More bailing
Posted by aogSaturday, 04 October 2008 at 19:53 TrackBack Ping URL

The previous exchange on this subject got lost in the weeds a bit, in my view, so I am go to restart both the discussion and my own digression.

First among the things that I think got lost is that, like an airplane crash, a situation like this is almost never the result of a single cause. There is usually a root cause, but it is very rare for that root to have grown to a serious problem without other contributing factors. While we can argue about whether “mark to market” was a contributing factor, I think we can dispense up front with the idea that it’s the only factor. I would say that should be the default position for any discussion of a root or contributing cause, unless specifically argued otherwise.

I am not interested in seeking a “villian” unless a successful such search would improve things in the future by enabling the removal of the villian’s power to do harm or discouraging future imitators. If we can’t do either of those, even if we find a villian, then it’s not a productive pastime.

As with villians, to me the point of finding contributing factors is to find ways to ameloriate or prevent them in the future. An important corollary of that is that factors over which we have no control are pointless to debate. One that comes to mind is the “greed” or “shareholder value maximization”. There’s nothing one can do about that short of massive genetic engineering so I find it pointless to discuss. One needs to design any financial system under the presumption of greed by basically all of the participants and designs that don’t deal with that fact of life are doomed to miserable failure.

After all this, I still see the FMs as the seed crystal of the problem. These entities basically created the mortgage security market by first dealing with them large scale and by providing de facto guaranteed liquidity for them. Without that government backing the problem would not have been able to grow so large.

The FMs were also used to engage in social engineering, in terms of home ownership, and as usual the long term result was a crash and burn.

Beyond that, however, a major contributing factor that doesn’t seem to get much play is the large amount of fiduciary malfeascance that was going on at the FMs over the last decade or so. This is actually what the efforts of President Bush (2003) and Senator McCain (2005) were aimed at, much more than the previous two items. If there’s one group of people who need to be named villians and prosecuted, it’s that crew.

To me, the proper preventative measure is simple. Don’t provide government backing for derivatives. Don’t mix public and private in the FM way, which created the worst of both worlds — all the greed of the private sector with the sclerotic reactions and impenetrable corruption of the public sector.

UPDATE 1: I will state that I think the repeal of Glass-Steagall is irrelevant to this issue. One can see this by noting how the liquidity problems have spread throughout the banking system, and indeed internationally. Either all of the local and regional banks that avoid the MBS market are not in danger, in which case we don’t have a real problem, or they are, in which case the division that Glass-Steagall enforced an obviously artificial one with no relevance in the real world.

UPDATE 2: Some claim that a New Deal style regulated banking system doesn’t suffer from crises. One might make the counter-claim that such regulation merely stores up trouble for the future, the way the USSR’s economy, rather than enduring periodic problems, simply collapsed catastrophically after many decades (hmmm, about as long as the New Deal financial system…). That’s a style as common to government intervention as periodic panics are to capitalism, so it would seem just as reasonable a claim.

Comments — Formatting by Textile
Harry Eagar Monday, 06 October 2008 at 00:54

I think you come in too late.

From before 1980, and in a pounding, natives-are-restless crescendo afterward, we were promised that removing government supervision of financial markets would unlock the powers of the market.

G. Bush may have been worried about Fannie Mac and Freddie Mae in 2003, although not so much that he would have advised commor or garden variety, unsophisticated workers not to stake their retirements into this monstrous system. Just the reverse, as I recall.

Gotta wonder about his bona fides.

Anyhow, it looks (according to latest reports, but how long will they be good for), that German commercial lenders managed to get $69B into the hole even without FMx2. ($69B is up 50% in less than 24 hours, demonstrating, once again, that the people working in the world financial system have no idea what’s going on.)

It’s obvious that the attempt to shift blame off on FMx2, CRA or anything else tainted with Democracy is not viable.

Peter Monday, 06 October 2008 at 08:01

But AOG, aren’t you just saying everyone had their snouts in the trough? They knew or should have known about all those risky Fannie Mae loans and what it might mean if house values went down. So why did they play along and how do you explain this kind of crap?

