"We are not on the verge of a new depression. The housing bubble collapse in California, Florida and a few other states is not enough to bring down the entire banking system. Investors who made mistakes in these markets should be held responsible and those who navigated the Fed-distorted market should be rewarded for their wisdom and prudence. Enacting the Paulson plan will not allow that to happen and our economy will suffer for it in the long run. The Japanese tried to prop up failed banks in the aftermath of the bursting of their twin bubbles and the result was 15 years of stagnation. Why are we emulating a strategy that is a demonstrable failure? A better alternative would be to allow capitalism to work as it should and stop the interventions of the Fed in the money market. Trust capitalism. It works." Joseph Calhoun
Amen. The Wall Streeters like Paulson, the professors like Bernanke, and the true politicians like Pelosi have now managed to herd us toward a future in which government runs the private sector through "interventions" of the kind described in this article.
The members of the House of Representatives who have resisted this process of consolidation of the government and the plutocracy into one thing should be rewarded for their action. Let us hope that a lot of them vote against the TARP.
Calhoun is right. The markets will sort this mess out if given a chance to do so. They are in the process of doing it now. The TARP is the product of the desire of the wealthy to protect their equity in companies that have failed. To some extent the failure was caused by a misguided government policy of "guiding" banks to a policy of making foolish loans to people who had a low probability of success in re-paying them. Cleverness and greed then played a large role in devising elaborate and fantastical schemes for securitizing "empty" loans, loan futures, and "slices" of loans into tradable junk.
Finance is a truly Darwinian "arena." If it is not, then it is merely another government department. Is TARP a step on the path that leads to a planned economy? pl
PS Oil is at 101.15/bbl as I write.
As long as they draw the line on hedge funds, I am inclined to support. A complete collapse of the banking system would not just hurt a bunch of fat-cat investors but almost every facet of the economy. Sure, everyone is insured for $100k by the FDIC, but they’re scraping the bottom of the barrel, meaning they would come looking to the US taxpayers to essentially cough up money to replenish their own bank accounts. Would having 100+ banks under FDIC supervision be any less of an intervention in the free market?
Is TARP a step on the path that leads to a planned
In order to “plan” something, you must know what you are doing, which the government obviously does not know at present.
QED: Whatever this may mean, a planned economy it shall not be.
while the idea that there is “no free lunch” is widely accepted, the idea that there is “no free market” is strongly
disputed despite evidence to the contrary
we have a planned economy –
it may not be planned in the style of communist dictatorships but it is the product of debate, planning and legislation
the telecommunications monopolies are the rproduct of legislation, the patent system driving the pharmaceutical industry is a product of legislation, the health care industry is the product of legislation, the auto insurance industry is the product of legislation, the energy industries are the product of legislation
the financial industries are a product of legislation
as we grit our teeth and complain about the “bush -paulson” bail out plan, the government acts to strengthens the market positions of stronger financial entities with inexpensive deals
darwin would not call this an evolutionary process but the most fit are going to survive and the least fit are going to cease to exist
Citigroup Buys Banking Operations of Wachovia
Published: September 29, 2008
Citigroup will acquire the banking operations of the Wachovia Corporation, the Federal Deposit Insurance Corporation said Monday morning, the latest bank to fall victim to the distressed mortgage market.
Citigroup will pay $1 a share, or about $2.2 billion, according to people briefed on the deal.
The F.D.I.C. said that the agency would absorb losses from Wachovia above $42 billion and that it would receive $12 billion in preferred stock and warrants from Citigroup in return for assuming that risk.
“Wachovia did not fail,” the F.D.I.C. said, “rather it is to be acquired by Citigroup Inc. on an open-bank basis with assistance from the F.D.I.C.”
Under the deal, Citigroup will acquire most of Wachovia’s assets and liabilities, including $400 billion in deposits and will assume senior and subordinated debt of Wachovia, the F.D.I.C. said. Wachovia Corporation will continue to own the retail brokerage firm AG Edwards and the money management arm Evergreen.
The sale would further concentrate Americans’ bank deposits in the hands of just three banks: Bank of America, JPMorgan Chase and Citigroup. Together, those three would be so large that they would dominate the industry, with unrivaled power to set prices for their loans and services. Given their size and reach, the institutions would probably come under greater scrutiny from federal regulators. Some small and midsize banks, already under pressure, might have little choice but to seek suitors.
Wachovia has been hurt badly by its 2006 purchase of Golden West Financial, a California lender specializing in so-called pay-option mortgages. The bank also faced mounting losses on loans made to home builders and commercial real estate developers, and its acquisition of A. G. Edwards, a retail brokerage firm, turned out to be problematic. In June, Wachovia’s board ousted G. Kennedy Thompson, the bank’s longtime chief executive.
As the credit crisis has deepened, a consolidation in the financial industry that analysts have predicted for years seems to be playing out in a matter of weeks.
The impact will be felt on Main Street, Wall Street and in Washington. While the tie-ups may restore confidence in the industry, they also could leave a handful of big lenders to determine fees and interest rates on everything from home mortgages to credit cards to checking accounts. Some small and midsize banks may be unable to compete with these behemoths.
Both Citigroup and Wells Fargo were deeply concerned about absorbing Wachovia’s giant loan portfolio, which is littered with bad mortgages, these people said. Bankers had little time to assess the risk.
Citigroup executives considered Wachovia a make-or-break deal for their consumer banking ambitions. With Wachovia, Citigroup would gain one of the pre-eminent retail bank operations after struggling to build one for years. It will also give Citigroup access to more stable customer deposits, allowing it to rely less heavily on outside investors for funds.
Don’t know much about history, la la la la…From the NY Times:
“The rescue package, if successful, would make the recognition of losses and the inevitable winnowing of the banking system more an orderly retreat than a collapse. Yet that pruning of the banking industry must take place, economists say, and it is the government’s role to move it along instead of coddling the banks if the financial system is going to return to health.
Japan’s experience in the 1990s is a cautionary example of the peril of propping up banks after a real estate boom ends. The Japanese government helped keep many troubled banks afloat, hoping to avoid the pain of bank failures, only to extend the economic downturn as consumer spending and job growth fell.
The Japanese slump continued for many years, ending only a few years ago, a stretch of economic stagnation known as Japan’s lost decade.
“The lesson from Japan is that tough love for the banks is what’s needed,” said Kenneth Rogoff, an economist at Harvard. “In the current crisis, you do want to get rid of the bad assets from the banks, to get markets working again. But the key is going to be in the details of how the bailout works. You don’t want it to be a subsidy in disguise that keeps insolvent banks alive. That would just prolong the economic pain.”
I have no doubt that true capitalism works, but what we seem to have is rampant greed, from the CEO’s on wall street to the average American who wants a life style they can not and maybe never will be able to afford. As the Eagle’s song says “I want it all and I want it now.”. That has been our mantra and now it is crashing down around us.
I admire Warren Buffet’s financial savy and he seems to feel the bail out is needed. Maybe he is just trying to protect his billions who knows. I know I don’t. This too shall pass, but maybe not in our lifetime.
Is TARP a step on the path that leads to a planned economy?
I hope not (and my hope is driving my thinking!)
My understanding is that the vast majority of Americans HATE this bill. We won’t tolerate slipping towards a more planned economy. (there’s that hope again) Capitalism is in our blood.
What I do not understand is when regulating the markets crosses the line into planning the economy. We tend not to cover such issues in telecommunications engineering.
I always return to pre-Thatcher Britain as an example of a mixed economy leaning heavily on the planned side…when the British government owned so many of the heavy industries. Have we *ever* gone that far left? No. And I cannot imagine we ever would without some serious social upheaval.
Dems in Congress are scared of being accused of fiddling while Rome burns if, and when, the economy goes Tango Uniform and people lose their shirts in the stock market. Fear is such a great motivator.
Fear works on me, too. I am not convinced that an intervention is *not* the best solution to save the patient. Although there are more and more doubts being voiced by economists that the consequences are as dire as Paulson et al are saying.
This is a good time to reflect upon the Hoover administration:
“Hoover rejected the Coolidge-Mellon imperative to keep the federal government out of active participation in the economy — a plan that worked well during prosperous times, but not during a major depression. Hoover first stressed voluntary action by business and labor to keep the economy functioning, but the continuing deterioration of conditions forced a change. Hoover allowed the government to become the source of funding for construction and relief programs, but he rationalized this departure by developing self-liquidating programs and having state and local authorities administer them.
Finally, at the end of his administration, the formerly confident Hoover was a beaten man. He had been overwhelmingly defeated at the polls, unemployment continued to soar and the nation was stilled by a major bank crisis. As he waited for Franklin Roosevelt to take office, Hoover was tired, bitter and out of ideas.”
