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Charles Wheelan, Ph.D. The Naked Economist

Charles Wheelan, Ph.D., The Naked Economist

Government Must Act to Protect Economy's Innocent Bystanders

by Charles Wheelan, Ph.D.

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Posted on Tuesday, September 30, 2008, 12:00AM

Should the government intervene to stabilize the financial markets and bring sanity to the escalating mortgage-induced turmoil? Absolutely.

The reason is straightforward: The financial rot is spreading to infect otherwise healthy firms, which poses a risk to people far and wide who bear no culpability for what's going on. The purpose of government is act on behalf of citizens in ways that make us better off. Stopping a financial meltdown is perfectly consistent with that mission.

Is this a "bailout" for homeowners, banks, and firms who did stupid things? Maybe. I suspect that the Treasury plan might leave some of them better off than if we do nothing. But we shouldn't let our eagerness to punish the wrongdoers blind us to the benefits of stopping their idiocy from making us all worse off.

The Fire Next Time

Here's the best analogy I can offer. Suppose a guy down the street has been smoking in bed for the last 20 years. That's a stupid, irresponsible thing to do, and lots of people have told him so.

He just happens to live next to another idiot who stores containers of gasoline in his garage. He, too, ought to be fully aware that this is a foolish thing to do.

Predictably enough, the guy smoking in bed starts a fire that explodes in force when it hits the gasoline-filled garage next door. Now there's a hell of a blaze going on. If these two guys lived alone in a remote area of rural Montana, we wouldn't have much to discuss. But they don't. Instead, the fire is spreading down their residential suburban street, burning houses where nobody smokes in bed or keeps gasoline in the garage.

Damage Control

That's about where we are right now with the financial crisis. The question isn't whether we should rush to save the morons responsible and put ourselves at risk in the process. We shouldn't. The question is whether we should intervene to save the rest of the neighborhood. We should.

The fire department may end up helping our smoker and gas-can man just because it's an unavoidable part of fighting the larger fire. That's unfortunate, but it's not a good reason to call off the fire department. I don't get enough utility out of standing amid the smoldering ruins of their houses to justify the risk that the same thing may happen to my house a few hours later.

If you want to fine these guys, or put them in jail, or take away what's left of their property -- fine. That seems perfectly appropriate. But just make sure you take care of the fire first, because that's what's dangerous here.

Exit Strategies

To be honest, I don't know the exact details of how this Wall Street "fire" ought to be fought. I suspect it should involve two simultaneous strategies:

1. A government fund to buy distressed derivatives, which would inject capital into the system and provide some mechanism for pricing these opaque securities. The first step toward recovery is making the securities liquid again, meaning that they can be bought and sold at a predictable price, even if it's a low price.

2. A government fund to buy mortgages in foreclosure, or at risk of foreclosure, from lenders at a discounted price. So if I've got a $200,000 mortgage and I can't make the payments anymore, the government would buy it from my lender for something like $180,000. The lender still gets a haircut, but probably ends up better off than taking on the administrative expense of foreclosure and then having to sell the house in a dismal market.

The government would then restructure my loan with terms that I could afford, such as stretching the payments over 40 years instead of 30, or perhaps even lowering the value of the outstanding loan.

As a homeowner, I, too, should have to pay a price for borrowing more than I could afford. The government should be entitled to any profits on the eventual sale of my home up to the amount of whatever break they've given me. So if the Treasury knocks my mortgage down from $200,000 to $160,000, and I'm eventually able to sell the house for a profit, I should send a check to Uncle Sam at closing for $40,000 -- plus interest.

That's the essence of a sensible plan: Restore stability to the housing market at realistic prices; and inject liquidity into Wall Street, again at realistic prices. Just to stop the fire from spreading.

Act Now

One of the curious things about economics is that if everybody thinks something bad will happen, then something bad will happen. This morning, my wife asked me if we should avoid the $2,000 hotel bill for our Christmas travels and stay with my mother-in-law instead (no small sacrifice). I said yes -- a perfectly rational response as our stock portfolio plummets along with everyone else's.