Much as I worry about civil servants around the world staying up late to draft new regulatory schemes, I’m having an equally hard time digesting the notion that banks, which everyone agrees undergird the free market system, owe no duty to the public and are under no general professional or vocational ethical restraints. I don’t expect my car dealer to address whether buying that new car is really a good idea for me, but I do expect my banker not to loan me money he doesn’t believe I can repay or invest my money in securities he damn well knows are a lot dicier than his pretty pamphlets suggest. There is only so much of this enchanted kindgom the average person can be expected to understand. Plus, despite the trope that they were making high risk investments out of greed for profit, it seems that some of the bigger players were driven more by preserving market share than prudent maximization of profit—gotta show the shareholders we’re keeping our space on the pie-chart. This is starting to sound like a health clinic where the doctors told everyone to eat, drink and smoke what they wanted in order to keep the patients happy and outflank the competition.

Anyway, the rage out there isn’t just directed at stupidity or even recklessness. It is born of a sense of betrayal, and there is no more dangerous, corrosive political or personal sentiment than betrayal.

Annoying Old Guy Monday, 06 October 2008 at 08:03

No, I don’t think so. I think I come in about right.

I find this interesting

G. Bush may have been worried about Fannie Mac and Freddie Mae in 2003, although not so much that he would have advised commor or garden variety, unsophisticated workers not to stake their retirements into this monstrous system. Just the reverse, as I recall. […] Gotta wonder about his bona fides.

But not anyone else’s? It’s amusingly ironic that you write

It’s obvious that the attempt to shift blame off on FMx2, CRA or anything else tainted with Democracy is not viable.

while blaming Bush for the actions of others. I would also read your statement as verifying that you put control of blame shifting over the facts of the case. I find it laughable that nothing “tainted with Democracy” has any causal relationship with the current problems. None at all — that’s clearly a fact based non-partisan starting point.

Annoying Old Guy Monday, 06 October 2008 at 08:14

Mr. Burnet;

They knew or should have known about all those risky Fannie Mae loans

No. My point is that because of the presumed backing of the Federal government, the loans were perceived to be far less risky than turned out to be the case. Certainly you will always have actors doing that, but it is only with government fiat that you get something as large as this. Just contrast Enron and the FMs.

the notion that banks […] owe no duty to the public and are under no general professional or vocational ethical restraints

I concur with you on this. Creating such ethics is part of the firewalling against greed which is required in any well designed system. The locus of the problem is when the government decides to stop being a neutral enforcer of such ethics and becomes a participant, i.e. buying MBSs via the FMs and engaging in social engineering by financial system manipulation. Do the government regulators / officials owe no duty to the public to remain umpires? I suppose my question to you, like that toward Mr. Eagar, is why would such a sense of betrayal apply only to the private sector actors?

I also think you misread the type of the majority of the bad loan originators, who are mostly not prudent citizens, but either people manifestly unqualified for a loan or just as greedy and actively scamming as the agressive lenders. Certainly there are some honest citizens caught personally, but everything I read about indicates that such are a small minority.

Peter Burnet Monday, 06 October 2008 at 08:35

Oh, I’m sure I’ve misread a lot of things. In fact, it will probably take ten years and some seminal analyses before I begin to get a handle on all this, and I doubt I’m alone.

Do the government regulators / officials owe no duty to the public to remain umpires?

Very fair, and yes, of course they do. In fact, while over-regulation can certainly be a big economic stifler, it’s nothing like the havoc government causes when it tries to get into promotion and management. But I think your sober analyses might just have to withstand a whirlwind of unevenly-directed rage for a time. Government officials weren’t the ones earning those bonus’s.