The Congress will enact the Paulson bill because it is afraid of doing nothing. If it does nothing until it gets the input of 100 (or 1000) leading economists on what to do, we’re headed for Hooverville.
This bill is a “bridge loan” until Jan. 20. Let the new government rework the plan at that time. Trying to get this current group )lame duckers and people running for reelection) to come up with an intelligent fix is simply not in the cards.
I feel I need to address another issue regarding the mortgage melt down. I have heard it implied that giving loans to illegal aliens in some part caused the meltdown. As a public health nurse, I work with the poor, legal and illegal. I have seen several families living in one house, I have seen several family members living in 1 room, I have never seen a family that was undocumented living in a home they have bought.
I am not saying this does not happen, I’m just saying there where I live in S. Calif, which has a very high latino population, I have not seen this.
I think what is happening is that anyone with a latino last name is being referred to by the right as illegal and that is just wrong. California has a large latino population that have been in California longer than most caucasians. They have fought in our wars in a higher percentage than caucasians.
I just believe that some on the right in their rush to vilify and cast blame, are doing a great disservice to a large group of people. They would do well to remember these people can vote.
Someone said something about Buffet favoring the TARP.
He should. He now owns five billion dollars of Goldman Sachs’ debt. pl
Good on you, Pat!
TARP is worse than Wall Street Welfare. Its a cesspool of corruption that rewards cronyism. It continues the now well established DC politician practice of treating US citizens as idiots while destroying our economic and legal framework.
I just want to bring to attention a few points.
First, look at the deep conflict of interest. Hank Paulson was CEO of Goldman Sachs from 1998 to 2006. On his watch GS was at the epicenter of the credit bubble. He personally profited from all the sham accounting that generated phony profits. Having being instrumental in imploding many a bank along with his other buddies on Wall Street he now gets to divvy up hundreds of billions of dollars of middle class taxpayer’s money to his cronies. This is unethical, immoral and just plain wrong. Neither he nor politicians like Barney Frank, Chris Dodd and Nancy Pelosi think anything’s wrong with this picture – when they have received hundreds of thousands of calls and letters from their constituents opposing this welfare for the wealthy.
Second, look how they treat us. They are crowing that they have put limits on executive compensation. That’s pure nonsense since they have done nothing of that sort. In fact the proposed legislation makes it explicit that existing compensation agreements including golden parachutes remain.
Third, the Treasury holds a conference call for Wall Street and not the public – making no pretense that they are an arm of Wall Street. They inform that the notion of tranches is just smoke and mirrors as they can draw down any amount they require. Although they are vague about pricing they insinuate that banks will not have to reprice downwards any of the securities which they would have to if they were sold to private parties.
Fourth, they argue that the the banks are too big to fail yet they allow them to get even bigger with all these sham “mergers” with the taxpayer guaranteeing all the losses on the illiquid securities.
Folks, this is Theft! Robbing the poor to pay the rich. But worse they treat us with utter contempt with this sham of a bill.
Like so many I do not trust Paulson. But what are all of us non-economists to do when the economists are so divided on the question of how quickly action has to be taken to increase liquidity? In the last week a terrible proposal for a finance czar was beaten back. That is a positive development. The current bill–if it passes–is probably the best that can be achieved in this Congress. It still does not address a host of serious economic problems. And it does not mean that in the future Congress will deal effectively with those problems, e.g., all forms of futures trading, including derivatives, that are NOT needed to raise investment capital but are desired by banks because futures instruments allow banks to make MORE MONEY. This crucial point has not been made by Barney Frank and Chris Dodd. (Dodd gets too much money from Wall Street to be totally trustworthy.) The show is still in the first act.
I’m tired of hearing this free market and trust capitalism rhetoric, it offers no solution to the problem. Capitalism as we have known it since the Reagan Revolution is dead. It is not coming back.
In Japan, they ignored their problems for a long time, but eventually they injected public funds into their banks. And it worked. Japanese banks are now profitable and buying bits of the U.S. financial system.
We will nationalize the financial system temporarily. It is inevitable. Taxpayer money should buy equity in these firms to be sold for a profit when they are healthy again. There should also be a tax surcharge on the wealthy to help pay for this.
Capitalism depends on a functioning financial system by definition. Unregulated use of derivative contracts has created a web on interdependent institutions which is now crashing down, taking healthy players down with it.
Capitalism cannot thrive without a strong public sector. I cannot think of a single place where it does. We have lost sight of that in this country, and we are now relearning a lesson that we once taught the world.
Given the range of informed opinion about “TARP”, it is difficult to determine whether the government’s action was necessary or even appropriate.
Mr. Calhoun speaks of failure of this bank or that financial institution, but he does not mention fraud as an element of the breakdown. Things will “fail” when they are no longer relevant, but they will also “fail” when the system is rigged. IMHO fraud is widespread on Wall Street. We are also learning how secretive the financial system became. That AIG did not set aside reserves for the transactions they were underwriting, is that a “failure” or is it “fraud”?
Unfortunately, little in this country get the benefit of sunshine; the government and corporations keep us in the dark; the game has been played without referees for too long.
So far, the government’s action has been limited to political intervention. Hopefully, prosecutors will work alongside real accountants (I will no longer call those keyboard jockeys “financial officers”) to gather evidence thus bringing the thieves to justice.
Keep in mind that a less-than-open free market brought us this mess; there should be reservation and suspicion about that market’s ability to right the ship without intervention. Until sensible and reasonable regulation and disclosure is introduced into the financial models, secrecy (and fraud) will be repeated again and again. Punishment for white collar-crime should be swift and severe.
We’ve got to get this done now; we can’t wait for the evidence to be a financial ‘mushroom cloud’!
Sounds like another manufactured crisis; of course having nothing to do with 30 years of de-regulation thanks to the neo-con economic movement. No worries Main Street America, Wall Street Welfare is much more important than your welfare. Early child care education? Sorry, got to pay off that debt. National Health Care? Sorry, look at the national debt!. Tax cuts? Why yes, that stimulates the economy. We can’t have some Democratic White House actually paying down the national debt (Clinton), what would happen to the stock market?
As was said earlier, there is no ‘free lunch’. No, not at all; just dinner and desert topped of with a nice glass scotch and a Cohiba.
Elect Obama and a Democrat-controlled Congress and you’ll see a lot more big government economic intervention.
Anyone who thinks that Democrats (dominated by unions, public employees and socialist university faculties) are capitalists is lying to themselves
Surely you jest? At what cost and who will bear the expense?
It would be wonderful if the world were that simple. It is just as easy to be a “true believer” in capitalism as socialism it seems.
Am I wrong in my judgement that banks nation-wide are withholding credit from quality customers in order to stampede this process?
Looks like a game of chicken from here. Standby for more heavy rolls as their grip is slipping and they need to regain control.
Here in the back end of Colorado for a time last week it was veery difficult to get any type of loan from the local banks by almost any customer. this is a liquidity crisis and if the loans stop much of both the mainstreet economy as well as the macro economy will stop. There are no good alternatives just bad and less bad.
We haven’t had from the 19th Century a ‘free market’. We have a regulated market operating under a bewildering variety of laws. It has crashed not primarily due to failures of capitalism, or grovernment intrusion, but from capitalistic excesses in any one who’s house appreciated over long term trends participated. To quote Pogo we have met the enemy and it is us’.
Oracle, I too do not trust Paulson because Lehman goes down via the free market but not AIG?
Conflict of interest for the Secretary?
You are correct the bailout is welfare for Wall Street; except the Wall Street Investment Banks are gone. TARP is a loan in the hope that you can keep using your credit cards until the next President decides how to handle the financial crisis.
What corporate broadcast media has not been discussing is the cause of the crisis; credit swaps. They were called “insurance” but are really bets made without collateral that the secularized mortgage securities would forever increase in value. NYT Times puts the total value of the credit swaps at 61 trillion dollars. More value than all the money in the world.
The weekend Washington Post had an article on a Prince Williams County VA townhouse that the bubble inflated in value to over $250,000. The owner lost it when she could not pay $230,000 Countrywide ARM. Freddie Mac is now trying to sell it for around $70,000. No buyers yet. The security that has this mortgage has just lost at least $160,000 in value not to mention any collateral “insurance” or loans on the books involved in creating and the leveraged flipping of the security.
Simply put all the money in the world has to be wiped off the books of the financial institutions. If John McCain is elected you are pretty much guaranteed a depression. Herbert Hoover is brilliant compared to Phil Graham, the champion of financial deregulation; McCain/Palin’s future Treasury Secretary. If Barrack Obama is elected, he will have to be smart and lucky in choosing from the following options to avoid a depression:
1) The financial system reboots after a Bank Holiday with the leveraged debt written off of the books,
2) The financial system is merged into JPMorgan Chase and Wells Fargo with all the leveraged debt written off of the books, or
3) US government nationalizes the financial system, creates the New Dollar and writes off all debt and charters hundreds of new banks.
