Yet another excellent article. See yesterday’s piece and the day before’s as well.
Nouriel Roubini | Nov 27, 2007
The letter by Senator Schumer questioning the $51.1 billion that Countrywide borrowed from the Federal Home Loan Bank system (specifically the Federal Home Loan Bank of Atlanta) has finally revealed the little dirty secret – that was known only to a few insiders and was noticed on a blog a month ago – that Countrywide, the largest US mortgage lender, has received a massive stealth public bailout that has put at severe risk taxpayers’ money. Here is Countrywide – the premier poster child financial institution of the reckless and predatory lending practices of the last few years – getting in severe financial trouble because of its rotten lending practice in subprime, near-prime and prime mortgages – and whose CEO Mozilo is under SEC investigation for potentially illegal activities – now receiving a massive $51.1 billion of public bailout money with little official supervision of such lending. Mozilo is under investigation for his accelerated sales of Countrywide stock under a 10b5-1 plan. Mozilo has made more than $100 million on stock sales this year, while Countrywide shares collapsed more than 50%.
As the Schumer letter correctly points out the collateral against this $51 billion loan is mostly toxic waste subprime garbage whose market value is now much lower than the face value of such mortgages; so $51 billion dollar of taxpayers’ money has been put at risk with garbage as collateral for it.
At least Northern Rock – that also received a massive official bailout in the UK – did so under the public scrutiny and serious criticism of such bailout by media, public, politicians and investors. Instead Countrywide – a huge mortgage lender that is most likely insolvent rather than illiquid – received a stealth bailout that only now is emerging to the public eye.
In the case of Northern Rock – another institution that is most likely insolvent rather than illiquid – the botched bailout led to public embarrassment for the Bank of England, the FSA and the UK Treasury. As authoritative analysts – such as Martin Wolf of the FT – have correctly argued, in cases where massive amounts of public money are at stake to bailout a nearly insolvent institution the fair punishment to the shareholders of such bank it to wipe out their equity and a public takeover – yes a nationalization – of the bank; that nationalization should be a temporary action to clean up the mess, get the incompetent and reckless shareholders and managers out, restructure the bank and then sell back to the private sector. Capitalism without punishment for reckless lending breeds moral hazard and pestilence.
As Wolf rightly put it:
If Northern Rock had been taken under public control at the same time, the Bank lending would have been unnecessary. Shareholders would have been wiped out, as was appropriate for an institution needing such a public rescue. The business would then have been sold off, in whole or in part, with any losses imposed on unsecured creditors (including the government). …What is now needed is better and more effective deposit insurance and bankruptcy provisions. If these had existed, Northern Rock would now be in some form of public administration and that is exactly where it should be today.
A fortiori the same public takeover should have been done in the case of Countrywide, the poster child of reckless mortgage lending and of the current mortgage disaster. Instead, rather than kicking out a reckless CEO – whose actions are now under SEC investigation – and putting the lender under public control, Countrywide has been rewarded with $51 billion of public money that was provided in a stealth bailout operation while the current shareholders and incompetent managers are still firmly in charge of the bank.
The right approach would have been – as Martin Wolf suggested for Northern Rock – to take over the bank and put it formally under public control. Instead the US Treasury, the FHFB, the Fed and the banking regulators have been tacit and/or explicit accomplices of the stealth public bailout of most egregious example of reckless and predatory lending, the core institution at the center of a subprime and mortgage disaster that is now taking the entire US economy into a recession.
The lesson of this sad and sleazy episode is that when profits are privatized and losses are socialized we get sleaze capitalism and corporate welfare that becomes public bailout of reckless lenders. All this from a US administration that hypocritically praises every other day the virtues of private markets capitalism. For all of us who do truly believe in free market economies where a variety of public goods are provided by governments and the financial sector is properly supervised and regulate this is not a capitalist system but rather socialism for the rich.
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