Hey AOG, remember all those posts by OJ on how it was reasonable to count total home equity in the national wealth indices when considering budget deficits because all those immigrants were going to need somewhere to live? “Those were the days, my friend, we thought they’d never end, we’d sing and dance…”

Annoying Old Guy Monday, 06 October 2008 at 09:06

I think your sober analyses might just have to withstand a whirlwind of unevenly-directed rage for a time. Government officials weren’t the ones earning those bonus’s

That’s fine. I am certainly not going to claim that there wasn’t a lot of malfeasance on the private side. What concerns me is the view that it was only on the private side. But, I don’t think I would go so far as to say that government officials weren’t earning those bonuses, it’s just that the money ended up mostly in campaign accounts rather than personal ones.

Oh, yes, I remember those days …

Annoying Old Guy Monday, 06 October 2008 at 09:10

Wait, let me clarify my previous comment.

I agree that there were very likely criminal acts committed by private actors in the crisis. I fully support bringing the legal hammer down on such. BUT I am completely against acting as if that’s a solution or even anything more than a necessary but temporary palliative. First you chase the critters out of your garden, then you repair the fence.

Harry Eagar Monday, 06 October 2008 at 12:56

I’m not suggesting that government didn’t contribute to enhancing the failure. I am suggesting that the failure was built in and would have occurred no matter what the government did once it was decided (by both parties but inspired by the Reagan wing of the Republican Party) that government had no role in supervising financial markets.

Maybe policy made it worse, but since my understanding of the history of financial markets is, they always crash if unsupervised, it is difficult to imagine how it could have been worse. Just different. (To be fair, we haven’t seen the worst yet; I’m anticipating where this will play out. Curiously, this morning the ‘market,’ which supposedly was lusting after a bailout one and a half paulsons ago, seems unhappy now that it has it. )

The greed/morality argument seems to wipe out the free market argument. The question is not whether to use political power to restrain markets, but only, How much?

Annoying Old Guy Monday, 06 October 2008 at 13:35

once it was decided (by both parties but inspired by the Reagan wing of the Republican Party) that government had no role in supervising financial markets.

Could you give me a cite for that? For instance, any Reaganite calling for the abolition of the SEC, or the FASB, or a repeal of the entire mass of security laws? I think you’re just throwing up a strawman saw on some editor’s monitor.

However, I do agree that the problem would have occurred, but that without the massive subversion of the markets, it would have been minor and of concern mostly to political junkies. I think there is a quantitative difference so large as to be qualitative. Again, Enron vs. Fannie Mae / Freddie Mac, the latter being where you are resolutely ignoring the real lack of oversight, pointing fingers at theorists instead of actors.

I don’t see how the greed / morality argument wipes out the free market argument. I, and the free marketers I know, think exactly the opposite, that since people are frequently greedy and immoral, one must minimize the amount of power such people can wield, which means as little government as possible because nothing is more powerful than that.

The question is not whether to use political power to restrain markets, but only, How much?

No, I don’t think so, but you touch on something very basic here. Despite what anarchists claim, free markets require government regulation to exist. That regulation creates the structure in which markets operate. That’s why I am a minarchist and not an anarchist. And whether that’s “retraint” is a bit of a philosophical question.

For me, I see the kind of regulation you prefer as very analogous to the forest fire prevention efforts of the forestry service a few decades ago, where the goal was zero fires. That turned out to be a very bad idea, as it simply made the inevitable fires more severe. Strongly supervised markets do well until someone like Barney Frank and his crew figure out how to game it, and then you get a massive failure.

Harry Eagar Monday, 06 October 2008 at 15:00

Just my point. Glass-Steagall was a very minimal interference with the markets. Really, all it did was remind moneychangers not to mix their safe money with the risk money.

In the old days, market manipulation came outside the financial system, by squeezing and loosening credit, not with the goal affecting financial markets, but on dampening inflation or enhancing employment by playing the (mostly residential) construction industry like an accordion.

That was a pretty dumb approach, both from an economic and from a social perspective, but it started under Eisenhower.

There just isn’t any evidence I know of that the financial system was going to collapse as long as minimal controls were in effect. If you want a name of someone who wanted to hollow out regulation, I’ll offer Paul Craig Roberts.