This NY Times article on the AIG Bailout dramatically illustrates Hank Paulson’s conflict of interest.
With only around $45 billion of capital if Goldman Sachs had to take a $20 billion loss on AIG related positions it could have sent GS stock into a tailspin and would have likely impacted Paulson’s own net worth.
These are not arms length transactions. IMO, the first step to increase confidence in the financial system is to have complete transparency. I also believe that Paulson, Bernanke, Cox and Lockhart should be forced to resign. It makes no sense to have these guys who have proven to be continuously wrong in their judgments managing the aftermath of the credit bubble.
“The continuing survival of classical [economic] theory can be understood only when it is seen that classical beliefs protect business autonomy and its income and serve to obscure the economic power exercised as a matter of course by the modern enterprise by declaring that all power rests, in fact, with the market” (John Kenneth Galbraith).
The American public largely buys the Adam Smith narrative as retold over the past 30 years. Government intervention in the market is wrong. Often, the non-intervention principle works to the advantage of big business especially under a lax administration (there’s a hidden hand if ever there was one). However, some of the players forget themselves and stray from dogma when dogma proves disadvantageous and then they demand intervention or, more correctly, lots of money to cover their losses. The ones who remain faithful to the free market myth eat their lunches. Even a rigged table has rules.
Nationalize everything and hang the plutocrats
Putting aside for a moment our huge and justifiable rage at the unfairness of having already seen our little bit of paradise redistributed to the richest five percent of the population and now being sent the bill for cleaning up the toxic mess those same people have left behind, what, in even the broadest of strokes do those objecting so vehemently to the bailout plan suggest as an alternative? Do you simply believe that we can wait out the credit freeze? Can farmers who are absolutely dependent upon yearly loans and small businesses that can only maintain inventory and workforce by the use of short-term credit survive until the banks are willing and able to lend? Do you believe that the justice of making the Masters of the Universe suffer will justify the suffering of those at the bottom of the food chain? Do you believe that we will be returned to a simpler, purer capitalism by letting the current, rigged market define the outcome? Does society have a legitimate interest in shaping that outcome or must we stand by and allow the terrible machine of the markets to chew up everyone and everything that it will until some state of equilibrium has been reached? I am perfectly willing to be convinced that there is a better way, but I have yet to hear even the slightest notion of anything viable. The House Republican plan was a joke that envisioned the banking industry funding an insurance plan with capital it does not have and giving the same miscreants who concocted the schemes that got us into this a capital gains tax cut. Do you have something in mind that could actually be enacted that would be better?
Really, let’s hear it.
I can’t abide McCain. I served under too many like him.
I reluctantly endorse Obama for lack of someone better.
If there was ever a time for the creation of a real 3rd party this is it.
Hagel in 2012? pl
Well, now we’ll see which economists were right and who was wrong.
Hold on boys and girls…it’s going to be a wild ride…
Our (bipartisan) political elite seems to feel that they are ENTITLED to the trust of the people.
$700 billion was too much for the people to bear…they looked up from their labors and their worries and asked: “What the f**k do you guys think you are doing?”
Our dear leaders will learn that such trust must be EARNED and, once lost, is hard to regain.
Or, lacking other arguments, will they simply resort to fear in order to maintain their (bipartisan) control?
Jedermann brings up a good point: What’s the alternative to just saying no to the bailout?
I am not totally convinced that the situation is so dire as to hand over 700 billion to the current administration. The fed has increased its term auction facility by 330 billion and added 300 billion to its emergency loan facility. If the problem is liquidity, there you go, 660 billion to “settle the funding markets down” (Bloomberg). On the other hand, if the problem is solvency it may be prudent to go a little slower. The two problems require different solutions. Dead wood is dead; watering it won’t help. Making the taxpayer eat the loss and suffer through this recession adds insult to injury.
Politically, just as President Bush has sought to tie the hands of the next president vis a vis Iraq, he also seeks to tie his hands vis a vis the economy (Norquist bathtub metaphor, etc.). Bad ju ju. Simply stated, I would prefer the Congress, better the next Congress, deliberates before writing the check. So far, the debate has been brief and more grandstanding than substance.
According to Forbes… America’s richest 400 people are sitting on accumulated combined wealth of 1.7 Trillion dollars.
Why not ask them to stump up the 700 billion…..?
Say a 40 per cent tax on their wealth?
It would still leave them able to buy his and her 74’s’ next christmas.
Meanwhile….. tomorrow will be a very interesting day for the Hedge Funds.
Sept 30 is one of four days of the year when “clients” are permitted to withdraw some of their money.
I hear Hedge Funds have lost money hand over fist during the summer…. so by the end of trading tomorrow I expect many of them to end up hollowed out shells… and that goes for many other players in the “Shadow” Banking sector.
And the Dow has just suffered the largest one day drop in history.
Get ready folks, this is going to be big. The market just crash nearly 800 points.
we are now beyond “calming the market” by saving investment bankers.
It is now about assuring japanese house wifes, chinese middle class, and asian investors.
If all of them bail out en masse. We are going to be talking about Korean style crash.
My SWAG would be that the markets and credit facilities will start to recover in a week or so when it is discovered that this is not the end of the world. pl
A new Treasury Secretary.
It’s not like Paulson has to worry about losing his health coverage.
It is fitting that the orderly solar process of the U.S. Congress is interrupted midweek by the first day of the lunar month Tishrei (Arabic Tishreen), the seventh month of the Hebrew calendar namely Rosh Hashanah (Hebrew: ראש השנה, literally “head of the year.”
Unlike Jan. 1 which can be a time for lighthearted celebration, this day ushers some solemnity. From wikipedia:
“Rosh Hashanah is the first of the High Holidays or Yamim Noraim (“Days of Awe”), or Asseret Yemei Teshuva (The Ten Days of Repentance) which are days specifically set aside to focus on repentance that conclude with the holiday of Yom Kippur. ”
I think we should be careful of the “financial system collapsing” rhetoric.
There will always be some capital and people willing to lend it at some price. Tony Soprano’s business gets better in a recession.
What will and unfortunately should happen is that credit will tighten — perhaps suffocatingly tight for a while. I agree that this is scary.
I don’t see why this is not the government’s response:
1. Nationalize the lenders that need taxpayer money (we should have nationalized wachovia rather than let citigroup buy it now — the taxpayer is on the hook for potentially $240 billion of that one despite citigroup getting all the equity) rather than prop them up.
2. Strip out the bad debts from the nationalized institutions and seek to rework via aggresive negotiations with creditors and slightly less aggresive (for political) reasons negotiations with home-owners. Haircuts now! should be the rallying cry — it puts the pain up front rather than getting into a japanese death spiral.
3. Sell off reworked debt over time — this could be very expensive BUT
4. Taxpayers have all the equity in reworked istitutions and can sell them for every ounce of what the market thinks they’re worth in the coming years.
5. Write sound regulations that recognize the great need for serious government oversight of not just institutions that operate with explicit government guarantees but also of those parts of our financial system (the “too big to fail” brigade) that politics demand we bail out when things go pear-shaped.
I don’t find claims of special government incompetence, and special wall street/private finance in these matters persuasive arguments against nationalization.
In a former life i was a financial journalist in southeast asia. Financial system there blew up in the mid-late 90s because of lack of sufficient oversight and corruption. The IMF, led by the US forced a number of these countries to pay vast sums of money to wall street firms for advice on how to fix their financial systems. Biggest hitter of them all? The financial “geniuses” at Lehman Brothers.
Doctor, heal thyself.
A comment or two up-thread blames “rampant greed.”
That’s like blaming the sun for rising.
Greed is there. It’s always there. It always will be. Blame the regulation, not a fundamental fact of human financial behavior, for where we’re at. There is no way to legislate greed out of existence.
Failure to account for (the positive motivating effects of) human greed helped lead to the collapse of communism.
Failure to account for (the corrosive effects of) human greed could also lead to the collapse of capitalist systems.
The answer lies in harnessing greed.
Yes, finance is truly a “Darwinian” arena–not! Witness the visible hand of the Treasury guiding insolvent banks to other equally insolvent financial institutions. The result will be a national banking oligopoly and the end of real competition. Insolvent financial institutions that Paulson selected for survival will garner much higher profits in the future at the expense of savers and borrowers alike.
“The deal further concentrates Americans’ bank deposits in the hands of three banks: Bank of America, JPMorgan Chase and Citigroup will control more than 30 percent of the industry’s deposits.”
