Point of no return

A sorry consensus is emerging among many critics of the Fannie and Freddie bailout: It's unfortunate, it's unfair, but it has to be done.  We're at a point of no return.

Take Gretchen Morgenson, writing in the New York Times:

Borrowers who are in trouble on their mortgages have seen their government move slowly — or not all — to help them. But banks and the executives who ran them are quickly deemed worthy of taxpayer bailouts.

But, it has to be done:

To be sure, bailouts are becoming increasingly necessary in our highly leveraged, interconnected financial world. One obvious reason that huge companies are not allowed to fail is that so many people are hurt by such debacles. If a family files for bankruptcy or loses a home, the pain still hurts, but its emotional and financial ripples are confined.

Bill Greider, writing in The Nation:

The Bush crowd, always so reluctant to support federal aid for mere people, stepped up to the challenge and did as it was told. Treasury Secretary Paulson (ex-Goldman Sachs) and his sidekick, Federal Reserve Chairman Ben Bernanke, announced their bailout plan on Sunday to prevent another disastrous selloff on Monday when markets opened.

But, it has to be done.  Actually, his own twist on the idea is to nationalize Fannie and Freddie, but the rationale remains the same.  (Emphasis below is mine):

The private shareholders "are walking dead men, muerto," Institutional Risk Analytics, a private banking monitor, observed. Make them eat their losses, the sooner the better. The real national concern should be focused on the major creditors who lend to Fannie Mae and other US agencies as well as private financial firms. They include China, Japan and other foreign central banks. Foreign investors hold about 21 percent of the long-term debt paper issued by US government agencies–$376 billion in China, $229 billion in Japan.

It is not in our national interest to burn these nations with heavy losses. On the contrary, we need to sustain their good regard because they can help us recover by bailing out the US economy with more lending. If these foreign creditors turn away and stop their lending now, the US economy is toast and won't soon recover.

Why, if it is morally unacceptable for a U.S. banking firm to "help" an individual in debt (say, a bunch of credit cards) by putting him or her in even more debt (say, a consolidation loan), is it somehow a moral imperative for the Chinese and Japanese to put the American nation in even more debt?

The fundamental misunderstanding about what's at stake is captured perfectly later on in Morgenson's column:

HERE is a question: Might not the routs, which inevitably follow the manias, be less painful if things were not allowed to get wild and crazy on the upside? Might not the American people be better off with regulators who curb market enthusiasm — whether in the form of errant lending or voracious, ill-considered deal making — when it reaches manic levels, to protect against the free fall, and the bailouts, that ensue?

No, no, no — perish the thought, especially when the taxpayer is there to pick up the bill.

But if the promise of the bailouts wasn't there in the first place, the financial sector wouldn't be taking the risks and the regulation would be unnecessary.  For more than two decades now — going back to some bad risks U.S. banks took in Latin America, plus the Continental Illinois rescue — the U.S. Treasury and the Federal Reserve have had a systematic policy of bailing out whatever part of the financial system got into trouble.  It's that promise that encourages the risk, which encourages the manias, which brings on the routs and the bailouts.  But that's more than most of the bailout critics can wrap their minds around. 

So they reconcile themselves to the bailouts anyway, because, well, everything would fly apart if it weren't done, and never mind the inflationary consequences of monetizing all this bad debt — which will be overwhelming.