A little wisdom from Norm about the financial bailouts

I have a professor, his name is Norm Nemrow; I watch him on my computer screen to learn Accounting 200. Occasionally I see the man in real life, but it's rare. But when I do, his enthusiasm for accounting is almost overwhelming. He certainly loves what he does, and he knows accounting up and down, backward and forward.

He made his fortune early on and decided he would retire--in his 30s. Then he got bored. He tried a few things, including golfing, but he wanted something to do. So he started teaching at BYU. He's an enjoyable professor and loves to have students ask questions.

I got this e-mail from him today addressing questions that he's received from students about the current financial crisis, and I thought I'd share (Amy, David might be interested in reading this--I'm sure he had at least one class from Norm!).

My Take on the Bailout

Students have been asking my opinion on the bailout and our current “financial crisis.”

Well here is my take. I am not convinced that the bailout will help us avert a serious recession which seems more probable with each passing day. By the way, the ultimate negative impact of a recession is higher unemployment and stagnant salaries and wages. We have already experienced this in some segments of the economy (real estate, construction, the automobile industry and financial services) but not the overall general economy… at least not yet.

The cause of the “financial crisis” has been explained fairly well in the Wall Street Journal but not in the main stream media and certainly not by our political candidates. In my opinion, our country’s economic prosperity over the past 12 years has certainly been built on significant advances in technology and productivity but it has also been built on a tremendous amount of consumer debt and spending. A great portion of that debt and spending was inspired by two significant investment “bubbles.” The first was the internet stock bubble which had its beginnings in about 1997 and created a period amount of illusory wealth which fueled consumer spending and related debt mostly in the form of credit card debt. The bursting of that bubble in 2000 brought with it a slowing economy in 2001. With the effects of 9/11 in 2001 the country faced real economic hardship. In response Congress passed President Bush’s proposed tax cuts and the Federal Reserve lowered interest rates and increased the money supply to spur the economy. This ultimately combined with the relaxation of lending standards at Fannie Mae and Freddie Mac (government sponsored institutions established to buy home mortgages) initially designed to expand home ownership opportunities ignited a real estate bubble. Rapidly rising home prices gave rise to many people borrowing against their newly created “equity” for additional consumerism and in some cases the making of other speculative real estate investments.

Now as the real estate bubble has burst and we are looking at this $700 million bailout in addition to the previous bailouts of Bear Stearns, AIG and Fannie Mae and Freddie Mac totaling an additional $300 + billion, some are asking where has all the money gone? The only answers I have heard from Barack Obama and John McCain and most media pundits is that it has gone into the pockets of greedy people on Wall Street. What a distortion. The fact is most of the money is in the pockets of fellow Americans who were lucky enough to have benefited from the real estate boom. Take for example a person who bought a $200,000 home then borrowed an additional $100,000 on a home equity line of credit when real estate values increased dramatically. They may have then spent that $100,000 on goodies such as a boat, trips to Europe, the payoff of various credit card debts, etc. only to find that when the hard times came and real estate values plummeted they could not stay up with their payments and were forced into foreclosure. The bailout money may now be used to buy that bad home equity loan from the institution/investors now holding it. In that case, who made out with the cash that is now giving rise to this bailout? It was the homeowner. Oh there were some mortgage lender fees, appraisal fees, and other fees paid along the way and when that loan was bundled with other loans and sold as an investment security there were other fees some of which ended up in high paid CEO salaries but to be sure most of the money we’re talking about went into the pocket of the homeowner.

To identify the other the primary beneficiaries of the lost funds now giving rise to the bailout just think of the others who received money on real estate loans that have ultimately or will ultimately go bad, like:
- People (homeowners) who sold their homes at bubble prices to others who simply couldn’t afford the homes they bought (non-qualified buyers with inadequate income).
- People (existing homeowners) who sold their homes at bubble prices to real estate speculators/investors who couldn’t afford them in the downturn.
- Developers, builders, other contractors and construction workers who built homes and then sold them at bubble prices to homeowners who couldn’t afford them (non-qualified buyers with inadequate income).
- Developers, builders, other contractors and construction workers who built homes and then sold them at bubble prices to real estate speculators/investors who couldn’t afford them in the downturn.
- Builders, other contractors and construction workers who built homes during the bubble and were paid through construction loans on homes that then could not be sold during the downturn.
- Etc.


In some cases, as in any investment bubble, there were also some people involved in fraudulent transactions setting up straw men (fake investors) to buy properties at inflated prices in collusion with deceitful appraisers. These embezzlers obtained fraudulent loans that will probably also end up as part of the bailout package. These cases, however, are relatively few and the perpetrators will be subject to criminal prosecution.

My point in all of this is simply to point out that when all is said and done, my belief is that most of the over $1 trillion of these multiple bailouts will have gone to pay for the excessive consumerism and the good fortune of some who were lucky enough to cash in on the “good times” of real estate bubble resulting from relaxed lending standards and the wild real estate speculation prior to 2008, all of which contributed to a growing economy which could not last.

Now my ultimate fear is that the bailout will do little to stem the tide of an economy that seems to be moving toward recession and in exchange we have set a precedent or pattern of practice that will haunt us as a country well into the future. That precedent is the growing role of government in our economy and our lives. There seems to be an inexorable push for more and more government (ie. socialism) and less and less personal responsibility and freedom with each passing day. Ultimately, my greatest fear is that we will end up killing the goose that lays the golden egg… free market capitalism. For me the smartest and wisest voice in all of this has been that of Neil Cavuto, the voice of Fox Business News. Below is what he had to say on October 3, 2008:

Neil Cavuto
Fox Business News
October 3, 2008

“Rescue, rescued.
Dead done.
And by the way, capitalism closed.
The biggest financial rescue in American history is now part of our history.
And so too, the free markets part of that history.
My biggest fear with this bailout here is what we could be losing here.
The freedom to simply fail.
To lose your business because you couldn't run your business.
Now there's a backstop.
The government.
Us.
Think about that.
Get beyond the fears that if we didn't use the government to back up these companies, we wouldn't have these companies, and soon, we wouldn't have lots of other companies.
We'll never know.
Clearly, this much I think we do know.
We never were given the chance to find out.
Never given the opportunity or scary chance to see what happens when market forces take charge of ugly situations.
Sometimes, those situations get uglier.
Selloffs uglier still.
But that's part of who we are and what we are.
They're part of the freedom we have in this country to take on any task and fail at that task too.
When you take away the failure part, you take away the sweet taste of the success part.
But now, I guess, I'm parting hairs...and we are parting cash.
About $800 billion worth of cash.
We're told that will be money well spent.
Me?
Well, I'm just spent.
Worried that the markets we catered to because of a tantrum...we'll cater to yet again when there's another tantrum.
And trust me, there will be.”

Finally, my feeling is that it is possible that we will see a softer recession in the near turn as a result of this bailout, but we will never know that for sure. On the other hand, I am fairly sure, that ultimately, the chickens will come home to roost. At some point in time an economic price will have to be paid for the excesses of the past. However, for us as members of the Church, I am supremely confident that there is safety in the counsel of our leaders. As long as we are faithful and obedient there will always be sufficient for our needs. So……Go forward with faith. Fear not. Study hard. Be excited for the future and optimistic that you might be able to make a difference for good in the lives of others and in the life of our country. I have great faith in you and in us as a people. God bless us and God bless the United States of America and all the nations of the world.