Impediments To A Sound Economic Future

By Lowell L. Kalapa

(Released on 10/19/08)

If nothing else, the fiasco in Congress over the recent effort to rescue the credit markets is an indicator that many of our elected officials do not have the courage or the willpower to do what is necessary to address crucial issues without politicizing the debate.

If you are still undecided about whether or not the “bailout,” now called a “rescue,” of the credit markets was a good idea, consider the following points. If the measure had not passed, nearly all lending would have come to a complete halt as financial institutions moved funds into more secure products such as treasury bills and certificates of deposit. With little capital available to lend, day-to-day operations of businesses, both large and small, would come to a halt as well.

It is not as if businesses don’t have the money to pay their bills, be it payroll or purchases, as much as it is a timing of the flow of money. Say a homeowner wants gutters installed on his home and contracts with a business that installs gutters. Although the business may ask for a deposit so that it can purchase the materials, the homeowner is not going to pay for the job until it is completed. In the meantime, the business owner has to pay his workers who are installing the gutters. Those workers must be paid on a regular basis be it weekly, semi-monthly, or monthly.

Since the business owner has to make sure the job is completed before getting paid by the homeowner, he may not have the cash to pay his workers who are still working on the job. So the business owner goes to his local bank or financial institution to borrow the money he needs to make payroll this week. The bank extends the business owner a line of credit to help him meet his payroll. But the money the bank lends through the line of credit is dependent on that bank being able to collect on a loan they made to another business owner or perhaps even to a homeowner who has a mortgage with that bank. When any borrower is late on the repayment of that loan or doesn’t make the payment on the loan, then the bank has to look elsewhere for the funds that it has lent to the business owner. When the credit market freezes, as it was about to do earlier this month because there are so many loans not being repaid, then the bank can’t lend funds like the line of credit to the business that installs gutters. The business owner cannot meet payroll and basically the business owner is forced out of business for the lack of available credit.

In other words, without the free flow of capital made available through lines of credit, the national economy would come to a grinding halt. Not only would it hurt the nation’s businesses and families, but it would have international repercussions as other countries also lend and borrow from the nation’s financial institutions.

Some may ask why should the taxpayer bail out the fat cats of Wall Street. Well, if the truth be known, some of the blame has to be put on Congress which actually encouraged lending of funds to families who had no business buying a home with no down payment and only paying interest. As part of the amendments to the Community Reinvestment Act several years ago, Congress wanted the poor, or those with lower incomes, to attain the dream of owning their own home. As a result, the Act encouraged financial institutions to make loans to families who might not have otherwise qualified for a mortgage. This meant foregoing the usual prerequisite down payment and in many cases allowed some to pay interest only on their newly realized mortgages. While financial institutions should have known better, it was the federal Act that gave out “brownie” points for banks and other financial institutions for “reinvesting” in the poor in the community that encouraged these mortgages.

This is what happens when some politicians who know little about financial institutions and credit markets try to “do good.” Inasmuch as it is we, the taxpayers, who elected these people to write our laws, we are in a sense responsible for this mess. As voters and taxpayers we are responsible for electing people with good judgment because it is these elected officials who make our laws.

Is anyone to blame or is everyone to blame? What is most critical now is to keep the credit markets flowing with the capital that the economy needs. Without the free flow of credit, everyone will be hurt. Is it worth the $700 billion? Only time will tell. But the alternative could have cost taxpayers a lot more.

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui News, West Hawaii Today, Garden Isle News, and the HawaiiReporter.com.