Another Bubble Inflating? - The Patriot Post

The Democrats’ narrative about the financial crisis of 2008 (and the justification for financial reform) goes like this: Investment bankers, typified by Goldman Sachs, manipulated markets, bamboozled investors, and in their greed, managed to bring the entire economy to its knees. The solution is more strenuous government regulation. Republicans, who are beholden to Wall Street, are blocking reform.

The Democrats excel at presenting legislative tableaux with predigested morals: Stern Democratic lawmaker grills slippery Wall Street executive. Democrats for the people; Republicans for the fat cats.

Do people really buy this anymore? Everyone I know who works on Wall Street is a Democrat. Anecdotes are not evidence, but consider this: According to the Center for Responsive Politics, Democrats received $11.3 million in contributions from hedge funds in 2008. Republicans got $5.9 million. Some critics of the Dodd bill note that it would give broad discretion to the FDIC and a new regulator to decide which firms would be bailed out and which would not. That isn’t so much preventing another crisis as institutionalizing “too big to fail.” The moral hazard problem – i.e., encouraging risky practices with the implicit or explicit promise of a bailout – remains.

Further, the Dodd bill – and the Democrats’ narrative – completely omits the role of government in the financial debacle. Neither Fannie Mae nor Freddie Mac is mentioned in the legislation. But the incentives created by government, specifically the sustained push through law and regulation to provide mortgages to more and more uncreditworthy borrowers, created the conditions for the housing bubble and for its eventual crash. The wizards of Wall Street may have concocted exotic ways to make money by betting on the fortunes of the real estate market, but it was the politicians who first destabilized that market.

Let’s stipulate that the masters of the universe on Wall Street may deserve flaying, and sensible reform requiring more transparency and limiting leverage is well and good. But when the federal budget deficit stands at $1.5 trillion, the spectacle of congressmen and senators waxing indignant about the irresponsibility of others is a bit much.

Leaders have a responsibility to be prudent with the taxpayers’ money. At least Wall Street trades are between consenting parties. But when politicians gamble with taxpayer money, it’s different. We don’t willingly sign on to these bets. Yet by their profligacy, elected officials are placing our financial futures at severe risk.

Nicole Gelinas, writing in City Journal, sketches what may be the next crash to rock our world. It’s another investment, like housing, that people assume cannot fail – municipal bonds. They are risk free, investors have long been assured, because the cities and states that issue them would do anything to avoid default. Besides, “they … have a captive source of endless funds … State and local governments … can always tax their residents and businesses to pay the bills.”

Between 2000 and 2008, states were rolling in cash, pulling in tax revenues that outpaced inflation by 15 percent. But instead of using this windfall to reduce their debts, states continued to spend freely, particularly on expensive union contracts, education, and Medicaid. When the recession began, Gelinas notes, “state and local officials should have realized that hard fiscal times were coming and begun cutting back … Instead they kept on spending, and borrowed to do it.” States are now deeply in debt. The most extreme cases – California, New York, and New Jersey – are well known. But the average state now owes 2.1 percent of its residents’ annual income.

The 2009 stimulus bill only exacerbated the problem by pumping $200 billion in “reality-distorting funds” into state and municipal coffers, delaying the reckoning and permitting states to continue their reckless spending.

What will happen when states can no longer sustain the public employee pensions and health benefits, the Medicaid payments, and the education spending? Gelinas offers a glimpse of a possible future in the case of Vallejo, California. The city declared bankruptcy in 2008 to escape from crippling union contracts. Vallejo was successful, but in the process, it delayed payments on its bonds for three years. Other bondholders might not be so lucky. It’s not hard, Gelinas writes “to imagine some future mayor convincing a bankruptcy judge that it’s only fair for bondholders, along with union members, to take big cuts in a restructuring.”

When Democrats preen that they are fighting for the average guy, ask this: When they vastly overspend, what happens to the ordinary person who dutifully pays his taxes and prudently invests in “safe” municipal bonds?

The Patriot Post® · Another Bubble Inflating?