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March 19th, 2008
04:44 pm - Bailing out the rich
Before I begin, no, I haven't forgotten about Part 3 of my Omnivore's Dilemma review. I'm actually hoping I'll get the balance of it written this evening. I put more effort than usual into those, so I don't want to just crank it out for expediency sake.
Now, on with the show...
I've engaged in several heated debates lately with people over the credit crisis, and the financial situation we find ourselves in. Since I am usually in the financial-conservative minority of these conversations, the argument I am most frequently presented with reads as follows:
"It's unconscionable that this government would bail out Wall Street investors and other mega-rich idiots who made bad investments while millions of people have no health care, and laid-off factory workers who can't pay their mortgages get nothing."
In a nutshell, that is. The fact is, the alternative to a bailout is much, MUCH worse, and those same laid-off factory workers who can't pay their mortgages are most likely the ones who would cause it to be so. Whenever a heavily-leveraged investment outfit takes a high-profile loss, it's immediately hit with a cripping one-two punch: Remaining investors scramble to get what remains of their investments out, and anyone who might lend capital to the struggling outfit immediately begins refusing to do so. This is precisely what happened to Bear Stearns.
Option one is to let the firm collapse. That'll teach 'em to make bad investments!
But the problem is that they're not part of some isolated leaf-node of the financial tree. They have trading partners, institutional investors, and hold assets owned by other institutions. If you follow the chain of investments (especially where housing loans have recently been involved), they lead all the way back to your neighborhood banks and credit unions. Look at the problems Cleveland's own National City is having, for all the evidence you need.
When you bail out the institutions, it props up that cascade of dominoes. The damage is contained. Taxpayers uniformly take a small per-capita hit. If you don't bail them out, the dominoes continue to fall.
Eventually, headlines start appearing like "First Bank of YourTown loses $1B on failed investment. FDIC prepares to step in on behalf of depositors." Unemployed factory workers John and Suzie Everyman start getting nervous about their life savings, so they go and they pull it out of YourTown NA. You end up with something that hasn't occurred on a retail level since about 1930... a run on the bank.
Before you pooh-pooh that as something that only happens in wild-west stories, realize that it's precisely what happened to Bear Stearns. Rumors began circulating that Bear couldn't make good on all of it's booked obligations. Investors immediately started withdrawing their assets and drained Bear's liquid capital from $17 billion to below $2 billion in less than 48 hours. They lost fully half of their assets in one 30 minute period at the market open. Had the Fed not bailed them out when they did, the firm would have been insolvent by the next morning. Whether the rumors were true or not is irrelevant -- bad investments might have killed Bear eventually, but they certainly would not have killed them last week. A run on the bank, little more than human panic, killed Bear last week.
Roughly 15,000 people would be out of jobs instantaneously. The crisis would have immediately spread to Putnam Investment Management and a half dozen other institutions up the food chain. With Putnam already in trouble, and ~9% of Bear's active portfolio at stake, it could have lost a significant amount of its capital within a few days to a panicked sell-off. They manage over $112 billion in mutual funds -- maybe ones you or your company retirement plans own. Lather, rinse, repeat with their other trading partners. It is reasonable to suggest that any of you with a 401k or IRA would have DIRECTLY felt the pinch of this in a very unsavory way by today or tomorrow. If you think what the stock market has done was bad... throw in a few major financial-sector insolvencies.
As a US taxpayer, a major financial sector bail-out will cost you (individually), somewhere in the neighborhood of the amount of money currently in your wallet. (I am, of course, assuming that 100% of Bear's collateralized assets are worthless, which is possibly true.) If the dominoes in the crisis chain had continued to fall, responsible US investors stood to lose, across the board, much more. Are you happy with your taxpayer share of the bail, or did you want your IRA to be cut in half, or more?
Or the next time you go to the bank to pull something out of savings, your bank tells you that it'll be 48 hours before they can get you the funds? It's unthinkable, right? Remember that your neighborhood bank is just as far up to their eyeballs in the mortgage mess as Bear Stearns was. And that your credit union (if you have one) is possibly even worse.
There are a lot of social "tragedies" in this nation, but a $30 billion bail-out that might have to be eaten by taxpayers is a much more palatable option than a financial cascade through the entire commercial banking system. You don't KNOW economic gap numbers until you'd see what happens when well-positioned investors recover their assets, and average Americans lose everything.
This is one place where I'm actually in favor of Free Market regulations. Not necessarily of their actions -- they should be free to make as risky an investment as they please. But in the disclosure of the activities. As recently as 48 hours before the bail-out, we were hearing stories of how their assets were properly balanced, and how exposure to risk was being judiciously reduced. The real numbers behind the story were hidden behind closed doors, and that's the part that I find unconscionable. Had the profile of their average investment been made public, and not hidden behind a mountain of no-doc transactions, they'd have never had the capital to get involved in this dangerous game in the first place. I'm opposed to preventing the behavior if they're arrogant enough to try it, but fully in favor of making them hang their dirty laundry on the line for all to see.
