By DAVID MOON, Moon Capital Management,
LLC September 28, 2008
As we learn more details
about a federal mortgage and business bailout package, it becomes clear that the
complicated collection of financial engineering has several
aims.
One of the
obvious goals is to help people and businesses that find themselves in difficult
financial situations.
I received a
note this week that read in part, 'The inability of the government to let a very
large institution suffer the consequences of its acts reminds me of how parents
do not want their kids to get hurt and they try to shield them from their own
choices.'
Perhaps that
sounds like a cruel, uncaring observation. It came from a member of the clergy '
someone who has spent a lifetime in low-profile, selfless service to
others.
When
investors and companies engage in capital-raising activities, they enter into
contracts that are supposed to govern the relationships by specifying the rights
and obligations of the parties. If one party doesn't like what happens, it still
needs to live with the consequences.
The same goes
for policyholders. And annuitants. And counterparties to credit-default swaps.
One of the
goals of this package is to help homeowners in various ways. Since the federal
government now controls Fannie Mae and Freddie Mac, do you really expect those
entities to shrink? Can you think of a single entity (or person, for that
matter) that has gotten smaller under federal control?
An investment
analyst recently speculated that in an attempt to 'help' homeowners and spur the
residential real estate market, Fannie Mae and Freddie Mac might eliminate the
down payment on certain home mortgages.
That's like
treating alcoholism with massive doses of bourbon.
Some of the intended protections for
wounded financial institutions are equally suspect. There are laws against
manipulating stock prices. If I buy or sell stocks with the sole intent
toaffect the movement in a stock price, it is against the law.
But limits and prohibitions on short selling ' which are among the latest
federal rules ' are simply moves aimed at keeping stock prices from declining.
It's reminiscent of Richard Nixon: 'It isn't against the law if the President
does it.'
In the last
couple of years, lenders have discovered that credit ratings are not the best
predictor of whether or not a homeowner will default on his mortgage. The best
predictor is the amount of equity he has in the home. Someone with a significant
amount of his own money at risk will continue to make his payments, even if it
hurts.
If he has
nothing to lose, it's easier for him to walk away. He might actually be less
willing to default on his bass-boat loan.
Psychologists
tell us that the less willing parents are to let their children take instructive
risks and endure the consequences, the less likely it is that the kids will
become responsible adults.
Fortunately,
parents don't depend on children to vote them into office, else every generation
of new young adults would require a bailout of some
sort.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).
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