The only remaining questions: 1) Did Paulson go into the crisis planning to exploit it for the beneift of a few big financial institutions? 2) Will Congress let him get away with it?
Instead of forcing mergers or buying trash for cash, it would be a much better idea to directly recapitalize a wide swath of financial institutions and maintain a competitive industry.
I always believed something has to be done. Obviously something failed today and our congress will try again later this week or next. So why not look at some better ideas that are more transparent versus hoping, praying or crossing your fingers for better days.
My suggestion. Take the 700 billion or less and have our government buy up distressed homes (250K cap), hire 20,000 people from the unemployment rolls and put them to work fixing these homes, renting the homes out to individuals in need and then sell the homes when the market has stabilized and on the upswing. That is transparent and should help all parties. At least its a start.
‘What I do not understand is when regulating the markets crosses the line into planning the economy.’
This one is easy. It is ‘regulating the markets’ when you approve of it, and ‘planning the economy’ when it disadvantages you
“My SWAG would be that the markets and credit facilities will start to recover in a week or so when it is discovered that this is not the end of the world.” pl
There are 117 banks on the FDIC’s “in trouble” list. I’m not sure where your optimism comes from.
Meanwhile, a fairly good explanation of why Wall Street IS mainstreet can be read here:
It seems we have a lot of comments from armchair generals on this one. I would like to read comments from people who have lost a job or money(other than a reduction in value in a 401K)in this mess. Lets hear from stockholders and bondholders in the defunct and soon to be defunct banks and corporations. lets hear from bank and brokerage employees who, tomorrow may not have a job. If all of these people are out on the street we will be paying a high price in both unemploymment benefits as well as social agitation and dislocation.
Here’s my attempt:
Whereas our economy is screwed, and
Whereas we are a nation of credit junkies who will start wars halfway across the world to guarantee our supply of gasoline and
Whereas our financial system is a hopeless tangled mess of greed and corruption
I submit that we should do what we always do: replace this housing/credit bubble with the next one. We are not a nation to own up to our mistakes and clean up our messes! Not us! We are a nation of delusional innovators, who keep their heads above water by abandoning failing markets and creating new ones out of thin air.
Therefore, we need to get that next bubble going so we can transfer all this imaginary wealth into a new industry before the house of cards comes crashing down.
For years we have resisted beginning an energy revolution in this country. Well now it can be a whole new bubble. It addresses climate change, the wars we’re losing, and the American economy. Obama has declared he would spend $150 billion over 10 years to make it happen. I say double or triple it. If we’re prepared to spend $700 billion to prop up a system that never worked, but only impoverished almost all of us and despoiled the environment, then shouldn’t we be willing to spend (i dunno, make it a nice big number like they say at Treasury) $500 billion on solar panels and wind farms and Detroit’s latest zero-emission cars? There are enough mature technologies in the alternative energy sector now to attract serious investment and venture capitalists have increased their funding for them over the last two years over 400 percent (i’ve heard).
If we’re throwing around ginormous piles of cash, we might as well do some good with it.
Well, you’re absolutely wrong, as the fool you quoted.
I have no direct interest in this, but anyone looking at the American credit markets can see that you are teetering on the edge of actual financial catastrophe. Interbank market now pratically has ceased to exist, ex the Government window at your Central Bank. BTW, the interbank market, to educate you, is the willingness of banks to lend, market rate, to each other, to cover cash needs, and is fundamental to proper credit market functioning. When one sees this collapsing and ceasing to function (without government intervention), you’re looking at an economy that is in deep shit. Indeed, what we’re seeing is looking rather like America wants become the new Argentina of the world. No interbank lending means cash hoarding, short term lending to firms at exploding rates to cover risk, and a serious contraction overall. No theory there, we’ve seen this happen again and again in badly run Third World countries where populists and economic illiterates ran policy.
As for the question above on the diff. between Lehman and AIG: Lehman was a big pure I Bank, system exposure not that bad, and its wind down was no surprise to those of us watching.
AIG is a global financial firm with USD 1 TRILLION in assets, and major cross exposure to all kinds of financial institutions, and its sudden effective cash flow insolvency was a huge surprise. Expected things are rather less likely to cause panics.
AIG blowing up, disaster of biblical proportions for global markets.
Frankly Lang, stick to things you know. Economics is not your area.
3rd party? I’m all for that.
I got my absentee ballot today (Florida) and there are 13 options for President – half of the names I recognize.
There are several suggestions for solutions that I think are a lot better than just handing over a trillion dollars to Hank Paulson to palm off to his cronies.
Below some solution ideas:
Economist and fund manager John Hussman’s plan.
Economist Nouriel Roubini’s view of the Paulson Wall Street Welfare plan and his solution to the financial crisis.
Then there’s Warren Buffet’s investment in Goldman Sachs an example of a private “bailout”.
I think the most sensible solutions to address the immediate crisis should include the following:
1. Transparency. All publicly traded financial institutions should immediately disclose a detailed balance sheet (not summaries). What will that do? It will enable investors to determine who has a liquidity problem and who are insolvent. It will eliminate balance sheet fog.
2. All OTC derivatives should be should be moved to public exchanges or else netted out and unwound. This would allow standardized contracts and margin management and reduce the threat of financial WMDs as it will all be out in the open.
3. Insolvent banks should be handled through the existing FDIC process. This means management and shareholders get wiped out and bond holders take a haircut.
4. Banks that are solvent but have illiquid assets should re-capitalize as GS and Buffet have demonstrated.
5. Taxpayer’s are only on the hook for FDIC insured deposit losses. Insured depositors are made whole.
6. Banks should not be permitted to lever more than 12x. Those that are “too big to fail” are “too big to exist (thanks Bernie Sanders)” and should be broken up.
Bottom line is that financial institutions should be able to work through their problems with minimal taxpayer assistance. That means Wall Street CEOs like Hank Paulson that created this problem will have to take a personal hit to their net worth. They will still have a lavish lifestyle and huge wealth.
IMO, tax dollars will be needed to soften the blow on Main Street as the recession hits hard – some predict with gale force winds leading to significant unemployment. That means we will need to make choices as we have to tighten our belts. The baby boomers start to retire this year and Medicare drawdowns will become enormous over the next decade. So substantial cuts in discretionary spending and defense will become necessary. I tend to agree with those that feel substantial public investments need to be made to our national infrastructure to upgrade it to the 21st century – investments in mass transit, power grid, broadband, energy efficiency, etc. Economic policies that channel significant effort to increase the productivity and real wages of the middle class should be favored. Wage income growth for average American has been in decline over the past several years. A re-orientation of incentives towards savings and capital formation and away from consumption. A business climate conducive towards private investment in plant and equipment rather than retail and housing. A monetary policy that focuses on a sound currency as opposed to asset inflation. We need a political environment that brings our people together in a new Manhattan Project around energy independence and the similar kind of focus and effort as we had in building the interstate system for a 21st century infrastructure.
But…we should also not forget the lawbreakers and traitors. All those that subverted our constitution and committed treason should be brought to justice.
A proposal regarding terminology:
A planned economy is probably not in the cards as that is associated with communism and state ownership of all the means of production.
A (well-)regulated economy is what could have prevented the current mess. That would have implied to, e.g., not grant exemptions from the capital-to-assets-ratio rules.
Then there is pure economic laissez-faire – which is kind of the mark-to-myth version of classical economic theory.
Finally there is the corporatist paradise: a command economy that is perfectly compatible with private ownership, but also very much responsive to the political leadership that insulates it against criticism from the rest of society.
Yes, there has been a whiff of the latter in the air.
We will see.
I have serious misgivings
about any plan cobbled together in a panic over a sleep-deprived weekend by
a bunch of people whose grasp of the issue is highly questionable at any rate.
Eventually the worthies pass this turkey. The Dow shoots up 1500 points. I liqidate my stock portfolio, move to a cabin on Great Slave Lake and live happily ever after.
It should also be noted that certain forms of bad regulation – protectionism – are historically and geographically ubiquitous and not indicative of any particular type of economic regime.
Deregulation, on the other hand, could trivially mean relief from overregulation, but in its latest incarnation referred to eliminating one set of rules – those of risk assessment – and substituting another set of rules – those of supposedly diluting risk almost indefinitely by hedging, securitizing, packaging, slicing and insuring it.
Lounsbury old thing.
We shall see. I expect an apology if you are wrong. Bought any oil lately? pl
This may have already been mentioned elsewhere, and if so I apologize. An interesting dynamic playing out here within the GOP is the battle between the Wall Street wing of the GOP and the “Bubba” wing of the GOP….Bubba won…and I am glad.
