Yaron Brook from ARI has issued the following statement about credit debacle:
But the mounting financial problems reveal that Paulson and Bernanke are as clueless as any other central planners who try to control an entire economy. They are not saving us from anything; they are delaying some of the pain that necessarily follows from a Fed-induced credit bubble, and redistributing that pain to innocent victims. They are punishing responsible individuals and rewarding irresponsible individuals.
“The bailouts must stop. The government must make clear that from now on, those who are in financial trouble must turn to the private market for help if they are to avoid failure; the government must no longer foist their failures on others, and invite another crisis in the future.”
For better or worse, Brook’s "do-nothing" approach to the problem is not a viable option. Any politician who stood for it would be immediately discredited in the eyes of the electorate. The political reality is that market solutions are not allowed in crisis situations like the one we are facing. Hence we find former Objectivist Alan Greenspan (who understands the underlying political climate better than any of the ARI folks) suggesting another approach. "We need laws that specify and limit the conditions for bailouts -- laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly rather than circuitously through the central bank as was done during the blowup of Bear Stearns," Greenspan has written in the paperback version of his autobiography, The Age of Turbulence. In other words, Greenspan is arguing that, since the government is going to intervene anyway (no preventing that), at least it should intervene in as rational a way as possible.
Can the government intervene without making things worse? Well, given how dire the situation really is, it may not really matter. If market forces were allowed to do their thing, the consequences would be little short of catastrophic. There is at least $2 trillion dollars in bad debt out there (and this is not even including bad derivative-related debt, which may be in the tens of trillions). If you allow company A to go under, then it can’t pay it’s obligations to company B. But then company B can’t pay company C, which in turn can’t pay company D, etc. etc. In other words, if the market it allowed to do its thing we would almost certainly see a collapse of a good portion of the financial system. Even more serious, such a collapse could trigger a very serious deflation, as the credit bubble bursts and suddenly you have massive contraction in the money supply (some of this deflation has already occurred, but it has been confined to the housing and asset markets). Deflation is one of the worse things that can happen to an economy in peacetime. If the United States went through a major deflation, that would greatly strengthen the anti-capitalist left in this country, which would put the nation in serious peril (and put an end to any hope for a market solution).
Perhaps the real truth is that nothing can be done one way or the other. Whatever we do, we’re screwed and there’s an end to it. As Doug Noland, the financial analyst who more than ten years ago saw what would happen as a result of wildcat financing of the nineties wrote:
As we are witnessing today, the issue is not some manageable amount of new “capital” to replenish banking system losses. Instead, the predicament is the massive and unmanageable amount of new Credit necessary to, on the one hand, sustain a mal-adjusted Bubble Economy and, on the other, the Trillions more required to accommodate a gigantic speculative de-leveraging. I have a very difficult time seeing a way out of this terrible mess.
16 comments:
While I agree that there is plenty of blame to go around, it seems clear to me that this situation would not have come to pass without the government sponsored Fannie Mae system. No truly private corporation would have been able to make mistakes with so many repercussions for the financial system. When Enron and WorldCom went under due to fraud, plenty of people got hurt, but it didn't threaten to take the entire economy down with them.
This is from yesterday's NYT:
____________
Dozens of interviews, most from people who requested anonymity to avoid legal repercussions, offer an inside account of the critical juncture when Fannie Mae’s new chief executive, under pressure from Wall Street firms, Congress and company shareholders, took additional risks that pushed his company, and, in turn, a large part of the nation’s financial health, to the brink.
Between 2005 and 2008, Fannie purchased or guaranteed at least $270 billion in loans to risky borrowers — more than three times as much as in all its earlier years combined, according to company filings and industry data.
* * *
Whenever competitors asked Congress to rein in the company, lawmakers were besieged with letters and phone calls from angry constituents, some orchestrated by Fannie itself. One automated phone call warned voters: “Your congressman is trying to make mortgages more expensive. Ask him why he opposes the American dream of home ownership.”
The ripple effect of Fannie’s plunge into riskier lending was profound. Fannie’s stamp of approval made shunned borrowers and complex loans more acceptable to other lenders, particularly small and less sophisticated banks.
Between 2001 and 2004, the overall subprime mortgage market — loans to the riskiest borrowers — grew from $160 billion to $540 billion, according to Inside Mortgage Finance, a trade publication. Communities were inundated with billboards and fliers from subprime companies offering to help almost anyone buy a home.
Neil Parille,
I have a hard time believing that any truly private company that made as many mistakes as Fannie Mae would still be around.
Neil: "While I agree that there is plenty of blame to go around, it seems clear to me that this situation would not have come to pass without the government sponsored Fannie Mae system"
The GSE's are primarily responsible for adding 10 years to the credit bubble. But they are not responsible for starting the credit bubble. The original bubble has its roots in the bad mixture of financial safety nets and unintelligent deregulation of the eighties along with the rise of wildcat derivative finance. In '98, the initial credit bubble should have burst, leading to a major stock market and asset market crash. But bigwigs in the finance industry (perhaps with the collusion of the Clinton Treasury) convinced Fannie Mae to buy up all the bad debt that had accumulated in the nineties, on the assumption once a GSE owned the bad debt, it would be converted to good debt, because after all, everyone assumed (rightly, as it turned out) that the government would never allow the GSEs to go out of business. From that point on, the credit bubble was driven principly by the GSEs and, after 9-11, by the Fed.
