As an investor and citizen, I have been following with increasing concern the shenanigans in the financial market. First it was the huge problem with greedy banks and an overextended Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) that had underwritten loans to more and more risky borrowers, gambling that the upside of high-interest-rate loans would offset the tremendous risk of default.
In retrospect, that was a sucker's bet and no surprise that we're seeing financial institutions failing because of their inability to conservatively balance and manage their portfolio.
The demise of Lehman Brothers (NYSE: LEH), fire sale of Merrill Lynch (NYSE: MER) and probable demise of American International Group (NYSE: AIG), sidestepped by a massive government bailout, show another facet of the same greed and poor business strategy.
There are a number of problems that got us here, but one big issue is the lack of regulation: strong Federal regulation would have tempered the unbounded greed of these institutions and helped avoid the troubles we now face. But a part of me says that the trouble is really because we're afraid to have a truly free-market economy based on pure capitalism.
I know, you're probably saying "we've never had pure, free-market capitalism in the United States" and I concur. Between tariffs, export controls, market regulation, business practice laws and the RICO laws, there have always been a lot of ropes fettering business practices in this country.
That's a good thing, even though I recall reading books in business school that argued quite vociferously that unfettered capitalism was the only path to world economic stability and, ultimately, world peace. I never bought it, however, because it's predicated on all countries allowing free access to their markets (though some economists have projections of how a free market trumps constrained markets in a global economy. It's just never been borne out).
We all do better and have a better standard of living and more "contentment points" in a strong, healthy, growing economy, so controls and regulations that help us move in that direction are obviously and de facto a good thing. Let's face it, as much as the late 90's might have been the "dot com bubble", it was also a very good time to be in business and I know I enjoyed the largess of the marketplace.
Which is why I find it so interesting that when I read the WSJ headline that Feds Plan $85 Billion Rescue Deal for AIG [sub required] or the Bloomberg report that the government is considering an AIG conservatorship plan, I dislike the notion and feel that if we really were a free market capitalist economy, we'd let the companies fail, knowing that new ones will spring up to replace them, stronger, smarter companies that will avoid these poor management decisions.
Fannie Mae and Freddie Mac were bailed out by the government. So was Chrysler, years ago, in a quite hotly debated rescue from mismanagement, Lee Iacocca's hubris, and poor strategic planning. But Enron wasn't bailed out and the Enron investors were left to their own personal financial nightmares.
The rule seems to be that if it's a big enough company or enough people are adversely impacted then the never-empty wallet of the Federal government opens up and billions of taxpayer dollars are allocated to alleviate the impending crisis.
One place we can perhaps assign blame is with President Ronald Reagan, actually. He was the first to have such a deep faith in the free market and a general mistrust of government and federal controls that he restructured the market. We've been in that financially conservative place ever since. Heck, it was President Bill Clinton who signed the Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act), which removed the walls separating banks, securities firms and insurers. Not good.
Since then both Clinton and Bush aggressively promoted home ownership, even for homeowners who couldn't afford it. The magic solution? adjustable rate mortgages that had a low interest rate when the prime rate was low, but could rapidly grow to create unmanageable mortgage payments as the rate went up. Now those high risk subprime loans back almost 40% of private-sector mortgage bonds and that's the root of the financial problem we now face.
Back to the central dilemma, though: should we bail out AIG or not? Should our hard earned dollars paid to the government as taxes be used to prevent these massive corporations from facing the dire consequences of their stupid, myopic actions?
I have to say that, yes, I think that we should. Or at least, we should have some sort of program that helps out those most affected by the demise of these companies. When mortgage holders find that their adjustable rate mortgages prove a nightmare because the rates have gone up, that's one issue, but when a large corporation actively and aggressively markets to these subprime borrowers without fear of consequence, that's very, very bad for the market.
The consequences are what we're feeling today, with a dramatic drop in the financial market, the bankruptcy of Lehman, Federal bailout of AIG, and more to come as the ripples affect other markets and industries. Bailout because too many regular Joes are affected by these failures, but for goodness sake, tighten regulations and fix things so that we can prevent this happening again in the future!