The near future is probably unknowable at this point… there are simply too many factors in play, and we don’t yet know which are the most important.
Post-mortem analysis of recent administration decisions (e.g., the choice to let Lehman fail) has indicated that the unintended consequences of those decisions may be turning out to be worse for the economy than the known effects that were being avoided, so I’d suggest that the one thing we know for certain is that we don’t know all that much for certain.
So I’m sticking with my own summary from six months ago here at SST, namely:
So we’re headed for trouble, and we have the economic equivalent of the Bush administration Katrina rescue team now on the job, making things up as they go along, and sacrificing the citizenry while they protect the well-connected. Heaven help us all…
The Bush administration is clearly still making it up as they go along (Exhibit A: the ridiculous original Paulson proposal), they’re still trying to protect the well-connected at the expense of the general citizenry, and such ill-considered special-interest economic measures seldom work out well in the long run.
Heaven help us all…
Somewhat off topic but
If the hedge funders get caught out in a short wringer by 1 Oct., I would guess oil futures could decline to $75 a barrel.
I once worked for a regional “Street firm”. It was strictly Carolina League; a mix of retail and small institutional investors. After 2 years or so, I realized that if I wanted to go to big leagues,”the Show” I would have to work for a firm like Lazard or Goldman, as an investment banker, or in institutional sales.
I realized, when I thought about it, that the whole game was about selling hamburger-tainted or not- to people less smart than you. Management is always about moving the meat, clients be damned.
It was something I ultimately chose not to indulge in.
Michael Lewis once worked as an institutional bond salesman with Solomon Brothers in NY and London.
He was in the Big Leagues from the start.At Salomon, Lewis met the legendary trader, John Merriwether, who later loosed Long Term Capital Management upon the world.
Lewis stayed for about two years.
And he wrote the most hilarious book about the “Street” I have ever read.
Check out Lewis’ Liar’s Poker. You’ll be glad you did.
And I apologize for stealing a few words from that great baseball movie, Bull Durham.
What has all this got to do with real people? Except those (most of us) whose lives and livelihoods have been hijacked by ‘free markets.’ Which are not free. At all. Credit crunch? Loans? To whom, for what? Various figures I have seen put the value of the derivatives ‘market’ (game) at 65, or 300, or 600 _TRILLION_ dollars. Really? This ‘free market’ can’t be saved by a ridiculous trillion dollars of relative spare change. Roubini has had this clearly described for years. And the best course that can be hoped for now – but his advice now will get the same attention that his warnings did leading up to this fiasco.
Free markets? Move to Cuba, or found a third party based on telling the truth, and the constitution. Hagel in 2012? I’ll buy it.
I’ll take Buffet’s advice. If I can’t understand it, or you can’t explain it to me in plain English, I will not invest in it.
No Politician (nor appointed official) in Washington can explain this in plain English–ergo no-go.
Hmm, its interesting to see the virulent reaction so many posters get from the term “planned economy”. Over here in Scandinavia, we had a similar crisis in the late 80s wich resulted in most banks being bought by the state, and then privatized back into the markets with the state retaining strategic shareposts in some of them. This allowed the state to influence the decisions of banks, and caused a refinancing of the banks without any loss to the taxpayers. In much the same way, the state retains various shareholding parts in many central industries, and has a very active investment fund run under the control of the (suppsedly) neutral national bank, injecting money and investment here and there. In no way has this hindered free trade in norwegian economy, rather it has served as a buffer against monopolization and inside trading, because the state has representatives in many big boardrooms and is on the inside instead of on the outside when it comes to regulation. Its called the silent agreement. It works fine. Why, sirs, is this a bad thing?
The human cost in any restructuring is very painful. But in this case – the layoffs in the financial industry are relatively small compared to other industry downturns we’ve had in the past – the collapse of the energy patch in the 80s/90s; rust belt and textile industry closures; the restructuring of the aerospace industry in S. Calif as part of the Cold War dividend; the ongoing shrinkage of the auto industry since the late 70s. In the aftermath of the S&L bailout in the 90s over 700 thrifts were liquidated. The tech/dotcom bubble unwind did cause significant layoffs. The number of real estate agents looking for other career paths is rather large. I believe the choice is between a prolonged stagnation like Japan or a sharp recession with clearing prices for assets. Neither is pleasant but we are going to have to deal with the hangover after the binge. I hope we make the adjustment quickly and get back to work rather than prolonging the agony.
LIBOR/OIS and other interest rate spreads have melted up and many swaps markets are bid-only, for a simple reason IMO. Opaque counter-party balance sheets. Every bank knows the crap they have on their own books and suspect the worst for their counter-parties. Another reason is predatory strategy. Better to hold liquidity. And why not central banks are being profligate – $630 billion pumped just today. While Paulson was getting his handout smacked, Bernanke had the helicopters in full drop mode. And don’t be too condescending the stress in Europe is even worse! Note that most of the highly levered swaps trade happen out of London. We don’t know yet all the ramifications of the Lehman bust. It no doubt had some impact on the run on AIG. Clearly some hedge funds who used Lehman as their prime broker have some hang time while their positions may be heading south. BTW, the AIG CDS blow up was no surprise to many. In fact this whole credit bubble unwind is probably the most well publicized and predicted financial event in the past 3 decades IMO. Some of the smartest investors I know got liquid early. You’ve got to give it to Sam Zell to time it. And some unsolicited advise – don’t bet against Pat lightly – he’s one smart dude!
You are right – “they’re still trying to protect the well-connected at the expense of the general citizenry, and such ill-considered special-interest economic measures seldom work out well in the long run.” IMO, this is not just about incompetence but arrogance and corruption. My biggest concern is the severity of the recession on Main St which has yet to arrive in full force.
“Do you have something in mind that could actually be enacted that would be better?”
An excellent post. But first, just a quibble about the logic.
We know that this failed plan had it’s certain downsides of course, but we didn’t know if it was going to work even. Just like we don’t know that *not* suffering those downsides and doing nothing might work. So one just as legitimately might ask how you know that doing anything is better than doing nothing?
However, given that it still seems reasonable to believe that something *might* need to be done, how about this:
As I understand it all this was to make sure the credit markets didn’t freeze up and refuse to make reasonable loans into the future and see the parade of horribles you mention.
So instead of bailing out the people who stupidly made bad loans in the past, or even the people who stupidly incurred those bad loans in the past, why not make the government the lender of last resort?
After all and again, supposedly we are doing something not because we’re worried about a failure to make even more bad loans inthe future, but because good loans might not be made, right?
So what’s wrong with the gov’t being ready to step in and make those alleged good loans that are supposedly going to go begging?
If the financial system don’t want the profits that results from the interest on same, as a taxpayer I’ll take ’em.
And while of course it’s socialistic, first of all so is all this other crap being talked about, and secondly it don’t have to last forever. Presumably the financial markets will recover at some fairly near point, so sunset the damn program after two years.
Biggest and maybe impossible hurdle would be administration of this, but wait a minute: That last plan that just went down the toilet would have been tough too. And there is some existing infrastructure already to help: The Small Business Administration (to be renamed “The Any Business Administration”), the various Farm agencies, the various housing agencies and etc., etc.
If one looks at the details of this last thing that just got flushed it’s my understanding that everyone agreed that the loans that Paulson was to buy would in no way be limited to just bad mortgage-related ones, so how does my plan differ other than to celebrate Adam Smith and Milton Friedman and etc. by leaving those who took and gave bad loans to the tender mercies of their own bad judgments?
you mis-interpreted my post. All of the comments so far on this blog have been by people who have not lost or gained anything directly(except me as a Lehman bond holder).It is easy to make flip comments and pronouncements when you have nothing at stake.
Have Cieran’s questions about timing: “Why now? What’s the rush?” been answered?
My SWAG would be that the markets and credit facilities will start to recover in a week or so when it is discovered that this is not the end of the world.
Oh goodie – it’s SWAG time!
Looks like you are concentrating on Wall Street. I’m going in for the entire economy.
Here’s my theory of when all this mess will finally end.
The entire mess revolves around the housing bubble. If my memory is right, in a “healthy” housing market, gains are typically 5-7% per year. I predict that the entire economy will not recover until the median housing price drops to what it would have been if we had had a healthy housing market rather than a bubble.
The bubble started around 2000 and ended roughly around the last quarter of 2005. Prices have been dropping since.
In 2000, the median home price in the USA was $119,600. It peaked at around $225K. If the market had been typically healthy, the median price the last quarter of this year would be around the $190K mark, give or take a percentage point.
Looks like the August median home price was $203,100 so we have about a 6% more drop before we even start digging our way out.
I looked at past housing slumps and it seems everything is stagnant about 3-6 months at the bottom.
