During his questioning of Ben Bernanke on 9/24/08, Ron Paul's diatribe was all over the place (as is his style), but by the end he had hit on the key points in one of the most lucid and candid assessments of the predicament:
1) The so-called "toxic assets" that the investment banks are trying to dispose of are only "illiquid" because the holders of this paper do not want to mark them to their market value. Instead of auctioning some of this this paper to the market in order to seek true price discovery, the banks want to place reverse bids to the Treasury Dept., essentially telling Treasury what price they will accept for the paper, which the Treasury Dept. is obligated to pay, until the $700B is gone, or until more money is authorized. When the buyer must accept the seller's price and must execute the transaction, it becomes a form of price fixing which elevates the price above the intrinsic value. Not to mention that this is a government transfer payment (read: welfare payment) equal to the difference between the "market price" and the price paid. Only if the assets appreciate over a reasonable period of time will the government be made whole, but if this expectation were rational, there would be a liquid market for mortgage-backed paper. The government tried price fixing in the 1930's, as Ron Paul astutely pointed out, which deepened and prolonged the Great Depression.
2) The heart of the problem is that home prices went up too far too fast, and now they have to come down, which is depressing the value of mortgage-backed paper and derivatives thereof. If problem is one of home price inflation the government, by essentially putting a floor under mortgage-backed paper, is fighting inflation with more inflation, which is a lot like pouring gasoline on a fire (to be fair, they are fighting the deflation in the debt instruments linked to property values). The point that I think Ron Paul was getting at is that the issue is less one of illiquid assets and more so one of fundamental solvency: a number of the investment banks cannot remain solvent if their assets are priced correctly. By inflating the value of mortgage-backed paper, you are simply allowing the taxpayer to stop a bullet that was meant for the investment banks. It does nothing to solve the underlying problem, which is that the asset backing the debt is deflating, and must continue to deflate, to reach equilibrium with rents and personal income.
3) The credit markets have "seized" because, as occurred in 1920's, credit was grossly (some might say insanely) over-extended for many years with poor underwriting standards and little oversight. Less-so than the credit markets having "seized" is that borrowers are fundamentally over-extended, and cannot handle any more credit. When the economy was growing robustly, and home prices were marking double-digit annual price gains, it may have seemed like a reasonable bet to issue mortgages to individuals of limited means, at least if you were willing to extrapolate those home price gains off into eternity, or if you have the opportunity to bundle all these loans together (making it difficult to judge their risk) and let the Wall Street banks sell them to pension funds. However, trees don't grow to the sky, and home prices had to fall to come back into line with rents and personal income (neither of which were growing nearly as fast as home prices). The home loans that were issued near the peak, especially variable-rate mortgages that kept the early payments affordable, are at the center of this storm, and are the loans that the investment banks want the government to take off their hands.
So, kudos to Ron Paul for shining a bright light on the faults of the government bail-out plan.
Christian Antalics
P.S.
For a comic yet surprisingly erudite interpretation of the Paulson Plan, check with the fictional character, Paul Bernankson.
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