I still don’t see how Barney Frank controlled the German real estate market. Where’s the connection?

I’m glad Peter brought up Orrin’s fantasies about ‘savings.’ When I lived in Iowa, I used to buy fireplace logs cut from 40-year-old oak trees that had grown up when Missouri farms were abandoned during the Depression. You couldn’t give that land away for a long time.

Annoying Old Guy Monday, 06 October 2008 at 17:42

all it did was remind moneychangers not to mix their safe money with the risk money.

And where, could you tell us, is the safe money? I write this over and over but it’s not getting through. If there’s “safe money” then we’re not having a major crisis. If there’s not, then Glass-Steagall wasn’t doing protecting. And so I find highly implausible your previous claim that the repeal was when the financial system started to go wrong.

I still don’t see how Barney Frank controlled the German real estate market.

I don’t either. Your point is …?

Paul Craig Roberts

Quoting from Wikipedia

His writings frequently appear on Antiwar.com, VDARE.com. Lew Rockwell’s web site, CounterPunch, and the American Free Press.

Next!

Harry Eagar Monday, 06 October 2008 at 19:09

And, all during the ‘80s, several times a week in the Wall St. Journal, that red rag. He was, as I recall, an assistant secretary or deputy undersecretary at Treasury under R. Reagan, of late, unlamented memory, and the most visible cheerleader for undoing the legacy of the New Deal securities and banking precautions.

He’s now a little more obviously a nut than some of the other nuts, but not necessarily any more nutty, now or then.

There isn’t any safe money, absent government insurance. That’s the point. If the investment banks had not commingled their fortunes with the savings banks, then we could let them all (or a great many) go the way of Lehman Bros. without shedding a tear. In fact, apparently that nut Paulson and that other nut Bernanke thought they could get away with exactly that.

Surprise, surprise! By abandoning the wise principle behind Glass-Steagall, they found out they could not unmix the cake batter.

The credit markets are not the same as the securities markets, although the free-marketeers have tried to make them so. For one thing (there are others), a company like Enron could not very well disappear natural gas. In a credit market, as Peter reminds Orrin, you can disappear savings. Securities markets, as long as they are not mere bucket shops, cannot go below 0. Financial markets can.

The people who calculate such things calculated that $2.5T (trillion with a T) were disappeared today within the span of about 5 hours. A $T or so magically reappeared later.

Where will it be tomorrow?

Annoying Old Guy Monday, 06 October 2008 at 21:36

Mr. Eagar;

I think it says something that the person you picked as representing the financial anarchists viewpoint ended up in the loony bin. That doesn’t augur well for it being a mainstream opinion among conservatives or Reaganites. But I will admit, you find one.

If the investment banks had not commingled their fortunes with the savings banks, then we could let them all (or a great many) go the way of Lehman Bros. without shedding a tear.

I simply don’t agree with that. Credit is fungible and doesn’t follow neat little boundaries, regardless of what regulators think. Credit and securities may not literally be the same market, but if a bank’s capital reserve is based on securities (as is commonly the case, even for non-investment banks), they’re hardly independent. And seriously, where do you think the “safe”, that is, government guaranteed, money literally is? Stacks of gold bars in a vault?

I was going to snipe at the basis for your $2.5T loss claim, but as usual you write sufficiently opaquely and without references so I have no idea what the basis of that is. Securities? Credit? Central Bank loan windows? If you’re actually trying to make an argument instead of just yanking my chain, that’s not a successful strategy.

Harry Eagar Tuesday, 07 October 2008 at 13:42

$2.5T was the estimated loss in market values when the Dow got down by 800 (as estimated by Bloomberg or MSNBC, I forget which).

Then the market recovered, and $1T magically reappeared.

Sweet.

I think it says something that the person I picked as representing the financial anarchists’ viewpoint ended up in the loony bin, too. Except I didn’t pick him. Reagan did.

