Despite Barack Obama’s centrist stance, the power of the Democratic Congress to wreak havoc on financial markets should not be underestimated.

As I emphasized in yesterday’s post on Bill Gross, mortgage cramdown (allowing bankruptcy judges to unilaterally change the terms of mortgages) crushed the stock prices of major mortgage lenders yesterday. It wasn’t another public whipping for Vikrim Pandit and the misbegotten management team at CItigroup, but a run out of mortgage-backed securities leading to a drop in the stock price of the major mortgage lenders. The collapse began on Friday, as I showed, with mortgage-backed securities cut from subprime loans, and fed into bank stocks on Monday.

Over at Tom Brown’s Bankstocks, Tom Brown excoriates CItigroup for agreeing to the Democrats’ bill:

Whoa. Citigroup really has become a wholly owned agency of the federal government. How else to explain the bank’s sudden willingness last week to support the Democrats’ disastrous mortgage-cramdown bill? I understand corporate executives occasionally lose sight of the interests of their shareholders. But in this case, Vikram Pandit hasn’t just forgotten his shareholders’ interests; he’s put Citi in a position to oppose them outright. This is what happens when the federal government becomes your biggest shareholder: people like Dick Durbin and Chuck Schumer get a hand in running things, and they don’t always have profit maximization (or even fiscal prudence) at the top of their minds. Instead, they seem to want to turn Citi into a publicly traded version of ACORN.

 

If the term “mortgage cramdown” sounds vaguely unattractive, it may be because, from the lender’s perspective, it is—and costly, too. In particular, the Democrats’ bill in Congress would give a bankruptcy judge the right to unilaterally alter the terms of a bankrupt borrower’s mortgage loan. The judge, of course, would be accountable to no one. Yet he could arbitrarily lower the principal balance, for instance. Or cut the loan’s interest rate. Which is to say, the judge would have the right to vaporize a bank’s assets with the stroke of a pen, and without recourse by the lender. Vikram Pandit now somehow seems to believe this is a wonderful idea. 

This little (or perhaps not-so-little) disaster points to the political dangers to the financial system and the economy in the present environment. The core constituency of the Democratic Party is the public service unions (teachers, healthcare workers, AFSME, etc.) who are now on the chopping block in the trillion-dollar municipal debt crisis (to which Bill Gross referred as a great opportunity). The solution to the crisis is 1) in the case of California and some other states, expel illegal immigrants, and 2) cut employment and salaries across the board. Public service workers will not easily accept their new poverty. There will be bitter fights, and in some cases an attempt to renegotiate terms with bondholders.

Political risks to economic recovery are far greater overseas, for that matter, than in the United States. China is engaged in a modest crackdown on potential sources of dissent, shutting down Internet blogs and websites that carry political news and discussions, as the country openly debates the unrest stemming from sudden unemployment.

Ultimately I believe that the major American political subdivisions are moneiy good — Gross is right that a default by a state the size of New York or California is unthinkable — but it will be necessary to go right to the brink of catastrophe to crush the resistance of state and municipal trade unions to the brutal and painful adjustments that will be required.

This entry was posted on Tuesday, January 13th, 2009 at 8:21 am and is filed under General. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.