So, here’s my official SWAG:
The housing market will bottom out in about 3 months at the nationwide median price of $190K (+/- 1%), and then stay flat for another 9-12 months while Wall Street toxins are flushed out of the system. The stock market will drop to around the 9,000 mark during this time. Oil will drop below $75bbl. We’ll be in a recession all of 2009. Housing will slowly start inching up in Q1 2010 when the recession is over.
Here Endeth The SWAG
More Hagel, less Hegel?
Sen. Hagel stood tall and opposed our foreign policy deceptions and lies in the Middle East before it was cool to stand tall, so he’s the man, at least when it comes to standing up to warmongers with soft hands, which, at one time, has included many fashionable Democratic leaders.
And after watching Hagel and listening to his questioning of Gen. Casey during the confirmation hearing in 2007, the Nebraska admiral proved himself more favorable to even ‘ol Born Fighting himself, at least in that one instance and at least in my opinion. Born Fightin’ was too chummy with Casey. Sure, Hagel may not have been “born fighting”, but he sure seemed willing to die fighting on behalf of America, meaning political fortunes be damned.
Without Hagel in the running, at least not now, it would be reassuring if the Democratic party would endorse something that is consistent with Hagel’s view — the 2007 NIE. In fact, perhaps the Democrats should make it part of the campaign strategy, meaning that they run commercials focusing on the findings of the NIE that end with the familiar Obama refrain, “I am Barack Obama and I endorse this message”.
So why haven’t the Democrats done so? Fear? I mean…geez…is it now unAmerican to support the NIE? Has it come to this? So much for moral courage on the part of Pelosi and company. Now I am not talkin’ about Obama necessarily, as he seems to like Hagel. But, instead, it’s some of Obama’s most trusted supporters — the ones who, relying traditionally on Hegel not Hagel, will use a centralized government to lift the rest of us out of the darkness of spiritual and material bondage and lead us to the utopia of yellow submarines and the such. Not unlike Bush Republicans, just expressed differently.
As Hayek and Orwell prophesized, the leaders of such a central authoritarian government will tell us how to think and act and even lead us to their version of “wholeness”, plus maybe even a little nuclear war as a sideshow. Way cool. I always thought that there was a chance that the ones who would drop the bomb would be the same ones who drive expensive European cars with a bumper sticker that says, “Visualize Peace”.
But I’m jumping ahead. First the upcoming VP debate. Biden — the man who talketh much — could have a field day if he mentions the 07 NIE to Ms. Palin and then question her about same. We’ll see. If he does, then I’ll probably vote with the enlightened ones of daily kos but fully expect to achieve saccidananda in return, courtesy of centralized economic planning and an authoritarian state.
If Biden fails to mention and support the NIE, …well…I am not sure yet. Assuming I am allowed to do so, I may just write in the proper noun, “Ron Paul”. Proper indeed. Sure looks like Paul was proper back before the financial fall. Much like Hagel and much unlike Hegel, Ron Paul stood tall before it was cool to stand tall.
And, if nothing else, those daily kos Democrats are cool, especially compared to all them thar’ folks from Palin’s culture who dared to vote Democratic in the past but now are considered the untouchable caste by all them thar’ tax supported and latte drinkin’ Brahmins of Democratic fame. You know the ones I am talking about — the ones who later go on to make millions holding worthless jobs at Freddie Mac and Fannie Mae.
It is of great interest to me that a large portion of the credit crunch is banks unwilling to lend money to other banks and financial services sector firms. Why might one ask? Stated reason is lack of trust but also I believe no accurate info. Certainly none as to valuation issues of various financial instruments out there in the wild blue yonder. Well we know for sure that both the FED and Treasury are arguing that there are no valid statistics and regulatory info provided to them on the total of derivatives and CDOs (Credit Default Swaps) and other elegant financial instruments because in part they were simply unregulated. Given that above circumstance isn’t it interesting that all of this is being done on the basis that “Someone” told Paulson and Bernanke about the issues and problems because the FED and Treasury really have no first hand info. I wonder just “Who” has been telling them about the problems and of course suggesting solutions. NO TRANSPARENCY ON ANY OF THIS KABUKI! Or is it the NO(h) theatre.
I’d like to point out the following……
We in the english speaking democratic west, a generation or so back, were persuaded that our future lay not in the boring repetitive slog of manufacturing physical items of measurable value but in the exciting opportunities opened up by the “Service” industries, the “Financial” Industries etc.
Those who were bright enough could earn bonuses selling Insurance to those who don’t need it…. those not bright enough could manage a tanning Salon… and the rest could flip burgers.
All of this was was to be built on DEBT.
A Credit card does not put money in your bank account, it is not credit… It is a DEBT Card that allows some financial institution and those who run it to own a chunk of your income.
This started under Reagan and Thatcher.
Thatcher proudly referred to this as the “Post-industrial” society.
We (the UK\USA) now have FIRE economies based on Finance, Insurance and Real Estate.
As for the so-called “Finance” industry….. it has spent the last ten years inventing computer generated algorithms (that not even those who designed the programs understand) that have packaged up Debt, disguised it as incoming wealth, sold it on to suckers world-wide, and creamed off hundreds of millions of dollars a year for the favoured few in the form of “Bonuses.
The Median income of an American has dropped by 2,000 dollars a year under Bush.
In the fiscal year 2006 the richest one per cent of Americans collected a bigger income then the poorest ninety per cent.
And don’t even ask why it is America has by far the most expensive Health system on the planet but is ranked so poorly in health outcomes compared to other countries around the world.
PS… another interesting figure I came across the other day… in 2006, the “Finance” Industry employed around three per cent of working adults, but scarfed down over thirty per cent of corporate profits.
William R. Cumming
There’s the aha! Why can’t the SEC, Fed and the Treasury get all publicly traded financial institutions to open their books and let investors know exactly what assets they own. Instead of the summaries they provide now. The mistrust will evaporate instantly as investors and lenders can make their own determination what each security is worth on the balance sheet. Of course for some institutions that would mean certainty that they can’t borrow under any terms but for others there will be access to funds on some terms. But that also means Paulson can’t pay top dollar for toxic assets from his favored friends with our money.
You get it! In 1980 the financials represented 6% of the cap weighting of the S&P 500. By 2006 they represented a quarter of cap weighting and a third of earnings.
PL, I’m not at all confident the US, and much of the rest of the world, isn’t “on the verge of a new depression”. The fundamentals that have traditionally made one possible (extremely high gearing, heavily inflated asset prices and severe misallocation of capital) are all present and have, unfortunately, been supplemented by new twists like the opaque and ubiquitous world of OTC derivatives. This toxic mix has been brewing for a long time and we seem at last to be in the denouement phase. While Calhoun writes well and presents parts of the laissez faire case quite nicely, I think he gravely underestimates the severity of what’s underway.
Like you, and Calhoun, my natural inclination is to trust the market to sort out most problems. Indeed, had they been allowed to do so over recent decades, we wouldn’t be in this mess. It’s the persistent unwillingness to suffer short term and necessary pain (in other words, to allow creative destruction to do its job) that over time utterly distorted risk perceptions and so allowed things to come to such a pretty pass. Given that unwillingness (hardly a surprise in a social democracy), the financial markets should have remained fairly heavily regulated. They’re far too important to have been given daddy’s credit card with which to conduct extravagant experiments.
Still, that’s all history and can’t be unwritten.
Had Calhoun’s advice been followed, I have little doubt we’d already be deep in depression. The process of debt deflation that always lies in wait once system wide leverage is high enough (and, Lord, knows, it’s never been anywhere near so high before) would already have swept through like a hurricane. All it needs to set it in train is for the sort of blithe and ignorant confidence that characterised recent years to be sufficiently shaken. Few banks would still be standing, lending would have dried up almost entirely, the markets would be in complete disarray and firms would be falling like leaves from autumn trees. Oh, and asset prices would be in the tank.
If all prices were free to adjust down as credit is destroyed in such a debt deflation, then things might in fact work out quite well after an absolutely traumatic 6-12 months. Assets and businesses would be priced at mouthwateringly juicy levels and those who still had some capital could start rebuilding from a far sounder base. But they’re not, particularly not wages. More than anything else, this was, I think, what turned the 1929 crash into the Great Depression. All the attempts to hold up prices and wages were precisely the wrong thing to do. They needed to be allowed to decline along with the prices of assets, which of course fell along with the broader money supply in a reflexive process. Only then would the relative prices allow for profitable, soundly based business to once again be done.
