Audacity to Do Nothing

The Audacity of Doing Nothing
02/11/09 - Blogs.Law.Harvard.edu by Philip Greenspun
(via Peter G. Klein)

Our prosperous society is built on predictible law and consequences. This is already a shining accomplishment in an uncertain world. It does no good to, in effect, suspend the law and take extraordinary actions because some people made bad bets, lost money, and have political influence. Changing the rules and using naked government power makes things much worse. It removes predictability and rewards the people who took outrageous risks.

See also Rewarding Bank Management for Failure

[edited] The "real money" investors didn't want to invest alongside the government. If the bank loses money, they fear the government will take 100% of the value left in the bank and leave private investors with nothing, including recent ones. This happened to recent investors in Fannie Mae.

The "real money" investors didn't want judges to modify contracts, as when bankruptcy judges reset mortgage payments at a lower level and reduce the principal owed. A central tenet of the U.S. Constitution is that people are free to make contracts.

A foreclosure is greatly preferable to these folks than a modification. In a foreclosure, the most senior investors get what they expected, their money back. The holders of the most junior tranches [last to be paid], which carried a higher return and were known to be high risk, would get nothing. This is also what they expected. If mortgages are modified by government action, it is unclear how the obligations among the various private parties should be adjusted.

One money manager scoffed at the idea that the markets had failed. "The markets are working fine, but they're giving people answers that they don't like, so people cry market failure." Stocks and bonds low? That's because investors are afraid of a prolonged depression and continued government interference.

A house in a jobless region of Michigan is worth almost nothing. A place with 50% of its former jobs only needs 50% of its houses.

The government is a lot bigger and more powerful now than in prior recessions. Rich companies and people can put some of their wealth into lobbying. They demand that the government prevent them from getting wiped out or at least slow the process.