A Double Dose Of Government Derived Foolishness

Tonight's post will be a two-fer. In this case touching upon mistakes made by the US government in the past that are being repeated again, as well as the Obama Administration's approach to Constitutional law, particularly in regards to contracts and bankruptcies.

As so many of us know, the present financial crisis can be said to have many fathers, most of whom decided that boosting homeownership was a good idea even though it already stood at close to 66% before the housing bubble started to inflate. Between legislation designed to expand lending to those wishing to own their own homes, and the unwise relaxation of lending standards (mostly at the behest of the government and as the results of lawsuits brought by groups that had absolutely no understanding of why lending standards existed), the dream of homeownership for many turned into nightmares. What's ironic is that this isn't the first time such a thing has happened. I have a feeling it won't be the last because we can't seem to get away from the idea that everyone should own their own home.

In December, the New York Times published a 5,100-word article charging that the Bush administration’s housing policies had “stoked” the foreclosure crisis—and thus the financial meltdown. By pushing for lax lending standards, encouraging government enterprises to make mortgages more available, and leaning on private lenders to come up with innovative ways to lend to ever more Americans—using “the mighty muscle of the federal government,” as the president himself put it—Bush had lured millions of people into bad mortgages that they ultimately couldn’t afford, the Times said.

Yet almost everything that the Times accused the Bush administration of doing has been pursued many times by earlier administrations, both Democratic and Republican—and often with calamitous results. The Times’s analysis exemplified our collective amnesia about Washington’s repeated attempts to expand homeownership and the disasters they’ve caused. The ideal of homeownership has become so sacrosanct, it seems, that we never learn from these disasters. Instead, we clean them up and then—as if under some strange compulsion—set in motion the mechanisms of the next housing catastrophe.

And that’s exactly what we’re doing once again. As Washington grapples with the current mortgage crisis, advocates from both parties are already warning the feds not to relax their commitment to expanding homeownership—even if that means reviving the very kinds of programs and institutions that got us into trouble. Not even the worst financial crisis since the Great Depression can cure us of our obsessive housing disorder.

We treat homeownership as if it were some kind of sacred goal. But it isn't. Treating it like it is the end all and be all of our existence has seriously skewed our financial markets and placed a number of families in jeopardy as they lose the homes they couldn't afford to buy in the first place. That brand of madness has got to stop. Unfortunately I doubt we'll learn our lesson this time, either. For sure, the government won't.

Along with the financial mess as a result of the collapse of the housing market, we also have to deal with the presidential shenanigans in regards to the Chrysler bankruptcy. It appears the Obama Administration feels not one bit of guilt or remorse in ignoring the Rule of Law, particularly when it comes to that pesky US Constitution. After all, why should the government bother itself with making sure a bankrupt automaker's bondholders receive their fair share of the assets? Never mind what the Constitution says about contracts (Article V) and bankruptcy (Article I, Section 8). It's just easier to ignore all that and do what is politically expedient.

The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

The absolute priority rule is a linchpin of bankruptcy law. By preserving the substantive property and contract rights of creditors, it ensures that bankruptcy is used primarily as a procedural mechanism for the efficient resolution of financial distress. Chapter 11 promotes economic efficiency by reorganizing viable but financially distressed firms, i.e., firms that are worth more alive than dead.

Violating absolute priority undermines this commitment by introducing questions of redistribution into the process. It enables the rights of senior creditors to be plundered in order to benefit the rights of junior creditors.

Knowing that if something bad should happen they would be stiffed by the government, why would anyone in their right mind invest in any business? You'd have to be a moron to do something like that. But with the precedent the Obama Administration is setting with the Chrysler bankruptcy, they are setting up the very conditions they are supposedly trying so hard to avoid. Investors will shy away, holding on to their cash, and letting the government get away with one of the all time bonehead moves guaranteed to squash economic recovery. They're forcing more people to “go Galt” at a time when the rest of us can least afford it.

Let's see how that will work for Obama.