Perhaps economies larger than those limited to the sphere of people you know on a first name basis are doomed to failure. Economies larger than a clan or small village need hierarchies, which , right out of the gate negate anything resembling a "Free Market"
When you get right down to it,looking at this objectively, the only economic model that has been in continuous operation in Homo Sapen Sapien's tenure on earth is that of the hunter-gatherer. Everything else has been ephemeral.
capmconnundrum: "Perhaps economies larger than those limited to the sphere of people you know on a first name basis are doomed to failure."
But that assumes (1) that a bad crisis is tantamount to a failure and (2) that an economic system that couldn't support more than a tiny handful of the world's current population is a success.
Gregnyquist:
"But that assumes (1) that a bad crisis is tantamount to a failure and (2) that an economic system that couldn't support more than a tiny handful of the world's current population is a success."
(1) A bad crisis is not tantamount to failure, just a reminder that all civilizations fail.
(2) assumes that success is predicated on scale. It night be, it might not be, depends on how you measure success. You could measure it my scale, you could measure it by longevity, it comes down to personal preference. I don't assume that one economic system is the answer for everyone.
capmconnundrum,
Really, can you name me a prosperous society with a socialist or feudal economic system?
China and Feudal Japan.
Kelly,
I wouldn't consider either of those societies very prosperous.
Damien:
"Really, can you name me a prosperous society with a socialist or feudal economic system?"
Thanks, Damien, prosperity is yet another measure of success we could apply, along with scale and longevity.
Kelley mentions China and Feudal Japan. Both good examples of scale and longevity, especially [Pre- Mao) China (5000 years and with an agricultural system that produced a huge and stable population). Given China's success at feeding all those people, an argument could be made for prosperity as well.
But then, prosperity is subjective to an extent. Is it a full belly? is it lots of free time? Is it iPods and BMWs? And to what percent of a given population is prosperity to be extended for a society to be deemed "successful"
"We need laws that specify and limit the conditions for bailouts -- laws that authorize the Treasury to use taxpayer money to counter systemic financial breakdowns transparently and directly rather than circuitously through the central bank as was done during the blowup of Bear Stearns,"
Then what? Do you honestly think (as a truculent realist) that the next time a politically well-connected firm collapses - without fitting the bailout requirements - that the requirements wont just be modified to fit the firm in question? Of course they will.
This is one thing I still completely agree with Rand/Peikoff about. Once you embrace some bad principle, then despite your best intentions, you cannot localize its effects. It will metastasize until it is completely rejected and ruled out on principle.
I agree that the government isn't completely to blame here. There were a great many irresponsible and immoral executives and lenders authorizing imprudent loans (and even more irrational borrowers eager to accept them.) However, what about how the government has been pushing home ownership with tax breaks and incentives for decades? That stuff really affects people's decisions; I've heard adults (with the means to pre-pay their mortgage and thus save $40,000+ in interest in fees) who do not prepay it because "we don't want to lose the tax breaks." Never occurs to them that they are losing far more in interest than they save in taxes.
(It's not entirely related to the financial collapse, but it goes to show how government/tax incentives can distort people's thinking to a great extent.)
Jay: "Then what? Do you honestly think (as a truculent realist) that the next time a politically well-connected firm collapses - without fitting the bailout requirements - that the requirements won't just be modified to fit the firm in question?"
True, there is a danger that they won't follow the law, but what's the alternative? Have no laws at all? The logic in the objection could easily be used to argue against having a Constitution. After all, it's quite true that many judges only follow the Constitution very loosely. So why have a Constitution at all?
Yes, it's a fair point to say that politicians and bureaucrats aren't always going to follow the law; that they'll take advantage of borderline cases and vagueness of legal codes to do as they please. But consider how much more arbitrary their behavior would be if there were no laws at all.
Greg,
The difference between the Constitution and laws for what constitutes a "legitimate" bailout is a matter of principle. There is a clear need for explicitly spelled-out rights and freedoms. The Constitution is one of the most remarkable achievements of western civilization and a huge reason more people immigrate here than anywhere else.
In contrast, you'd have a hard time finding people (other than investment bankers and executives) who believe there are "legitimate" excuses for bailing out billion-dollar corporations who are failing due to incompetence and greed. Any attempt to define a "legitimate" bailout would be arbitrary, contested by companies who did not fit the requirements, and ultimately expanded to where it is now.
That's why the ideal solution is an unconditional ban on government bailouts of any kind.
I would even be OK with this bailout going through, if it were stated that it was the last one of its kind. How else is the painful but much-needed message going to be sent that people need to take responsibility for their actions?
>Neil: While I agree that there is plenty of blame to go around, it seems clear to me that this situation would not have come to pass without the government sponsored Fannie Mae system.
Alternatively:
http://www.mcclatchydc.com/251/story/53802.html
Jay: "I would even be OK with this bailout going through, if it were stated that it was the last one of its kind. How else is the painful but much-needed message going to be sent that people need to take responsibility for their actions?"
The point of the "bailout" is not allow people to escape responsibility for their actions; it is to prevent a catastrophic collapse in finance capitalism which would hurt many more people than just the bankers and hedge fund managers whose bad decisions got us into this mess. I think too many people are focused on what's going to happen to Wall Street. They're more interested in revenge than what's good for the economy as a whole. The principle question should not be: How can we punish or make an example of all those Wall Street fat cats who got us into this mess? but rather: Can the bailout actually prevent a catastrophic financial collapse without, at the same time, leading to serious long-term repercussions? The fact is, very few people were complaining about what has been happening on Wall Street during the last 20 years before the debacle. Many people benefited by the Credit Bubble and ignored warnings by those of us who saw what was going to happen. It's difficult to assign responsibility for a disaster that was abetted by so many.
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