Without that flexibility, we’re faced with an unhappy dilemma. Do we allow things to take their course in the financial markets (as Calhoun suggests) and quite possibly endure levels of misery and unemployment that could match those of the Great Depression, and linger for year after year as successive governments try all the usual nostrums but refuse to let the wider economy also adjust? Or do we try the Japanese route, keeping things apparently intact, socialising losses, trying to hold up prices, taking on vast new public debts, effectively appropriating private sector savings to spend on various make work schemes? Or perhaps some uniquely American mixture of the two?
It’s by no means certain, in any case, that the US has the option of taking the Japanese route. When their hard times hit in 1990, they were a large net creditor and ran a decent trade surplus. Whether it was good policy or not, they could at least afford to finance their own bailout. No such luck for the US. It’s deep in the hole and has, as yet, shown no signs of finding a way out.
This is a seriously large problem, one whose origin, nature and eventual resolution will be debated and analysed for decades, perhaps centuries, to come.
Here’s what I don’t understand… The big issue right now is that the credit market is “clogged” and banks are not lending – not to each other, not to businesses that need the money for growth, etc., etc. However, where is all the money that was pouring into CDSs (their volume was doubling every year, but the brakes are on as no one wants to buy them any more given the uncertainty) and these other financial instruments? Is it all being held as banks, institutions, etc. are scared of taking any risks and want to keep liquid?
It’s not the fact that they loaned money like drunks to anyone with a pulse (and even some without) that is causing the current credit “clog” problems, it’s the fact that they now have a hangover and have suddenly turned parsimonious and are hanging on tightly to their money and not loaning it to good prospects!!
Possibly this is a ridiculously silly suggestion (otherwise surely someone would have suggested this), but perhaps the government intervention shouldn’t be on the “back end” (i.e. helping the financial companies clean up their toxic waste), but on the “front end” i.e. some sort of federal guarantee of all new loans struck provided they meet certain criteria… (related to ‘real’ underlying assets vs. second, third, and fourth order derivatives that are mostly ‘air.’)
Check out the cartoon at the link below. It is sheer genius – explains part (not all) of the current crisis much better than about 70% of all the articles I’ve read (the origins of the crisis, not the proposed solution):
I’ll take Buffet’s advice. If I can’t understand it, or you can’t explain it to me in plain English, I will not invest in it.
“Possibly this is a ridiculously silly suggestion (otherwise surely someone would have suggested this), but perhaps the government intervention shouldn’t be on the “back end” (i.e. helping the financial companies clean up their toxic waste), but on the “front end” i.e. some sort of federal guarantee of all new loans….”
Tosk, it’s either ridiculously silly or you and I are just unrecognized geniuses in our own time since I suggested something like the same just a few posts before yours and the response was deafeningly non-existent.
In any event I differed from you a bit by not advocating the gov’t guarantee loans but instead make ’em directly for awhile and I’d stick with that idea. Again if the idea is that this “crisis” will make getting “good” loans impossible, then why not have the gov’t make ’em directly? But to let someone *else* decide if they are good or not and then to *guarantee* them, nuts, isn’t that what Fannie and Freddie were in essence already doing?
Tosk, Tom B:
Banks won’t lend to each other in substantial measure because they simply cannot assess the risks. This is largely the result of the perverse combination of the creation of ultra-complex financial instruments based on mortgage debt and the housing bubble. Many of the products of the so-called ‘rocket scientists’ would be hard enough to value accurately in more stable times. Once you add in the fact that house prices are heading down, but nobody can judge how far they will fall, while foreclosures are increasing, but nobody can judge by how much they will rise, the likely returns on these securities are extraordinarily unpredictable.
But there is a larger problem that as falling asset values in highly leveraged institutions leaves many of these quite patently undercapitalised. Undercapitalised institutions are forced to try to reduce their assets, and, of course, this means they will make fewer loans, even to portions of the U.S. economy which are in a state of robust health.
Recapitalising the banks is one of the things that the Paulson plan was trying to do. Unfortunately, in addition to the other problems involved in taxpayer bailouts of precisely the people who caused this shambles, the evidence from how recent financial crises suggests that public acquisition of bad assets is a highly ineffective means of getting these back into a state where they will lend.
A recent IMF study, discussed both by an admirable lady called Yves Smith at the Naked Capitalism blog and by Nouriel Roubini, suggests that such public acquisition is less effective than direct recapitalisation of the banking system. The technicalities of this are beyond me, but it appears that a wide range of private sector mechanisms have been used — such as stopping dividend payments, debt-for-equity swaps, requirements for matching Tier 1 capital injection (whatever precisely that is) by current shareholders. Alternatively, or in addition, there can be public injection of preferred equity.
But whether or not the government does become directly financially involved, decisive government action is characteristically necessary in making recapitalisation possible. Also necessary are prompt decisions about which companies, in a grossly overextended financial sector, really are insolvent. These can then be left to collapse, like Lehmann, unless there are genuine systemic dangers in allowing this to happen, as with AIG. In this case, the government may have to take over the company. But once the mess has been unraveled, the government can — and in the U.S. case I would have thought certainly will — sell anything worth selling back to the private sector.
What is also striking is that a substantial number of economists of very different ideological persuasions seem agreed that direct action to assist homeowners could be valuable. As the former IMF chief economist Kenneth Rogoff put it, it ‘makes no sense for banks to foreclose on homes when there are workout options whereby people could stay in their homes and banks could recover far more money.’
There are useful discussions on the RGE Monitor site, which is run by Professor Roubini, of a wide range of alternatives to TARP which have been put forward over the past few days.
(See http://www.rgemonitor.com/ — in particular the ‘Alternatives for TARP’ section in ‘Spotlight Issues.)
Tosk & TomB-
I bought my house using a VA loan. As reward for drinking away all my pay in English pubs…uh, I mean serving my country…my loan required no down payment. In essence, Uncle Sam was carrying the mortgage insurance that I would have had to pay since I did not put 20% down. Private mortgage lenders then made the loan as if I had paid 20% down. I think FHA works basically the same.
Maybe just expand FHA and other government programs similar to the VA loans to everyone – especially those who are at or near foreclosure – as part of an overall package?
David Habakkuk wrote:
“A recent IMF study, discussed both by an admirable lady called Yves Smith at the Naked Capitalism blog and by Nouriel Roubini, suggests that such public acquisition is less effective than direct recapitalisation of the banking system….”
Hey David, thanks for this as well as the all the rest too. Very informative.
And since we got you on the hook how’s the market and economy doing over there on your sceptere’d isle in light of all this? And did you folk have a “subprime” phenomenon too or is that our glorious invention alone?
We have a subprime\housing over-valuation crisis of our very own.
Like yours, our government, both the conservatives and their replacement plunged down the De-regulation\Debt fuelled economy route.
We are a little better off then you, for now.
For instance… Our Government debt as a proportion of GDP stands at 40 per cent…. yours is about to hit 74 per cent. And almost all of your debt, ( That’s 90 per cent….Nine out the ten trillion) was built up by Reagan, Bush 1 and Bush 2.
Put another way… the Government of the USA now owes 4 times as much as it recieves in revenues, and the US taxpayer is about to find the biggest single item in the Budget is repayment of interest on that debt.
Our National Health Service which covers everyone in the country for any kind of medical problem uses a little under 10 per cent of GDP…. Yours costs 16 per cent of your GDP.
So we still have some slack that you no longer have.
Even so I know a major train wreck coming when I see it plowing down the wrong side of the tracks.
We’ve been on a colossal thirty year debt binge too…. and find, just like you do , that foriegn Corporations, and Governments are now the owners of entire industries that we founded and developed.
The French Government just took control of our Nuclear Generating industry here… So now every time I switch on a light… I’m subsidizing the french taxpayer.
The French government also owns a large chunk of our water infrastructure.
By the way… I find the CIA World Fact Book a useful resource when checking out basic facts about another country… The entry on America and it’s economy is quite illuminating.
From the CIA World Fact Book
“…Since 1975, practically all the gains in household income have gone to the top 20% of households.”
The same has been true in my country.
Maybe just expand FHA and other government programs similar to the VA loans to everyone – especially those who are at or near foreclosure – as part of an overall package?
This is the kind of bottom-up solution that has been discussed lately in the more responsible spheres of practical economics. And the approach you suggest has the virtue of actually working to solve the underlying problem. But…
Now the problem has grown much larger in scope than mere foreclosures in subprime and Alt-A mortgages. The extreme leverage that has been piled upon these mortgage-based financial instruments has now become the lion’s share of the problem.
I think of it as throwing a match into dry brush (with the match as the mortgage foreclosure problem, and the brush as the investment vehicles derived from those mortgages)… you can readily solve the problem of putting out the match, but that doesn’t really solve the larger problem of extinguishing the fire, because the fire has taken on a life of its own.
