An article of mine – for today’s Crikey! It was written yesterday morning and so doesn’t consider the latest developments. Thanks to Ingolf for some suggestions. (Which reminds me, on a couple of columns recently, I should have mentioned several people who’ve helped out including Tony Harris, James Farrell, Ken Parish and Andrew Leigh. Sorry if I’ve forgotten anyone, but I send out drafts to whomever I think might be interested and able to make worthwhile suggestions. If you want to be on the list of advance receivers of draft columns,let me know.
Does the Paulson package remind you of anything? It reminds me of the invasion of Iraq. And the Northern Territory intervention. And the Tampa. It’s the new black for government. The executive grabs hold of a crisis (or as in the case of the Northern Territory intervention beats up a crisis it has known about for years), comes up with an unprecedented, outrageous plan, and then plays “deal or no deal” against the clock with those in the political system whose traditional role it is to review, to debate, and to try to improve upon such plans (according to their own no doubt less than disinterested lights).
But that role is successfully foreclosed in the manufactured drama and urgency of the moment. They’re accused of lack of patriotism, being dithering do-gooders, not “getting it” — the ‘it’ being that ‘everything has changed’ or whatever. Those on the outside who quibble are alleged to be daiquiri drinkers and, as you can appreciate, that pretty much puts and end to the matter right there. And the stakes are so high, and the issue is so loaded that opposition to the will of the Government is political death. The whole thing goes through and disaster stalks, very often to strike a few months later.
Of course in this case there really is a crisis, and dealing with it really is urgent (though that’s no reason not to have been thinking and working hard on a more comprehensive rescue plan for a good while). But it’s still such a pity, such a goddamn shame that, at least from this distance the package looks like such a bad one. And a surprise given the involvement of a person of the calibre of Ben Bernanke whose brilliant academic life has been a perfect (intellectual) preparation for this moment.
I have no doubt it prepared him for some of the inspired improvisation weve seen so far. Perhaps he knows things I don’t — well things that really matter that is. But all the commentators whom I trust on this have the same kind of reaction — that while it might well have been necessary for something to be done, this something comes from the very worst tradition of Wall Street capitalising its profits and socialising its losses.
The state is being forced into the role of market maker of last resort. That’s all well and good in the situation we find ourselves. Perhaps it’s even welcome. But market makers normally charge for their services in providing liquidity and in bearing risk. Its only fair, and its also efficient. The crafters of this rescue package should have been trying to maximise the upside for the taxpayers who will have these investments foisted upon them. That would be only fair. And it would minimise inefficiency by minimising the moral hazard this intervention builds into future expectations. Instead were getting the opposite with minimal upside for taxpayers.
I’m no expert on American politics, but I presume that with a nip here and a tuck and much cooing and breathless prose from the pundits, the package will be go through, in the same kind of charade of accountability that accompanied the invasion of Iraq and the Tampa escapade and the Northern Territory Intervention.
Then we can repent at leisure.
nic:
A bailout in principle is a trade off by taking the hit and possibly averting a really serious recession. It’s more than serious when the credit markets have seized up and equities look like dropping 30%. The aftershock can be pretty devastating. This bailout as someone said doesn’t really resemble the one done in the early 90’s as it looks more like the Japanese model (Credit Suisse economists are making that suggestion). I can send it to you if you like.
The likelihood of this getting passed is typical of American politics. It’s directly inverse to the amount of whining and screaming from the Congress. The more the object to it, the more likely they are going to vote for it.
What I don’t understand is why they don’t do what i wrote at ALS blog:
If the banks offered the mortgage back at say 40 cents in the dollar they could write back some of their provisions marked at 22 cents.
JC,
I really am trying to wean myself off responding to you, so slipshod is your reading of what I write, but the problem is that this can then mislead others.
My piece actually says that it’s probably a good thing that the state is becoming the market maker of last resort. So I don’t need an economics 101 lecture on the value of this kind of action. I’m in favour of it.
My objection is that it’s structured to benefit Wall St. From what I can see it is a handover of massive amounts of cash onto the balance sheets of banks – a plan to buy their toxic assets at prices above market rates (something that Paulson has obfuscated about in public and admitted in private. Bernanke has now said the same).
Yes, this will help with liquidity. If this was our only option we’d be in the difficult situation you mention. I’d probably be in favour of the bailout as better than the alternative – a recession or worse. But it’s not our only option. There are oodles of ways a bailout can be structured to maximise the upside for those who put the cash in, this seems to minimise it. And maximising the upside for the mugs who have to stump up the cash also minimises moral hazard in the future.
And what of all the pathologies that got us into this? Executive packages that let people walk away from a sinking hulk with millions? Since we’re playing fast and loose with property rights in order to right the ship, shouldn’t we be giving those things some attention? Where are they in the package?
JC – where do the holders go for finance to buy the loan back?
Ummm how so?
I really don’t think you understand the strategy of the package and why it was structured the way it was. If Treasury does a reverse auction the effect may be that it could force the mark to market even at a lower price causing some of the participants to the wall, more demand for recaps and further tension on the stock markets. The stampede to the lowest price is what they’re trying to avoid.
do you really think the US treasury and the Fed haven’t modeled for this possibility.
One doesn’t have to be in favor or in support of the package to understand that an auction could cause a race to the bottom in terms of pricing for very illiquid products.
If you attempting to avoid further financial tension with the large participants it’s possibly the best alternative.
lastly stock warrants have been made or have been discussed as being part of the package so the taxpayer may receive upside on the equity side.
FDB, it may not be for all, but there could be lots of these troubled home owners that may afford a new mortgage set at 60% discount to the original mortgage.
Nicholas
Surely the Howard government deliberately sinking the SIEV-X and the Apollo moon landing hoax should be added to your list? Why, I am sure Margo Kingston could help you out with a few others, too.