I don’t know what you mean when you say credit is fungible, if you mean anything more than that the business cycle rises and falls. Seems to me that treating it as if it were fungible is part of the problem.

Annoying Old Guy Tuesday, 07 October 2008 at 14:14

You’re mixing people’s estimates of the value of securities with their actual values if you think that money really appeared and disappeared. I also note that you have avoided, once again, the heart of my point, which is — where, literally, do you think the capital assets of non-investment banks are?

P.S. What I mean by fungible is that, like the oil industry, the credit markets overlap enough so that if credit is tight in one area, it will pull credit from other areas, and therefore a severe enough problem anywhere is a problem everywhere. If that’s so, then treating credit that way isn’t a “problem” but an acknowledgement of reality, however much we might wish it otherwise.

Ali Choudhury Tuesday, 07 October 2008 at 14:34

Buffett on regulation:

http://newmarksdoor.typepad.com/mainblog/2008/10/if-you-think-st.html

“QUICK: If you imagine where things will go with Fannie and Freddie, and you think about the regulators, where were the regulators for what was happening, and can something like this be prevented from happening again?

Mr. BUFFETT: Well, it’s really an incredible case study in regulation because something called OFHEO was set up in 1992 by Congress, and the sole job of OFHEO was to watch over Fannie and Freddie, someone to watch over them. And they were there to evaluate the soundness and the accounting and all of that. Two companies were all they had to regulate. OFHEO has over 200 employees now. They have a budget now that’s $65 million a year, and all they have to do is look at two companies. I mean, you know, I look at more than two companies.

QUICK: Mm-hmm.

Mr. BUFFETT: And they sat there, made reports to the Congress, you can get them on the Internet, every year. And, in fact, they reported to Sarbanes and Oxley every year. And they went—wrote 100 page reports, and they said, ‘We’ve looked at these people and their standards are fine and their directors are fine and everything was fine.’ And then all of a sudden you had two of the greatest accounting misstatements in history. You had all kinds of management malfeasance, and it all came out. And, of course, the classic thing was that after it all came out, OFHEO wrote a 350—340 page report examining what went wrong, and they blamed the management, they blamed the directors, they blamed the audit committee. They didn’t have a word in there about themselves, and they’re the ones that 200 people were going to work every day with just two companies to think about. It just shows the problems of regulation.

QUICK: That sounds like an argument against regulation, though. Is that what you’re saying?

Mr. BUFFETT: It’s an argument explaining—it’s an argument that managing complex financial institutions where the management wants to deceive you can be very, very difficult.”

Glass-Steagall’s repeal didn’t really make much difference. Counterparty risk spreads the safety net to risky entities with or without explicit merger. The real problem was buying the worthless mortgage products.

Harry Eagar Wednesday, 08 October 2008 at 13:37

I agree G-S repeal didn’t make any difference, other than symbolism, by the time it happened. So much of what had once been restrained by G-S had escaped the parameters of the law that it was almost a dead letter. It should have been extended.

The point is that correct policy would have been to extend it, not end it.

‘You’re mixing people’s estimates of the value of securities with their actual values’

Huh. Heresy. The actual value is the market value. Or are you setting up to determine real values different from what the market says? You sound like a commie to me.

As for capital, to me there’s a meaningful difference between securities and equities when it comes to commercial banking, if only who gets to feed on the remains when there’s a liquidation. You can organize banks another way, and the Germans do. They hold huge equity stakes in operating businesses, but they also put directors on the boards and watch their money closely.

True enough, as we learn this year (although I already knew it), when markets become disorderly, it doesn’t matter so much what species of dubious paper you’re holding.

Annoying Old Guy Thursday, 09 October 2008 at 10:22

I agree G-S repeal didn’t make any difference, other than symbolism, by the time it happened.

That what were we arguing about? Oh, well, glad to see you on board!

Or are you setting up to determine real values different from what the market says? You sound like a commie to me.

You’re right, I withdraw the comment.

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