But we're merely contributing to the economic slowdown. The hotel that would've had our holiday business will cut back on spending, or even lay off employees. And those employees will cut back on their holiday spending. Which will hurt the retailers, which will drive their stock prices down, and so on -- despite the fact that none of these people had anything to do with the mortgage mess.

The best economic lesson right now -- or at least the most accessible one -- comes from Jimmy Steward in "It's a Wonderful Life." He knew a bank run when he saw it and was willing to put his own capital at risk to stop it. The U.S. government ought to do the same. It will make us all better off in the long run.

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  • BlingB - Wednesday, October 29, 2008, 4:27AM ET  Report Abuse

    • Overall: 1/5

    Your economic commentary is of equal value to a festering wart, oozing its putrid contents onto the taint of a Yak on some far off mountain side. Find something else to do that prevents your mind from wandering this way, and carry on so. There are women and children about that need not be exposed to such needless atrocities.

  • Nick - Saturday, October 25, 2008, 3:14PM ET  Report Abuse

    • Overall: 2/5

    Strange words from a libertarian. The capitalists want free marketers only when there are profits. Otherwise, they become socialists and want the working people to bail them out. This government is good at destroying value and liberty. They should use their talents and set up a Guantanamo for CEOs and CFOs.

  • Chris - Thursday, October 16, 2008, 11:18PM ET  Report Abuse

    • Overall: 3/5

    Presents a good case, but it seems like borrowing water on credit to put out fires.

  • Keith - Sunday, October 12, 2008, 12:23PM ET  Report Abuse

    • Overall: 5/5

    this guy should be a prototype for economists; or, at least training/educating future economists.

  • David - Friday, October 10, 2008, 4:50AM ET  Report Abuse

    • Overall: 5/5

    Great Idea. My issue has been with "bailing out" the idiots who knowingly bought houses they could not afford, and signed mortgages they didn't understand. But while we sit on our duffs and argue online about whether this is right or wrong, Rome continues to burn.

  • Yahoo! Finance User - Wednesday, October 8, 2008, 11:26PM ET  Report Abuse

    • Overall: 1/5

    OK Mr. Naked Economist time to get dressed. After reading your fairytale analysis of the problem in which we find our selves and your solution to the problem, I then read your Bio. It’s all very revealing! You do not understand how big this problem is! The so called “sub prime mortgage” crisis isn’t the half of it. It’s not even a tiny fraction of the problem. The mortgage default only amounts to hundreds of Billions of dollars. Ever hear of “Credit Default Swaps?” CDSs may amount to a few hundred Trillion in the US alone. The national debt is what? Ten Trillion or so? Oh, and it doesn’t end with Credit Default Swaps. There are many, many more little side bets and other shenanigans going on that we don’t know about yet. But you and I are going to pay for this one way or another…by inflation (AKA the hidden tax) for sure, thanks to the Federal Reserve. Why am I not surprised that someone who “is a lecturer in public policy at the Harris School of Public Policy at the University of Chicago“ doesn‘t have a clue? It is myopic people like you who helped bring us to this end. I’m not saying you created this mess, just that bathroom philosophers LIKE YOU helped it along. So go ahead and spend 2000 bucks on a hotel room this Christmas to help bail out the economy. Better yet why not just add it to your $50,000 credit card statement? Let your debt ride. Think of all the nice people you will be helping out. Me, I’m staying home. But then I paid off my mortgage 20 years ago and I had my hard earned savings in CDs and a money market account long before the collapse. I have been expecting this for a long time. I’m no genius but I knew something wasn’t right. Charles, I am sure you are a nice young man but you need to understand that the Ph.D. at the end of your name does not certify you as an informed man with understanding. Just because a lot of people come up and schmooze you at the end of your lectures does not mean what I suspect you think it does. "It's a Wonderful Life" is a MOVIE made at a time when most movies had a happy ending. "It's a Wonderful Life" was WRITTEN to have a happy ending. This fiasco is not a movie and it will NOT have a happy ending. This problem is far worse than anyone realizes and it results from a large dose of greed and arrogance with a liberal measure of stupidity. My best regards. Bob

  • MICHAEL - Wednesday, October 8, 2008, 10:46AM ET  Report Abuse

    • Overall: 5/5

    Clear examples that most people can understand.