This isnt a bailout its a takeover, JC you have already alluded to that.
Dont think I have Rog.
This is a bailout and so was Bear Stearn. AIG was a takeover. There is a difference.
Notwithstanding all those definitions I dont really know how the Government could use an auction system to take out these securities without causing a race to the bottom in terms of pricing these securities and forcing further tension if that is what theyre trying to avoid (as a result of further mark to market downgrades).
The other problem with not going with Paulsons plan is that funds for recaps is as scarce as hens teeth so the very consequence of the bailout is to force even more tension by not using Paulsons plan. The upshot is that you end up with a large number of bankruptcies at one time through an auction.
Im not supporting the plan or against it by the way. Im just holding my breath and crossing my fingers it will work.
Its a takeover JC, in return for solving ‘the crisis’ they are demanding $$$$ without a plan and strings. The principle of market forces, transparency and accountability have been abandoned.
A bailout is a short injection of liquidity, who knows what this is.
I am surprised that you arent concerned at the loss of govt control and the surrendering of taxpayers money.
They’re not exactly taking over the firms, Rog. They’re buying the crap off the banks. (with the obvious exception of AIG)
I’m really ambivalent about the thing.
I don’t like this sort of intervention but I don’t like the idea that by not trying we could end up in a wholesale global depression. I really don’t know. The early 90’s plan did work out although I think there was a lot of monetary help from the fed with easy monetary policy.
However as far as things go Paulson’s plan isn’t that bad me thinks.
See here. I wrote about it at ALS blog and why I think it’s the best possible bailout plan ( or takeover using your term) going.
http://alsblog.wordpress.com/2008/09/24/paulsons-bailout-plan-with-new-information/
One of the main objections to the bailout is that there is no plan.
Ron Paul argued for reform years ago and predicted the current situation as has the Austrian camp
Again though, rog, F&F have existed since 1938. So whatever caused the recent situation, you can’t realistically blame it on the sheer existence of F&F, or on anything that has been more or less the case for the last 70 years.
Fannie Mae has evolved since 1938 (as has the motor vehicle); in 1968 Fannie was privatised and Freddie was created in 1970 to provide some competition.
The big problem is that for a long period they were tax exempt and exempt from oversight (they do not have to submit public reports) with implied govt backing – no other public companies have such largesse
Sure, and I think it’s been pretty clear for a while that there were (and probably still are) big issues with the way both operated. But whatever the causes for what’s happened recently are, surely they can be largely pinned down to changes that have occurred over the last 10 years at most. And I suspect as much as anything it was a case of finance industry innovation gradually becoming more and more obscure, until it reached a point that otherwise expert market players were unable to properly assess the risks associated with the debt they were trading. Even if there had been no F&F, and no 1% interest rates, overly obscure debt packaging, and the ability to make bad debt look good, was surely inevitably going to lead to trouble.
Rog, I’m with you on the “Frannies”. They were always a disaster in the making.
Their whole business model was utterly reliant on the low borrowing costs that stemmed from the implicit government backing. Without that, and the numerous breaks and exemptions granted to them because of their quasi public status, they wouldn’t have existed. Allowing(indeed, encouraging)private firms to run up huge debts on the public tab was as close to insane as it’s possible for a policy to be.
Still, as per NPOV, they’re far from the only culprits.
While I don’t pretend to be qualified to comment on the accuracy or otherwise of this article, it is the first I’ve seen that’s actually put some meat behind the claim that excessive deregulation is at least partly to blame for the crisis. It makes a case that the invention and proliferation of credit default swaps, combined with the Commodity Futures Modernization Act of 2000 which shielded them from regulatory oversight was what enabled the sub-prime mortgage industry to boom, as financial institutions were increasingly unable to properly evaluate the risk level of the debt they were holding.
http://www.dailykos.com/storyonly/2008/9/21/9322/74248
I’d also say it’s hardly just the usual suspects bleating about how the crisis can be blamed on excessively laissez-faire politics: last night Mr Turnbull (who, by the way, I genuinely hope gets a stab at running the country sometime soon) noted the lack of regulation of the financial industry in the U.S., commenting that it was unfair that Australian banks and other lenders were getting sucked into the credit crisis, when our lenders are well regulated, and hence carried very little bad debt. And now France’s supposedly conservative President Sarkozy has opined about the end of the free market economy.
But I have to say, much as I’ve always been personally suspect of any ideology that claims that “markets always know best”, it does seem rather too convenient a scapegoat in this case. We really don’t know what might have happened in a world with an entirely unregulated and non-interventionist economy, and of course we never will (though of course, countries like Somalia, where the government has been largely inoperative for years, might give some clue). Further, I can certainly accept that consequences of government intervention *now* in an attempt to break the crisis have the potential to be far worse than doing as little as possible. A lot of people did see this crisis (or something like it) coming many years ago, and if there was a time to intervene, then surely small interventions as danger signs appear are better than massive interventions after the fact.
Shame to see two such insightful comments go entirely unremarked, NPOV. Like you, I suspect many of the conclusions that will be drawn from this mess are likely to be profoundly mistaken.
When governments backstop the financial system, close regulation becomes vital. Without it, the natural tendency of animal spirits to occasionally run wild will over time become unconstrained by any sense of risk. Only this fatal combination can produce the recent Olympian heights of absurdity.
I don’t think the current debacle has all that much to do with market failure. Markets will always fail; it’s part of the discovery process. The problem arises when these painful but necessary localised failures aren’t allowed to run their course. They don’t, unfortunately, disappear; instead, given enough time and enough bad decisions — both private and public — such as those you allude to in your comments, and they will eventually build towards a systemic crisis.
Sadly, the messenger is quite likely to be taken out and shot.