I spent a few days recently in the company of some money managers with a total of about $2 trillion to invest, precisely the sort of folks whose confidence the government is currently trying to win. How did they feel about all of the rule and policy changes coming out of Washington and the new more muscular government? Terrified.
The “real money” investors didn’t want to invest alongside the government. Their concern is that if things go south, the government will take 100% of the value left in the bank or whatever and leave private investors, including recent ones, with nothing. This is precisely what happened to recent investors in Fannie Mae.
The “real money” investors didn’t want to see judges modifying contracts, e.g., bankruptcy judges resetting mortgage payments at a lower level and reducing the principal owed. As far as they were concerned, a central tenet of the U.S. Constitution is that people are free to make contracts. Given how mortgages are split up among investors, a foreclosure is greatly preferable to these folks than a modification. In a foreclosure the most senior investors get what they expected, i.e., their money back. The holders of the most junior tranches, which carried a higher return and were known to be high risk, would get nothing. This is also what they would have expected. If mortgages are modified by government action, however, it is unclear how the obligations among the various private parties should be adjusted.
The punch line:
Much of the justification for government intervention comes from the assertion that markets have failed. One money manager scoffed at this idea. “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. House in a jobless region of Michigan worth almost nothing? A place with 50% of its former jobs only needs 50% of its houses. There are plenty of former steel towns where the price of a comfortable house stabilized at $20,000 decades ago and has barely moved since.
What did these guys want the government to do? Nothing, basically. “Back in the 19th Century, there were a lot of steep crashes, guys got wiped out, and the economy came back quickly.” What’s different now? The government is a lot bigger and more powerful. Rich companies and people can put some of their wealth into lobbying and demand that the government prevent them from getting wiped out (or at least slow the process).