Bailout or Cop Out?

I was a college student in Boston in the late 60’s when I first heard the term red lining. It referred to the long standing banking practice of identifying certain neighborhoods with a proven history of loan and mortgage defaults. Not surprisingly these were areas with high concentrations of low income people, many of them minorities. Liberal democrats on Beacon Hill saw this as a political opportunity and began railing against this alleged discrimination.
The local bank presidents, who were summoned before various state panels investigating this “outrage”, meekly testified they were in the business of loaning money to people likely to pay them back…nothing personal, just sound business practice. You’d have thought these guys were testifying in 300 thread count Pratesi’s and pointy hats judging by the liberal’s reaction.
The critics of red lining were mostly black activists and rabble rousers along with liberal democrats like then State Representative Barney Frank. Along the way legislation eventually forced most banks to extend credit to less than credit worthy applicants. The creation of Fannie Mae and Freddie Mac completed the circle by allowing even more deadbeats into the mortgage pool.
Red lining eventually became a dirty word and the battle cry became “affordable housing” for all. Liberal democrats told the poor they were entitled to a house regardless of their ability to service a loan. More regulations made it tougher and tougher to foreclose on delinquent loans. Eventually many of these people simply walked away from these properties.
Now we have whole inner city neighborhoods looking like post war Dresden. Properties bought with funny money are now in foreclosure and taxpayers are being told they have to write out a check to clear up the tab. It turns out the bank presidents were right. If you can’t afford the mortgage, we shouldn’t be obliged to give it to you.
So here we are forty years later with the stock market around your ankles and the credit market seized up like a ’54 Chevy. The same genius’s (hello Barney) who brought you this debacle have now concluded a check for 700 billion will do the trick. The government buys the bad paper from the failing financial institutions thereby injecting much needed liquidity into the system. This is like putting a few towels on the floor as your bath tub overflows and going back downstairs to watch a football game. It’s probably not going to work. The days of the mighty United States waving its hand and making things go away are over.
Like our recent penchant for pain free wars and interventions, Americans refuse to accept any real pain or sacrifice as a consequence of their actions. Many, many Americans fed at the trough of easy money until the music stopped. Americans would still be at it if housing supply hadn’t overwhelmed demand so spare me the whining. In the financial world we will shortly be returning to, people and institutions will be going old school.
For all the demagoguery about Wall Street fat cats and golden parachutes, the real villains here were the predatory lenders emboldened by lax government regulation and the people who tried to game the system by taking out loans they knew they couldn’t afford. We will now enter a period of financial due diligence and red lining will be back…until the next time and there will be a next time. There always is.