  • Yahoo! Finance User - Wednesday, October 8, 2008, 2:41AM ET  Report Abuse

    • Overall: 4/5

    I like your writing style - examples are self explanatory and always simplify a seemingly difficult concept. Keep up the good work!

  • ETT - Tuesday, October 7, 2008, 1:19AM ET  Report Abuse

    • Overall: 1/5

    You've got to be kidding me. You are using the analogy of a threatening home fire to the unforgivable termination of our Constitutional liberties for which scores of people have given up their lives? Congress just signed off on a Bill that gives dictatorial tyrannical control of our entire monetary system which is based on ...guess what......Trust! By the way, it's Jimmy Stewart not "Steward"! Don't even think about that analogy. George Bailey would have given his life for his country to protect the Constitution! never mind the cash for his honeymoon! He did that and guess what? They had a wonderful honeymoon anyway! Funny how the lower and middle class here are ready to fight this out to preserve our freedom and the rich and ruling are saying "take it....take it take it! You have to take it!" I would rather live in a wooden shack with a leaky tin roof for a decade than give up my liberty for even a moment! Enough! I'm mad as hell and I'm not going to take it anymore!!! Good night Mr. Potter! And good riddance! I would give you 5 negative stars if given the opportunity.

  • Armadillo - Monday, October 6, 2008, 11:30PM ET  Report Abuse

    • Overall: 1/5

    I think a Ph.D. level writer should add enoough substance to exceed average WSJ or other publications articles to entertain both laymen and educated readers... sorry, no there yet!

  • Bio Diesel - Monday, October 6, 2008, 4:37PM ET  Report Abuse

    • Overall: 1/5

    I don't know where you got your PHD, but please keep the lets bring in socialism as the answer articles a rest. We all know our government is a failure so you idea of more government is ridiculous.

  • JohnS - Monday, October 6, 2008, 2:18PM ET  Report Abuse

    • Overall: 1/5

    "The financial rot is spreading to infect otherwise healthy firms, which poses a risk to people far and wide who bear no culpability for what's going on." I disagree. The government is spreading the rot onto healthy firms and the taxpayers by using taxation and inflation by robbing investors of capital and giving it to failed banks. The banksters are going to turn a painful, but short, recession into a full blown depression.

  • Yahoo! Finance User - Monday, October 6, 2008, 1:14PM ET  Report Abuse

    • Overall: 1/5

    Yea, and if anyone was hurt the guysstoring the gas and smoking would be sued for eeverything thiey are worth and imprisoned for life!

  • Pdx - Monday, October 6, 2008, 12:14PM ET  Report Abuse

    • Overall: 1/5

    Puppet column... Hey Charles, who created subprime in 1996? Who kept it alive in 2003? Who sued Citibank to force them to make more subprime loans on behalf of the poor? I doubt a billionaire like yourself is that dumb. So my conclusion is that you are a puppet.

  • Ryan - Monday, October 6, 2008, 12:10PM ET  Report Abuse

    • Overall: 1/5

    Moral hazard. And no the gov can't rescue the financial world. Go take a class on credit contraction and deflation.

  • WendyM - Monday, October 6, 2008, 11:15AM ET  Report Abuse

    • Overall: 1/5

    How's that bailout working out for you, Charles? Still think government has the power to stop financial disasters? Ayn Rand told you so.

  • Rick F - Monday, October 6, 2008, 10:46AM ET  Report Abuse

    • Overall: 1/5

    This was not the fault of the free market. This was the fault of government. Looking to the same people who caused the problem to solve it is idiocy. If you truly care about the "little guy" stop stealing from him to prop up the markets.

  • Matthew - Monday, October 6, 2008, 9:36AM ET  Report Abuse

    • Overall: 2/5

    The market was never given a chance to take care of itself - thanks to the DEMS that BLOCKED regulation of the RISKY loans that the DEMS required through CRA, affordable housing, etc. Add in ACORN, OBAMA (yes, him too), and RAINES, and there was NEVER a free market. Someone needs to bring corruption charges against the members of the "Fannie Pack" who were padding their pockets at the expense of their constituents (who aren't better off by the way if they are on the street with wrecked credit due to foreclosure). I agree with your suggestion to extend loans over longer periods and having the homeowners pay back the amount that was forgiven.

