The federal government had little option but to bail out financial giants like Fannie Mae, Freddie Mac and AIG, local financial experts say, because inaction would have had dire, far-reaching consequences.
The subprime mortgage crisis, housing market slowdown and credit crunch have created a full-fledged economic crisis in the last several weeks. Fannie Mae and Freddie Mac have been taken over by the federal government, as has AIG. Morgan Stanley and Goldman Sachs have taken steps toward reorganizing themselves as bank holding companies and will face more regulation by the FDIC.
Lehman Brothers, one of the nation’s largest investment banks, has declared bankruptcy. And federal officials are weighing a $700 billion bailout program that could allow the government to take a more aggressive role in assisting failing financial firms. No one in Washington, on Wall Street or in Milwaukee knows where the chips may fall, but what is certain is that we are witnessing a historic event, one that will have long term effects.
David Massart, president of Wauwatosa-based Next Generation Wealth Management Inc., believes that federal officials had no option but to proceed with a large-scale financial bailout. "Chairman Bernanke and the Treasury are doing as much as they can to reassure investors and the American people at this time – quite simply, to stabilize the banks and Wall Street," he said. "The current crisis is as much of confidence as it is anything else. In a perfect world, you would prefer the government not to intervene but this current scenario was (and is) one that we haven’t seen before. I believe their process is threefold: deleveraging of the financial system, adding stabilization and trying to put in place the necessary actions to prevent major dislocations in the markets."
Kurt Bauer, president and CEO of the Wisconsin Banker’s Association, said the bailouts of Fannie Mae and Freddie Mac were particularly important.
"If both companies had been allowed to fail, the secondary market for mortgages would have all but disappeared, which would have led to a further decline (perhaps dramatic) in housing values," Bauer said. "The reason is that banks need to sell mortgages on the secondary market in order to replenish their liquid capital. If that market is gone or significantly reduced, then banks would be forced to keep more mortgages on their books resulting in fewer loans being made, which would increase their cost, and make it harder for people to qualify."
However, there will be long-term consequences of the government bail-outs, said Jose Freyre, certified financial planner and founder of Monarch Wealth Management Inc.
"The government intervened and that goes against free-market economics," he said. "This creates a ‘no risk of failure’ moral hazard that sends the message that no matter what a company does as long as they are large enough to have an big impact in our economy in the event of failure, the government will step in if/when they get in trouble. Where do you draw the line?"
Ultimately, the American taxpayer will not likely recover its investments in the ailing financial firms it has invested in, many financial experts said.
"As for the risk to taxpayers, I doubt that we will recoup our investment," said Greg Myers, managing director with Mason Wells, a Milwaukee-based private equity firm. "We may very well make money on selected transactions, such as AIG given the equity position the government took, but on balance it will be very costly to taxpayers."
Tommy Huie, president and chief investment officer of M&I Investment Management Corp, agreed that taxpayers will likely see some impact from the government intervention. However, there will also be positive outcomes from the federal intervention, he said.
"Taxpayers may feel some impact for a short time before we reach a final accounting of supportive actions through the federal government policy responses," Huie said. "However, there are some less obvious positives that we can take away from the current initiatives – a stable, fully functioning financial system will allow for revived credit to be extended by banks to businesses and individuals, and lower rates overall for these loans (e.g., mortgages, auto loans, small business loans, issuance of commercial paper)."
Most of the impact of the government intervention will be long term, Bauer said, because of the massive liability the United States has taken on.
"The amount of new debt liability the government is assuming in the name of the American taxpayer is almost incomprehensible and will require that an even larger portion of the federal budget be dedicated to debt service," he said. "Future federal tax increases are a very strong likelihood. So are cuts to subsidies, grants and other programs the federal government provides to support state, county and local governments, which may lead to tax increases at those levels as well."
However, many Wisconsin-based companies and consumers are well prepared to weather the storm, Huie said.
"These collapses and subsequent financial support will put greater pressures on the federal budget deficit and impact the real economy by slowing near-term growth," he said. "While business investment may be curtailed, Wisconsin’s strengths in manufacturing, construction, and technology should help the state weather this period."