MOAB – Mother of All Bailouts
In the midst of Wall Street’s fourth straight troubling day came rumors of a massive Congressional bailout plan to purchase troubled assets from all banks and dispose of them. Rumors of this plan emerged when Democratic Senator Chuck Schumer spoke of it on the Senate floor this afternoon. Suddenly, the Dow skyrocketed 600 points from its daily low to close at 410 points up. Yes, Wall Street liked the Mother of All Bailouts (MOAB).
MOAB will be developed by Congress in conjunction with the Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke. Details at this point are unclear, but a possible model is the Resolution Trust Corporation of the early 1990s, which disposed of assets from hundreds of failing S&Ls and then folded back into FDIC in 1995.
While MOAB will please investors in the short term – it signals willingness of the Federal Government to commit the full US Treasury behind stabilizing the troubled credit markets – the long-term effects are dangerous to say the least.
1. This would be an unprecedented exposure of risk to the taxpayers. Did we decide to make these faulty loans? No. So why should we have to bail these irresponsible banks out? What does this do to the dollar? What is the inflationary impact?
2. Whatever happened to moral hazard? When the Fed let Lehman Brothers fold on Monday, analysts praised Paulson and Bernanke for preventing moral hazard, which is a term that refers to the willingness of governments to bail out investors and shield them from losses due them for poor behavior. Profits are privatized and losses are socialized. It encourages more reckless behavior. It seems now that the government cares little about moral hazard.
3. This “comprehensive” plan is more of a giant band-aid than a proactive mechanism to prevent this from happening in the future. Considering the moral hazard generated by this MOAB, investors in the future will conclude – rightly – that if they form large enough combinations they will be “too big to fail” and so suffer no real risk of bankruptcy. The only way to prevent that is a completely new and rigorous regulatory mechanism, backed by the President and Congress. To put it mildly, we have no such regulatory mechanism or environment in place right now.
4. As Calculated Risk points out, this new MOAB entity may actually “reduce regulatory capital as losses are realized. The opposite of the goal!” After all, these are fully-functioning banks whose assets would be handled, not entire failed banks awaiting full-on liquidation. The problem at hand is a shortage of liquid capital, not just the presence of bad assets.
Do you think the Mother of All Bailouts is a wise move for the Federal Government? Is this the proper use of taxpayer dollars? And what does this say about “free-market capitalism” when its biggest advocate (Bush Administration) goes this far in expanding governmental interference in the market?
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