  • Yahoo! Finance User - Monday, October 6, 2008, 8:28AM ET  Report Abuse

    • Overall: 1/5

    Chicago PhD's at their finest... learn the difference between socialism and capitalism yet?

  • Yahoo! Finance User - Monday, October 6, 2008, 7:02AM ET  Report Abuse

    • Overall: 2/5

    This is what free enterprise do for you. It has created thousands of "financial cowboys" ceatively converting, buying and selling of options, enlarging turnovers of big banks which is perfectly legal. I can understand that those cowboys in the know are exploiting every oppurtunity they lay their hands on. Wether it is use to create jobs is another matter.

  • Yahoo! Finance User - Monday, October 6, 2008, 3:15AM ET  Report Abuse

    • Overall: 1/5

    You probably didn't have to work as hard for you capital as I did. Go ahead and put you capital at risk. I'm done.....

  • Yahoo! Finance User - Sunday, October 5, 2008, 11:13PM ET  Report Abuse

    • Overall: 5/5

    TOO much radical feedback here, don't think it's just a coincidence. I don't go with the "purist" school of thought, i.e., "let the market take care of itself." It's too late for that, like a patient that can only survive with a blood transfusion (and the market WILL survive). How many of you would refuse a blood transfusion because it goes against your purist ideology? It will take time to work through this, but this country should not be undermined by radical ideology. Yes, I don't like that I have to pay my hard-earned taxes to people who screwed up and many knew better, but I'm not getting sucked into the doomsday mentality. Our country has endured numerous crises; this too shall pass. Too those of you who say throw the losers off the ship, I say throw the panic mongers with them, since you are contributing to the problem as much. We need productive contributions to this problem.

  • Yahoo! Finance User - Sunday, October 5, 2008, 7:38PM ET  Report Abuse

    • Overall: 1/5

    Sorry Doc but you should go to Hollywood and write scripts. In the first place in the long run we are all dead. Its time to throw people out of the boat that are not rowing. If we bail out the screwups we are the suckers. It took me eight years to graduate from college and every dime I could save is in U.S. treasury issues over the last 30 years ( zero common stocks). Thank God I got a business degree and can fully understand what is going on now. My advice to everyone is to listen to the advice of guys like you and do just the opposite.

  • Bill - Sunday, October 5, 2008, 12:35PM ET  Report Abuse

    • Overall: 1/5

    The bailout does nothing for the 12 month supply of houses which must be sold down before there is a need for new homes which equals more jobs growth in spending thence the economy in general. You have lost faith in free enterprise and opted for a socialistic remedy which will once again benefit the rich. The republican party was so sly at letting the democrats take the lead on a bill that favors the core constituence of the repulican party. The picture of Bush and Paulson Smiling and laughing as they congradulated one another on "The Great Heist of 2008" pretty much says it all. Bill

  • Yahoo! Finance User - Sunday, October 5, 2008, 9:43AM ET  Report Abuse

    • Overall: 1/5

    Hasn't government and Wall St done enough? If you want to understand the problem you need look no further than the repeal of the Glass-Steagal act in 1999 and understand how it allowed Wall St to run a muck as it proceeded to fill it's pockets with record profits and bonuses based on flawed and reckless business decisions. Then take a look at how each side of our elected officials voted on the repeal motion. Pathetic. 90% of our those responsible for making decisions in our best interest voted Yea. http://www.senate.gov/legislative/LIS/roll_call_lists/roll_call_vote_cfm.cfm?congress=106&session=1&vote=00354#position Absolutely disgusting! Let the failing institutions and individuals fail. I am not responsible for my neighbor's mortgage payment nor his stupidity. It is time that WE, THE PEOPLE, take responsibility for electing the career politicians which allowed this to occur and vote them all out. They are no less guilty than those on Wall St and Main St that profited from this mess. Mark my words - It will be years, maybe a decade, before we recover from this latest binge of greed. The suffering we've seen to date is just the seedling of what we've sown.

