Bailouts hit close to horne

By Gary Zauner Crow's Weekly Market Report

Opinion aside, studies show that "politically connected" firms are more likely to be bailed out than "non-politically connected" firms. One comprehensive study of 450 firms in 35 countries found that those firms linked more closely to political engines "exhibit significantly worse financial performance than their non-connected peers at the time of a bailout and over the following two years."

1f\NE of the great debates that \-f appear during difficult economic times, when institutions that steer economies experience fiscal difficulties, is whether government bailouts are appropriate or necessary.

This argument hits closer to home now that a string of bailouts and potential bailouts has sprouted from highly questionable mortgage lending practices and their influence on a vulnerable U.S. economy. While the government tries to save lending institutions from their own irresponsible behavior and demise, homeowners may also receive relief for agreeing to questionable mortgages that could very well be described as "too good to be true."

For many, the question of whether bailouts are appropriate or necessary revolves around whether a particular bailout is for the greater good of the economy and country. For others, bailouts do nothing but deteriorate the ethical fiber, will and strength of an economy. For yet others, bailouts, if utilized, should be fair and equitable for both institutions and individuals.

Bailouts are also usually considered when governments perceive that intervention is good for the overall economy. The Chrysler bailout in 1979 consisted of guaranteed loans of $1.5 billion and helped save thousands of jobs. The savings and loan bailout in 1989 came after hundreds of savings and loans failed, costing the U.S. government $124 billion. Two weeks after 9/l I and in response to a dramatic drop in airline passengers, a bailout of $15 billion was extended to already unprofitable airlines. Those same airlines today are still struggling to stay profitable. The perception at the time of each of these bailouts was that without extending a parachute, the country's economy would have suffered considerable harm.

The National Association of Homebuilders has been unabashedly backing a housing "stimulus" package in light of the dramatic decline in home construction over the past couple of years. The bill was recently passed by the House and is now awaiting a vote in the Senate, where aPProval is expected soon. According to NAHB, "The American Housing Rescue and Foreclosure Prevention Act contains several provisions that would help put the economy back on track, save jobs, and restore confidence."

Provisions in the bill would make it easier for struggling homeowners to refinance their subprime loans to prevent foreclosures and to increase access to affordable mortgage credit. According to NAHB, the Congressional Budget Office estimates this could help as many as 400000 struggling homeowners stay in their homes. In other words, the bill would bail out homeowners, limit the amount of available homes in the market, and get builders back to building faster.

Meanwhile, opponents of the bailout raise a valid point: Why should the government bail out homebuilders when they helped create the mess in the first place? It is a viable question, particularly when thousands of homebuilders made more money in the latest housing boom than theY could have ever imagined. Now, the government is ready to provide them with aid when many either failed to see or react to the bubble bursting, some thinking the good times would last forever.

As a result of the current housing crunch, homebuilders are blaming lending institutions and lenders are blaming homebuilders for the cuffent MESS.

They are not the only two entities crying for government intervention. The National Association of Realtors and the Mortgage Bankers Association are also looking for help following a period in which their members compiled record profits.

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"We are at a crossroads in the history of American capitalism," regarding bailouts and how they are handled.

Perhaps the single most pressing concern regarding bailouts is the one often referred to as "moral hazard." It is the prospect that an element of risk makes people and institutions act differently than when little to no risk exists. Take the person who dog paddles to the deep end of the pool, knowing lifeguards are there to pluck him out if something goes wrong. When no consequences for one's actions exist, caution is thrown to the wind, leaving another party, in this case the lifeguard, to bear some responsibility for the consequences of those actions. It is theorized that when this continues to occur, lenders and homebuyers become less cautious, which in turn deteriorates the integrity of markets and the economy.

The theory of moral hazard is just that-theory-and not an acceptable explanation to many as to why governments should not bail out institutions. After all, they say, just because a person has dental insurance doesn't mean they will stop brushing their teeth. Some argue that bailouts, which are usually in the form of low interest loans backed by subsidies from taxpayers, are often less expensive than the alternative. One example would be keeping airlines operating, which provides more competition and less expensive airline tickets.

Complicating matters is the potential bailout of Freddie Mac and Fannie Mae, two government-sponsored lending institutions that are somewhat insulated from the same risks private or public companies must face. Together, they support nearly TOVo of all U.S. mortgages worth trillions of dollars. The reason for the potential bailout is that the two mortgage giants nearly collapsed after jittery investors sold off a large number of Fannie and Freddie stocks.

Treasury Secretary Henry Paulson announced that both the Treasury and the Federal Reserve will lend money and buy stock in both companies if needed to shore up the faltering firms.

It has been argued for years that Freddie Mac and Fannie Mae should have their ties to the federal government severed. Opponents of this arrangement between government and institution argue it is a breeding ground for moral hazard, in which the government plays lifeguard for institutions and industries in over their heads with debt.

If the sell-off of Freddie Mac and Fannie Mae stocks does not necessarily point to the degree of the housing crisis, it certainly speaks to the sentiment of investors regarding the current debacle mortgage lenders have created. Homebuyers who accepted those questionable mortgages, sometimes at llo%o of their home's worth, are not without responsibility, either.

Taking bailouts a step further, what about the forest products industry? If buyers, builders and bankers are considered for bailouts, why not lumber and panel producers? Do markets based on prices generated through the dynamics of supply and demand warrant a little boost when housing construction slows to a crawl?

Despite the importance of the LBM industry, bailouts would be unlikely. After all, it would appear that a significant amount of mismanagement, fraud, ignorance and "connection" is needed to warrant a bailout.

- Mr. Zauner is senior news editor for "Crow's Weekly Market Report," the longest-running source of prices in the North American lumber and panel industry. Free trial subscriptions are available at www.risiinfo.com/crows.