Thursday, November 06, 2008


But this writer misses the distinction between the two.
It would be nice to think that if George Bailey had been around in September, the United States government could have saved itself $700 billion, Iceland could have averted near bankruptcy, and the rest of the world could have avoided another trillion dollars in bailouts and the prospect of a deep and long recession.

Here we go. . .
In the film the Building & Loan faces what is now called a “liquidity crisis” — the association could not possibly cover its obligations with available cash, let alone guarantee any loans. The townspeople rush in demanding their life savings. “You’re thinking of this place all wrong,” George tells the crowd. “As if I had the money back in a safe. The money’s not here.”

As the movie clearly states, depositors were supposed to sign a paper and get their money in 90 days. They are holding shares not a savings accounts. This is a crucial distinction that must have been lost on the writer.
You think you are just depositing your money here, he suggests, but actually we’re all helping one another. And if some homeowners can’t meet their payments, “what are you going to do,” George asks, “foreclose on them?”

“We’ve got to stick together,” George says, or the truly evil banker Henry Potter will gain control of everything. “We’ve got to have faith in each other.”

Left out of the passage is the reason for George's speech. Potter will buy their shares for a fraction of the cost in cash and then he'll own the town. George convinces them that it's in their best interest to keep the building and loan out of Potter's hands. The proper analogy would be the government as Potter.
And, at least for a while, the pitch works. George’s view of the savings and loan as a form of social welfare institution was learned at the feet of his father, who built that savings and loan, telling him, “It’s deep in the race for a man to want his own roof and walls and fireplace. And we’re helping him get those things.”

The movie states more than once that George's father was not a great businessman, in fact, he's called a chump because they were building and selling houses for a lot less than they could have. But the Bailey's understood two important things about economics. First, they could get their customers from Potter's slums by making it cheaper for them. The first Condo I ever bought had a mortgage of less than $400 a month while an equivalent rental was going for $575. Second, if the houses were worth more than the sales price, the investors had a built-in equity in case of default. He was a horrible businessman that Bailey, except that his ledger proved he had a tremendous amount of assets over his debt.
The Baileys could almost be early incarnations of Fannie Mae and Freddie Mac — government-created companies established to help make that same dream possible among American citizens. Beginning in the mid-1990s they were steadily pressured by politicians and the public to guarantee loans to ever more risky borrowers in the name of this very ideal.

This is an awkward comparison. You cannot equate Fannie with the Bailey Building & Loan, because Fannie lacks the community component. There is no social pressure to be responsible to Fannie. Fannie is like Potter except that the initial interface has a smile.

And to say they were pressured by politicians is not the right characterization. The government said that they would back the loans and take away Fannie's risk. I don't think any company would have felt pressured in that situation. They were co-conspirators and nothing less. Fannie is Enron without the indictments.
What really helped that project along, though, was the discovery on Wall Street that such risky loans could be bundled with others like some multipack at Costco and resold as highly rated securities. It is as if George had found a way to go into business with Potter, answering his scornful challenge “Are you running a business or a charity ward?” with “Both!”

It becomes a charity ward once you loan money to people who can't pay on houses that aren't worth it. Freddie did. George didn't.

The Bailey's had a found a market of people wanting out of Potter's slums, but it wouldn't have worked except that Peter Bailey knew how to build houses more economically. And they were building houses not just loaning mnoney. Had Freddie and Fannie discovered a way to build houses more cheaply this awkward analogy would have at least a little steam. The government was running a charity ward and Fannie was administrating it.
So debased had judgment become, and so unpredictable were the consequences, that the safest thing to do was absolutely nothing. Liquidity turned solid; credit froze. And this reflected a collapse not just of business activity but also of trust, or, to use George’s word, of faith.

The consequences are easily predictable in hindsight because it is easy to see where common economic sense was disregarded for the greater "social good." The meltdown was the result of intentions over substance. The biggest lesson to take from the meltdown is that we just elected a President who will be pressured again and again to find the greater social good over common sense and fiscal responsibility. It will always be easier for him to side with intentions and our economy will suffer from it.

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