the myth of the free market...

With the recent news of the Fannie May and Freddy Mac bailouts, I thought it might be interesting to go over the exact process of a bailout.

So here's how it goes. A privately owned or publicly traded company gets itself into financial troubles, in this case by buying a whole bunch of debt (in the form of mortgages). Unfortunately, they vastly overestimate the face value of these items. (E.g., a 30-year mortgage for $250,000 ought to be worth $250k over 30 years (simplified here by leaving out interest). However, they purchased hundreds of thousands of these and overlooked the fact that many of these new homeowners had no possible means to to pay $250k, even over 30 years.) So they pay a bunch of money for something and actually get nothing in return. When this becomes apparent, everyone who's loaned them money comes asking for it, and the company approaches the verge of collapse. Then, for whatever reason (friends in high places usually), the federal government decides that allowing such a company to go under would be "bad for America" and steps in with a bunch of cash to fund the debt of such a company. That cash comes from tax payer dollars. The net monetary effect is to take tax money from every American and transfer it to a few Americans. (Slightly different this time, see below). It also prevents what free-marketeers say is the upside to a free market, that the company in question (and the people that invested in it) get punished for their poor choices, thus preventing such problems in the future. (This is why Dick Cheney was against the housing market bailout.)

Savings and Loan scandal of the late 80s/early 90s followed the same pattern. Bear-Stearns was similar, and rumor is Lehman Brothers is next.

This type of action, which occurs at regular intervals in America, is the antithesis of the free market.

The new wrinkle with Fannie and Freddy is that for perhaps the first time, the majority of the investors in question were foreigners. Meaning that rather than sending tax dollars to a few select Americans, we sent that money overseas. America is being sold for parts, and it's being done by the very institutions that are supposed to protect it.

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14 Sep: Anne's link: NPR link