that a home provides. Shelter, storage, family camaraderie, a place to watch TV, a yard for children to play, etc. Market prices fluctuate, but will ultimately settle at points that reflect homeowners and potential buyers’ valuation of these benefits relative to other goods and services. Home prices need to decline in order for the housing market to stabilize.

5) High home prices are bad for almost everybody, yet the political rhetoric used to justify this bailout rests heavily on the desire to prop up housing prices. Subsidizing the housing market makes homes more expensive, not more affordable. Even current homeowners gain little or nothing from appreciation because a home sale usually is coupled with a purchase of a different home. Home price appreciation is not an increase in income. Then, of course, there are property taxes, which increase with the “market value” of a home, making ownership more expensive still.

6) There are well-run banks out there. Most of them are small and mid-sized banks that did not get caught up in outsized risks. When the poorly run banks fail, the well-run banks will rise up to take their place. Of course it will take time to clear out the dead brush, but if we allow bad banks to fail and good banks to survive, the broader economy can only benefit.

This bailout does the opposite. It artificially strengthens the weakest members of our banking system and allows their poor decisions to infect the entire system. The weeds can then choke down the trees and prevent them from growing into a strong stable forest. The allowance for failure is the cornerstone of free market capitalism. If we allow this to go forward, we have no business calling ourselves a free market. Bailouts do not exist in a free market.

7) Government bailouts are not an exception; they are built into the business model of the banking system. An individual bank, under uncertainty, takes actions to maximize its own expected profit. It does not consider the overall expected welfare of society. Believing that government will backstop losses, the bank takes on more risk than is fiscally prudent. This exposes the bank to greater potential profits while exposing taxpayers to more potential losses.

Aggregated over all banks, the outcome is certain. Due to randomness some banks will win, some will lose, but the system is rigged to lose money as a whole. If we bail them out now, we will be bailing them out again. We cannot be fooled by rhetoric that tells us we must stop the bleeding now, then reform the system. The only way to reform the system is to let it sink on its own, and the only opportunity to do that is now.

8) Bailout mania is still in its infancy. Taxpayer exposure to bank losses will spiral out of control. This program will expand well beyond $700 billion. The Fannie Mae / Freddie Mac bailout will balloon from $200 billion to well over 1 trillion. And of course there will be more emergent “crises.” One need only look back at the past year’s worth of comments from Bush, Bernanke, and Paulson to see that they have systematically underestimated the level of losses in the banking industry. In March, we were told that a $29 billion loan to JPMorgan Chase would be the extent of taxpayer exposure.

9) Our politicians have no idea what they are doing. In all honesty, we should not expect them to. They are experts in getting people to vote for them, not in effective economic policy. Most of their policy advisors are experts in getting votes, not effective policy. Barack Obama, John McCain, Chuck Schumer, Barney Frank, John Boehner, and George Bush repeatedly expose their collective ignorance when they speak about this issue. They are very smart people to be sure, but they are not equipped to be reacting to this problem. The same is true for almost all of the Congressional members. They don’t even understand the problem; we should not empower them to solve it.

In a rare moment of clarity, Harry Reid did say that “no one knows what to do.” Unfortunately, he was promptly criticised by other politicians. But Reid is right. Harry Reid, you are the Senate majority leader and neither you nor your colleagues understand this, and you know it. You must fight this proposal and all Americans should stand behind you on the issue.

As noted above, even those who are supposed to be experts, Bernanke and Paulson, have shown a complete lack of competence. They are recklessly throwing our money at a problem they clearly do not understand.

This is an important time for our country and its people. We are in an economic downturn for sure and it is likely to get worse. We have spent years creating economic problems and there will not be an easy fix. Some suffering is inevitable and politicians cannot deliver us from our troubles no matter how well they can speak. But all is not lost. We can learn from mistakes, re-allocate resources and continue with strong economic growth. The human race has endured for a long time and will continue to prosper. This is not a catastrophe and we should not panic.

The problem is that the downturn hit us at the worst possible time – during a presidential election campaign. The reaction is therefore politically motivated and highly inappropriate. But there is another side to that coin. We the people have a unique capacity to veto this course of action. Every member of the House of Representatives can be fired this November, 33 senators can be sent home, and we are not limited to Obama or McCain in the White House. On November 5, 2008 100% of the power will rest with 435 representatives, 100 senators, and one president. Our time to affect policy is now.

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