So even if the foreclosure problem is remedied, the leverage problem (i.e., the use of mortgage-related investments as collateral to permit borrowing money for speculation aimed at increasing yield) will continue to haunt our economies for years to come.
This problem is ably illuminated by David Habakkuk’s post above. The fundamental problem with the “rocket scientists” running the financial show was that they constructed their financial models using the assumption that home prices would always rise, and ignored the obvious fact that stagnating values or (god forbid!) decreasing home prices would wreck their pyramid scheme by the process of deleveraging that we are now seeing.
Leverage magnifies profits when money is to be made, but it also magnifies losses when the market turns, and what we’re seeing now is the painful process of everyone covering those losses by liquidating their assets simultaneously, which lowers the value of those assets (thanks to the laws of supply and demand!), which makes the problem worse.
We were supposed to have learned the lessons of avoiding excessive leverage during the Great Depression. Apparently we didn’t (probably because we stopped calling it “buying on margin”, and chose new obfuscatory economic terms instead), and so while fixing the root problem as you suggest has much value to society (and especially to folks in danger of losing their homes), it won’t necessarily fix the larger problem of deleveraging.
Thank you DaveGood. Thank you very much indeed. Nice to get a bigger perspective, and so keenly put too.
It’s actually quite difficult to work out quite how much of a mess the UK is in. We are earlier into our house price collapse than you are, and where we are going to be further along the line is anybody’s guess.
In addition to the debt figures that DaveGood mentioned, another positive for the UK is that our reliance on securitised lending, though high, has not been as high as in the U.S. But against this there are two major negatives. According to the OECD, U.K. household debt had reached 177% of disposable income in the U.K. by the end of 2007 — as against 141% in the U.S.
Also, work done by the IMF suggests that the portion of the house price rise not explained by fundamentals — the scope of the bubble, in fact — was higher in the U.K. than in the U.S. (as also in Australia, France, and Spain.)
A quote from Alan Greenspan, vintage 2005:
‘With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. The widespread adoption of these models has reduced the costs of evaluating the creditworthiness of borrowers, and in competitive markets, cost reductions tend to be passed through to borrowers. Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending; indeed, today subprime mortgages account for roughly 10 percent of the number of all mortgages outstanding, up from just 1 or 2 percent in the early 1990s.’
And my countrymen knighted him — for his ‘contribution to global economic stability.’
Good evening David….
I agree that at first glance our household debt of 177% is worse then America’s 141%.
However, Consider the UK’s position on state benefits such as State pensions etc ( All paid for from taxes.)
The UK’s is reasonably solid.
Now look at America, their system was re-invented by Alan Greenspan in the 80’s under Reagan.
“Plan”…. payroll taxes on working Americans were raised so as to garuntee a surplus in the Social Security Fund that would be invested so as provide a sure stream of cash to pay those Pensions\benefits etc now, that those being taxed could count on later.
Only Bush 2 says there is actually nothing in that fund,, just “a bunch of worthless IOU’s”
What he didn’t say was that the signatures on those IOU’s are those of Ronald Reagan, George H Bush, and George W Bush ( And fairs fair… Clinton did it too, though Al Gore advised him not to touch it)
They simply took the money and spent it… there is no surplus.
So in essence… America has yet to realize that the pot of money Greenspan\Reagan forced them to pay into through higher taxes, that was supposed to Garuntee a minimum pension come the time they need it, has been looted.
The American working family have been swindled out of their paid for pensions and benefits, they just don’t know it yet.
While this loss ( Which is about 2 Trillion dollars) has not been factored in and cannot in the strictest term be called a debt ( It’s actually a crime)…. it still represents a severe hit to every working American Family and ranks on a par with debt.
I’d agree that “Fundamentals” had little to nothing to do with the rise in UK House Prices.. A Bunch of people, including our own government, ( Who saw it as a way of financing ever expanding Debt based on over-valued “assets” to power an expanding economy) were behind it.
But I saw no-one in a position of authority, no section of say the media or the political class do anything other then cheer it on.
There is one area in which we hold a substantial advantage over the American Economy….
And that is for any given Unit of production we use half the energy America does.
And that will be increasingly important in the years ahead.
But we are far from being in a good position..
Right now Germany not only doesn’t have an “Economy” powered by Shopping 24\7… It is running a massive trade surplus making stuff the world wants.
And the Typical French worker is not only 8 per cent more productive then his American counterpart…. he has not been allowed to build up the kind of debt we have.
There is no such thing as “Credit Card” in France.
If you tried to buy anything with money you don’t have using the French version of what we know as a “Credit Card”… the transaction is blocked by the issuing bank.
You know it’s interesting that in both your comments and then again in so many others and so many other articles and etc. elsewhere Greenspan’s name keeps coming up. And then I read this Financial Times article and boy it got me to wondering even more:
A rather precise article, noting Greenspan’s conscious decision to do nothing about bank’s margin requirements (which he’s been hyperactively defensive about since), and then actually putting the kibosh on others’ efforts to regulate those over-the-counter derivatives saying that such regs. would “disrupt” things.
Made some sense to me in terms of what technical things might have prevented or limited all this.
In any event you guys keep talking about what things are like over there. It’s very informative.
Corporate credit and consumer credit cards are next big things. They are shaky
The London interbank offered rate that banks charge each other for loans rose for a fourth day, driving a gauge of cash scarcity among banks to a record. The biggest drop in financial short-term debt outstanding since at least 2000 caused the U.S. commercial paper market to tumble 5.6 percent to a three-year low, according to the Federal Reserve.
The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising even after central banks pumped an unprecedented $1 trillion into the financial system.
You are all metaphysically wrong.
Free markets are intrinsically unstable.
Governments all over the world have found it prudent, nay necessary, at times to intervene in the operations of the markets.
This is one such case.
And as in all such cases there are winners and losers.
Yes, perhaps markets would correct themselves, perhaps not. To establish the truth of either scenario, one has to hire a large number of econometrists, build a theoretical model of the World Economy, and then investigate the (linear) stability of a set of hundred of couple – possibly non-linear – differential equations.
In the absence of such models, the belief in the eventual resolution of these problems without market intervention is akin to religious faith – I rather put my faith in God.
Moreover, non-intervention means that people ought to be left to their own devices to cope with (possibly) years of unemployment; market has deemed these human resources surplus, best let market liquidate them.
I stand by my comment of last year. Can other posters do the same??
I haven’t seen a “report card” on this post.
It has been a year.
What on earth are you talking about? pl
I stand by my comment of last year. Can other posters do the same??
I’ll stand by mine, as well.
And I wish I could say that “things have changed since then”, but alas, I can’t.
Babak is suggesting that the stability of a free market could be determined by performing a stability analysis of some set of underlying differential equations, i.e., those relations that govern the dynamics of the market. That would be an interesting exercise, but it wouldn’t prove anything, because we clearly cannot model the dynamics of the marketplace using our current state of mathematical knowledge.
He also makes the point that economic beliefs are about as rational as religious ones. I would tend to agree with him on that count, or perhaps even to argue that economic beliefs may in fact be less rational…
Finally, it’s pointless to argue about the behavior of free markets, because we don’t have those, anyway. The stock market is rigged, energy markets are fixed, monopolies and oligopolies are the order of the day, and governments are backstopping their financial sectors and doing so with a level of caprice that only a deity could truly appreciate.
We have plenty of markets, but precious few of import are free.
Interesting but not truly important to understanding.
GREED and IRRESPONSIBILITY are the plain English answer. Pl
Sent wirelessly via BlackBerry from T-Mobile.
“Investors who made mistakes in these markets should be held responsible and those who navigated the Fed-distorted market should be rewarded for their wisdom and prudence.”
“PS Oil is at 101.15/bbl as I write.”
This can be paraphrased quite nicely as “Those who creatively buy financial futures on oil, then restrict the supply or access to refining capacity or storage capacity they possess, thus driving up oil prices, which make their oil futures even more valuable, should be rewarded for their wisdom and prudence.”
This is the essence of market manipulation.
The TARP was a bad idea, but not the underlying cause of the economic problem. Lack of regulation led to the ‘creative destruction’ the Chicago School of Economics so loved. It is not a pretty sight and has real consequences. There are fundamental flaws with our current financial system. They will not be addressed with the TARP. It requires real regulator reform of the financial markets which is unlikely to come given both the level of influence Wall Street financial firms have within both political parties and the administration.
They all grasp the issue ML.
Here is some good reading:
Joseph Stiglitz on the Size of Banks: http://www.bloomberg.com/apps/news?pid=20601087&sid=aYdgQkXu9eBg#
Matt Taibbi on the Goldman Sachs Inluence:
It seems to me that I said that. pl