Of course, that very problem is why the whole subprime collapse has occurred in the first place. Dubious loans packaged up in opaque instruments with an impossible-to-trace trail of responsibility.
Still, we are where we are, and I'd advise anyone with a brain in their skulls to stop whining about the bail-out. It probably won't be the last in this crisis. It's not "benefiting the rich" -- if anything, it's benefiting the average citizen. The rich will do just fine, regardless! They have the capital to hedge against stuff like this. It's your small-sized investor who stands to lose the most if institutions start collapsing. Economics are a brutal mistress. No more so than to those who get stuck in the tread of her jackboots...
Current Mood: ![[mood icon]](http://l-stat.livejournal.com/img/mood/ibrad/erked.gif) annoyed
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Comments:
A Brief Financial History of Bear Stearns:
2006: Pay out $4.4 billion in bonuses.
2008: Require $30 billion taxpayer funded bailout.
I add that while people may call for "regulating the free market," they tend to actually want regulations that correct for the fact that the assumptions of perfect competition are not met.
![[User Picture]](http://l-userpic.livejournal.com/8998562/1520447) | | From: | ![[info]](http://l-stat.livejournal.com/img/userinfo.gif) darlox |
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| Date: | March 20th, 2008 12:22 am (UTC) |
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Heh. Well, you won't catch me arguing that it's a disgraceful clusterfuck. But, as the Economist, I must ask: Do you disagree? Was there any alternative to a bail-out that was any more palatable than what was done?
| | From: | darlox |
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| Date: | March 20th, 2008 12:27 am (UTC) |
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Er... I just realized that the above should have read:
... anything other than a disgraceful clusterfuck...
As in, yes. It's ridiculous.
There was (and still is) a debate among economists about the moral hazard implications of such a bail out. It is a serious concern, and one I don't think the Fed adequately addressed. I think a bail out was a good idea. But I think there should have been (and should be for any future bail outs) a serious effort to not bail out the people who created this mess.
To a certain extent, it is too late to do this. The people who created/contributed to the problem have already waltzed away with their $4.4 billion in bonuses and bought their aston martins and houses in the hamptons. They will not pay because the current incentive system in place at investment banks and hedge funds let them take huge bonuses when their funds have good years, and yet they take no losses during bad years. They won't even help fund the bail out to the same extent as most tax payers because, due to a tax loop hole congress won't close, all those bonuses and extreme incomes are taxed a lower capital gains tax rate and not taxed as traditional labor income.
Next time, remind me to wait for the actual economist to post before trying to do so myself.
I mostly agree with you, except for one thing: bailing out institutions that make bad decisions means that there's no downside to risky behavior. It encourages future Bear Stearns-s to go ahead and leverage like there's no tomorrow because if the bet pays off, everyone goes home richer than God, and if it tanks spectacularly, the government bails them out and everyone goes home richer than Jesus.
In other words, it's just like most of the proposed mortgage bailouts I've seen: it rewards spectacularly bad decision-making. And, by indirection, punishes (in the sense of providing lesser or no rewards) those who exhibited good decision-making.
So, in the end, economics is not a brutal mistress to those who incur her wrath, because the government is there to interfere with the natural operation of the markets... assuming you're a large investment bank.
Which is what pisses me off, really, more than anything else: the hypocrisy of a system that requires we all bow to the holy writ of non-interference in free markets when companies are making huge profits on obviously risky schemes, and applaud intervention to bail out those same companies when the vultures come home to roost. Let's just get some consistency, please. Either there should be intervention on both sides of the coin, or neither.
And yes, I agree with you 100% that not bailing out Bear Stearns-- or, more accurately, not handing a great big honkin' pennies-on-the-dollar present to JPMorgan Chase-- would quite likely lead to a greater financial crisis. I think said crisis is long overdue, frankly, and this just puts it off a while. And probably makes the eventual crisis that much worse.
![[User Picture]](http://l-userpic.livejournal.com/9060754/1527677) | | From: | cynic51 |
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| Date: | March 20th, 2008 02:58 am (UTC) |
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Didn't the investment banks lobby to get rid of some regulations that helped prevent the massive stupidity we are seeing now? They've got what's coming to them. If it takes the whole economy with it, well that's the price we pay for letting politicians remove those regulations. And if my 401(k) and the value of my house goes with it, that's tough. Because honestly, it's going to happen sooner or later, and the longer it takes the more it's going to hurt.
| | From: | darlox |
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| Date: | March 20th, 2008 03:15 am (UTC) |
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I'm confused, and more than slightly dismayed, by the assertions that some sort of bottomless crash is inevitable. When you look at all the actual fundamentals, right down to the most basic scarcity of resources, there is absolutely no reason to suggest that a long-term downturn is even predictable, much less probable. When you look at what caused the housing bubble in the first place (sliding dollar value, minor to moderate recession, etc...) the turn to real estate was a direct reaction to a need for a tangible resource. Unfortunately, it got a bit out of control.