  • Joe - Sunday, October 5, 2008, 8:55AM ET  Report Abuse

    • Overall: 5/5

    The most blame for the current financial situation SHOULD BE on the stupid people who bought homes they knew they weren't financially entitled to. Those of you who think this bail-out is a scam and unnecessary are probably the same people who think Obama will make a good president. I almost hope he gets elected so you who vote for him can actually see how stupid you are. Fortunately we'll never know how bad things would have been without the bail-out. I certainly hope we never find out how bad it will be to have a Muslim liberal president and a black first lady who doesn't even like this country. I say go ahead elect the AH, cancel the bail-out, raise taxes and see the results - you deserve what you'll get. Then you can all join the white house to kneel, bow to pray several times a day wishing for better times.

  • Yahoo! Finance User - Saturday, October 4, 2008, 9:18PM ET  Report Abuse

    • Overall: 1/5

    This bailout is the biggest scam ever. Americans are so stupid its not even funny. I spoke with all the community banks where I live and they are all doing great. I got approved for a 20k loan for a car at every bank. The banks manager said we just arent lending to deadbeats, the reason the big banks are in this mess. He said credit still exists fine for reasonably responsible people. Bailing out the big banks is not fair to all the community banks that would have grown and taken on new deposits. Every banker I spoke to said the bailout is a fraud. What is disapearing now is not credit, but excess credit. These are two different things. People on the news are so dumb but lemming like sheep like Americans believe them, lolololol. Plus, all these financial columists that are for the bailout are so because they know they will be out of a job if the economy contracts more. The only thing is the government is only delaying the invevitable. Remember the lost decade japan had. Well, you can thank our fraudulent congress now because our stock market will not go up for another 20 years. How is it this bailout bill fails, then a week later has all the votes needed? Its because people were paid off. Its such a scam and people believe it!

  • Yahoo! Finance User - Saturday, October 4, 2008, 12:56PM ET  Report Abuse

    • Overall: 1/5

    Yeah, what a great idea. The big shots are seeing the value of their investment portfolios and real estate go down. It's time to act! I know -- let's nationalize the financial industry!! The big shots know best what the prices for stocks, housing, oil, etc,.. should be! Uh-huh. The best "plan" would be to get rid of the likes of Barney Frank, Chucky Schumer, Chris Dodd, Hank Paulson, Ben Bernanke, and Chris Cox... eliminate Fannie Mae and Freddie Mac, and get the government out of the mortgage industry... shut down the corrupt enterprise and Democrat enclave on Wall Street known as Goldman Sachs... put Franklin Raines, James Johnson, and Jamie Gorelick in jail... and put a sock in the mouths of Harry Reid, Nancy Pelosi, Barack Obama, Joe Biden, and Warren Buffet... Or, you can just take the route that libtards always take -- whine like babies while blaming Bush for the problems YOUR ILK have created.

  • lowpg - Saturday, October 4, 2008, 11:45AM ET  Report Abuse

    • Overall: 4/5

    The fact that lots of people give this 1 star and talk about being robbed demonstrates that they can't see past their own noses. Wheelan's analogy is a good one. This ain't fun and it ain't a course we would have chosen - it is an unfortunate necessity. But remember that the government is just not shoveling out money - it is getting something in return, on the cheap. It may even make money on this, but if it doesn't, the ultimate cost will be far, far less than 700 billion.

  • PK - Friday, October 3, 2008, 6:15PM ET  Report Abuse

    • Overall: 1/5

    Wow! This guy is a tool. Same old drivel, like you have a gun to your head and are being robbed but it is for your own good. Credible people have been predicting this train wreck for a long time. Hundreds of Economists oppose this plan. No other options were even considered even though there were others out there that did infact protect the taxpayer and didn't reward the probably fraudulant behavior by the financial institutions. This was a bad plan that they loaded down with pork and then passed without any meaningfull alteration. Some of the financial guys I read are saying: "Buy food and bullets and pray."

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