Signs of common sense in D.C.

Published August 26, 2012

If one is a fluke and two is a trend, let us give thanks for the apparent trend toward common sense among, of all persons, some high-level federal bureaucrats.
Twice in the space of a few days top federal regulators have defended taxpayers and free markets — which is to say, anybody who buys or sells anything, meaning all of us — by rejecting pleas for bailouts.
Most recently, Securities and Exchange Commission Chairman Mary Schapiro rejected Knight Capital’s entreaties to negate billions of dollars of trades the company mistakenly exe-cuted Aug. 1. Runaway software cost the company losses estimated at $440 million, imperiling Knight Capital’s survival.
On July 31, Ed DeMarco, acting director of the Federal Housing- Finance Agency, stood up to Treasury Secretary Tim Geithner, other Obama administration officials and powerful Democratic lawmakers to reject a plan to allow Fannie Mae and Freddie Mac to write down mortgages for certain borrowers who owe more than their houses are worth.
Both decisions took courage as well as common sense.
Schapiro was blindsided but apparently unflustered upon receiving news that Knight Capital had ended up accidentally buying $4.5 billion of securities and wanted permission to back out of many of the trades. Her answer: You bought ’em, you keep ’em. She stood firm on guidelines the SEC insisted on after the “flash crash” in 2010 when hundreds of securities trades were canceled, angering many investors and traders and hurting the reputations of securities exchanges.
The resulting $440 million of losses could have ruined Knight Capital. Instead, something we’ve seen far too little of in recent years has happened. That something is called capitalism. Not crony capitalism or state capitalism. Just capitalism.
A group of companies has put up $400 million to keep Knight Capital in business. Those investors receive stakes in the company and seats on its board of directors.
Upshot: A major financial player has been rescued by private investors instead of by taxpayers. Existing Knight Capital shareholders will take a big financial hit, as should happen whenever a company’s mistakes send it reeling toward ruin.
Schapiro had to think and decide quickly. DeMarco, for his part, withstood months of pressure from top Obama administration officials and legislators who wanted him to allow Fannie and Freddie to write off mortgage principal on loans to “under-water” borrowers.
Shortly before DeMarco’s decision, the Treasury Department released a report saying the plan would save Fannie and Freddie $3.6 billion. This contradicted a 2009 statement from Treasury’s Geithner, who told a congressional panel principal reductions would be “dramatically more expensive for the American tax-payer, harder- to justify (and) create much greater- risk of unfairness.”
DeMarco’s FHFA expected fewer borrowers to participate than the Treasury Department estimated, for a net savings of $500 million.
“The potential benefit was too small and uncertain relative to known and unknown costs and risks,” DeMarco said in an-nouncing his decision.
Those risks included the possibility that thousands of underwater borrowers who are current on their mortgages would stop paying in hopes they, too, could end up with mortgage debt reductions. Such a program also could have been expected to stir resentment among millions of borrowers who did not use their houses for financial speculation or as automated teller machines to live beyond their means.
Schapiro and DeMarco did what was morally and economically right instead of what would have been politically easy. Too bad more people in Washington don’t do that.
Steve Stanek is a research fellow at The Heartland Institute in Chicago.