But the tangible value of real estate hasn't gone away. Once the market shakes out the people who couldn't really afford to be in it, the prices will bottom out, and investors will begin to snatch up properties at fire-sale values. That'll stabilize prices, and the trickle-down into the consumer market will follow. Of course, I have no magic crystal ball to say if, or when, this will happen. But every historical precedent says that it's the most likely outcome.
All indications are that global markets have yet to feel the pinch of their own complicity in the mortgage crisis. In the near future, that dirty laundry will start to come out, the ECB and Asian banks will be forced to cut interest rates, the dollar will rebound slightly, and the bottom will cushion out for the US. Long term, who knows?? But the "it's going to happen sooner or later" argument falls flat. The Savings & Loan crisis of the 80's cost 4x what this little excursion has, and almost immediately preceded one of the longest periods of sustained growth in US history.
| From: | (Anonymous) |
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| Date: | March 20th, 2008 07:23 pm (UTC) |
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"...cost 4x what this little excursion has..."
So far.
"...and almost immediately preceded one of the longest periods of sustained growth in US history."
Um, duh. So did the Great Depression. Busts are generally followed by booms, followed by busts.
I'm not arguing there's a bottomless crash in the offing: no such thing, unless you literally crash civilization and society outright. Please don't mischaracterize me as doing so.
Yes, but let's not forget what it took to pull this country out of the last Great Depression that it suffered. I.E. a world war that killed at best estimates 50-60 million people worldwide.
While I am generally in favor of darwinism, social and otherwise, I _really_ do NOT want to live or bear children who will become the cannon fodder for such an event. And since we've gained so much more knowledge since then, imagine the billions we can kill with the next world war.
I spend my days roving among the memorials to those lost in the 20th Century wars in a perhaps vain attempt to keep history from repeating itself by attempting to teach others to learn from it. We as a society need to watch very carefully to make sure that we don't spiral down that same economic path that leads to the same problems.*
*Mind you, I know that we don't currently have a country suffering under the equivalent of the heavy punitive burdens of the Treaty of Versailles, BUT what other countries in the world right now are struggling? Hmmmm?
Actually, the Depression was basically over in the U.S. by about 1937, with the exception of unemployment, which was high compared to pre-Depression levels. And even the war effort of a few years later didn't absorb all the slack. I'm sure someone around here will blame that on the New Deal, which may even be correct.
And I have no more desire to end up in a global war than anyone else outside of the Project for the New American Century, thank you very much. My contention would be that if we don't want to get to the same place, we need to take action to prevent massive downturns by working to prevent their formation, not trying desperately to fix them while in progress. In other words, it'd be better to insulate the wires and run them correctly than stockpile a bunch of fire extinguishers in hopes of suppressing the inevitable fire before it burns down half the house.
Having both isn't a bad plan either, but get the first part right and you'll never need the second part.
Most of the serious work I've read on The Great Depression suggests that while the New Deal may have been counter-productive in terms of recovering from the depression, the extreme depth and duration of the depression was caused by trade protectionism on a world-wide basis.
Oops, misread your post. You were speaking specifically of unemployment. I assume by "even the war effort a few years later didn't absorb all the slack" you are referring to the support of the Allies before we entered the war? I've never heard anyone argue that there was an excess of labor after we entered the war.
"Having both isn't a bad plan either, but get the first part right and you'll never need the second part."
Ah yes, but there in lies my single biggest pet peeve with most humans in general.
The inability, often willful, to plan ahead, to put even a little forethought into the future consequences of their current actions.
Mind you, that's what provides me and my SO with job security. But it gets DAMNED annoying dealing with it.
| | From: | darlox |
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| Date: | March 21st, 2008 03:11 am (UTC) |
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That is true, but the Depression was a market crash predicated on a fallout in consumable goods. It was the first manufacturing crisis. The current crash is based primarily on a fixed resource -- real estate. Since the supply is not decreasing, and I see no way we could conceivably manufacture more, a war wouldn't solve the issue even if we had one.
Not to say that conflict isn't somewhere in the future, but the circumstances are a bit different. If the credit crisis spreads to the manufacturing (less important because most of it has already been outsourced) or service industries (more important because that's where all of our "white collar" income is these days), THEN we're in real trouble. But so far, that hasn't occurred except in the form of a broad market pull-back. Pray it stays contained to investment market firms...
Don't forget that monetary policy was conducted differently at that time. The Fed's commitment to the gold standard led to something that would surprise most people today-- a tendency to decrease the money supply during bad time, and increase it during good times. Monetary policy was much more pro-cyclical (and tended to exaggerate economic cycles) than it is today.
I also add that, whatever one might think of the Fed's actions, there are very few economists alive today who understand the causes and consequences of the Great Depression better than Ben Bernanke.
Heh. I didn't see this response until today, where I said mostly the same thing. |
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