How Long Will We Keep Bailing Ourselves Out?

In business circles these days people speak of “the real economy” as contrasted to whatever the hell is happening downtown on Wall Street. Perhaps Wall Street is the name for a virtual or playland economy.

Evidently some kind of convergence of the real economy and the other one occurred recently when it was announced that a frightened group of the nation’s largest banks met in Washington to create a $100 billion safety net to be used to keep funds holding subprime mortgage bonds from tanking. The money, it would appear, will be used to buy the bonds at above open-market prices in hopes that by doing so their value will go back to pre-panic levels.

This is a desperate move. Something like it has been successfully used before when a major hedge fund got itself in trouble and threatened to knock over the financial dominoes Wall Street strives to keep upright and profitable. That occasion, the demise of Long Term Capital Management, was, though huge, small potatoes compared to what the world of excessively high finance is grappling with now.

That is why the Washington meeting was convened by the Treasury Department, and why the Brits are urging their banks to join in the effort. If it should fail, and the price of these various subprime bonds and bond funds collapse for good, the money borrowed to buy them will have to be repaid by selling other securities, thus possibly setting off a landslide. Triggering a rout of such proportions could bring the Wall Street economy and the “real” economy together with a sickening thud. What it might do to the value of millions of people’s 401(k)’s is a conjecture best left for another time.

The number and value of the loans is eye-popping. Between 2004 and 2006, the period when the housing market reached the top of its frenzy, financial institutions issued mortgages whose combined value is or was $1.5 trillion. Last year alone high-rate mortgages—as subprimes are sometimes called—comprised almost 30 percent of all mortgages.

In the coming months $650 billion worth of adjustable rate mortgages will see rates reset drastically upward, and what effect that will have on home buyers, developers and financial institutions is unknown.

When subprime mortgages became a topic of conversation, they were presented to the public as yet one more affliction suffered by low-income minority people. A “them not us” kind of thing that would hurt only those living in trashy little developments that, to the naked eye, are scarcely better than trailer parks.

The Wall Street Journal decided to test this premise and found it does not hold water. The Journal discovered that while “the concentration of high-rate loans is higher in poorer communities, the numbers show that high-rate lending also rose sharply in middle-class and wealthier communities.”

As the mess gets messier, everybody is starting to blame everybody else. At the top of the heap is Robert Rubin, who is getting mud pies and ice balls tossed at him for the first time in his public life. The former treasury secretary is being paid in the vicinity of $30 million per year to be the chairman and resident wise man at Citigroup, which is taking losses in the multibillions for its part in the subprime disaster.

Those mortgage brokers who have not yet gone out of business are being savaged for cheating, deceptive practices and high-hogging it at the expense of simple, honest American Dreamers, although some of them are getting it in the neck for being too stupid or too lazy or too greedy to read what they sign.

As foreclosure rates are reported to be doubling in some parts of the country, what some people might call vultures are moving in. The best publicized is investment banker/shrewd operator John Paulson, who has been shorting securities or bonds backed by high-interest, subprime mortgages. Without going into the mechanics of short sales, the crux of it is that the lower the price of such bonds drops, the more money Mr. Paulson will make.

Short sellers of anything from wheat to stocks are generally disliked and looked upon as close to criminals, although what they do is not against the law. But there is something about making money off of falling prices that drives people nuts. They are being driven even nuttier by Mr. Paulson, who is backing a bill in Congress that would give relief to homeowners faced with a jump in their mortgage payments owing to their interest rates going up.

Mr. Paulson’s bill would modify the recently passed bankruptcy act, which all but wiped out any relief for debtors. If passed over the dead bodies of the banking industry, the modification would give judges the power to lower the mortgage payments of despairing homeowners. It would also knock the stuffings out of the value of real-estate-backed bonds, which would be good for Mr. Paulson but highly ungood for Citi and Robert Rubin.

Passing or not passing the bill will give the legislators a choice of which disaster is worse, allowing defaulting homeowners to be evicted, or letting the bonds drop in value, thereby endangering the retirement savings of yet other millions, not to mention the additional real possibility of the stock market taking a major swoon.

The underlying economic system that has brought us to this pretty pass grows crazier by the year. What they call “growth” depends on people spending money they do not have. The mere mention of the possibility of American consumers cutting back on purchasing sends the stock markets around the globe into a tizzy as predictions of recession are heard.

Thus we must buy, buy, buy or the country will slip into a recession. But if we keep on buying, we are headed for bankruptcy. Unless, of course, that evil hour is postponed by a banker coming along to refinance the loans we are unable to pay with a larger loan we cannot pay.

You may well ask, how long can this go on? It has gone on for a long time and—who knows—we have been wiggling and worming out of these crises for years, so with a little adept bookkeeping and a lot of imagination, the end may not yet be near.

How Long Will We Keep Bailing Ourselves Out?