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September 24, 2008

Independence Day?

Friedrich von Blowhard writes:

Dear Blowhards,

A great quote about the bailout comes from (of all places) the Wall Street Journal:

David Ader, government-bond strategist at RBS Greenwich Capital, notes that it is a politically difficult sell to go to voters and tell them you’re proud to have kept employed "many of the same firms that created the mess and paying more for their crappy securities than they themselves would be willing to pay. Vote for me." [emphasis original]

One question: in debating this bailout, nobody seems to even consider a possibility that leaped out at me. If the troubles on Wall Street are preventing Main Street from getting responsibly extended, reasonably priced credit, why can’t we just end-run Wall Street? Take the $700 billion Mr. Paulson is asking for and start up, say, 10 new banks with it. Guarantee the deposits publicly with a better guarantee than the FDIC. They’ll have no difficulty attracting deposits. Then have them lend out money at conservative leverage (say, 10 to 1, much less than Citibank) and generate $7 trillion in new credit. Hire a staff from among the recently laid off, and management from, say, Japan, and pay them so that they only need to make 10 percent ROE (thus making a nice return for the taxpayers) and their bonuses only get paid out when it’s clear that the loans have actually been repaid. No derivatives, no fancy stuff, just plain vanilla lending. Main Street is saved, and the rest of us can find entertainment and moral improvement in watching Wall Street implode and disappear.

Let me point out where this wild fantasy comes from. To whit, everyone, including Mr. Bernanke, says that the ‘real economy’ will suffer without credit. Credit is apparently like, say, electricity and water -- a health and safety issue for the economy. We have 'utilities' in electricity and water -- so why not in credit? Some of those utilities are privately owned but heavily regulated; some of those utilities are publicly owned, at the local, state and federal level. And you know what? The publicly owned ones work just fine. In Los Angeles, I’m currently a customer of the private Southern California Edison, but previously I got my juice from Los Angeles Department of Water & Power. The bottom line: power from LADWP was half the price.

I'd love for somebody explain why it is apparently unthinkable for America’s taxpayers and borrowers to declare their independence from the current crop of moronic incompetents now masquerading as financiers. Remember, this is the same group of guys who misallocated credit (their supposedly core competency) on a scale unknown in human history.

How exactly did these bozos get to be so indispensable? Isn't this indispensability entirely in the minds of Bernanke and Paulson? And doesn't that make them, in the most polite terms imaginable, captured regulators?



posted by Friedrich at September 24, 2008


The government is not very good at running the post office, and they've had years of practice. There's no reason to suppose that they'd be good at running a bank. (Consider Fannie and Freddie. That didn't turn out so well.) Of course, the government also isn't any good at pricing mortgage backed securities either, so there's no good reason to expect that the bailouts won't flush a lot of money down the toilet either.

The big problem is that when house prices go down, all of the home borrowers have that much more reason to just walk (or worse, stay put and just stop paying). That puts more houses on the market driving down prices further etc. This would be catastrophic for the banks, but so what? All of the shareholders that backed all of the management who got in this mess deserve to be wiped out. It's not like the specific set of banks that we have now are the only institutions capable of matching borrowers and lenders.

Posted by: Alex J. on September 24, 2008 10:03 AM

Please, guv'nor, can ye spare seven hundred billion for a spot of tea to warm the insides of a poor bank? Aye, thank ye and God bless ye, sir! You're a true gentleman, as I don't mind saying.

Posted by: Rick Darby on September 24, 2008 10:14 AM

This is a semi-nationalization of the U.S. credit system, and it could work. One thing I will say for certain: we will not completely recover from this until we overturn the free-market utopianism of 1980-2008. Heavy regulation of big and indispensable institutions at the center of the economy (like utilities and major banks) worked over and over again to produce stability during the 20th century, especially the 1940-1980 period.

It's probably true that there was a cost in flexibility. But "innovation" in pursuit of private profit by giant institutions that we are all dependent on is not always a good thing. During the 90s, Wall Street sold all of us on the notion that "financial innovations" by wealthy bankers were like real material innovations by little inventors coming up with a better mousetrap. Instead, it was speculators using our money to set up a massive and unstable casino at the heart of the economy.

We have to break loose from the pro-market propaganda and realize that in some cases major institutions need to be insulated from the profit motive, not completely handed over to it.

Posted by: MQ on September 24, 2008 10:44 AM

...the current crop of moronic incompetents now masquerading as financiers.

Nicely put.

I rarely watch TV news, but I did catch the C-Span coverage of the Senate hearings on the bailout yesterday at the gym. (Fortunately during an empty hour, so nobody was around to see the crazy lady pounding on the treadmill, mouthing obscenities and flipping off the TV screen.) I fully expected Bernanke and Paulson to keep coming up with arguments for why any solution that protected the bailers at the expense of the bailees just couldn't work, and my expectations were met. Aside from this specific attempt to keep the wealth siphon siphoning their way, I got the strong impression that these guys had no idea in the world what they were doing or where this was all likely to end up. Clever people on whom it has just dawned that, though they are ever so clever relative to all the other apes, they're still dumb apes who are in way, way, over their heads in the ever-so-clever mess they cooked up. (But they figure they're still clever enough to bamboozle the dumber apes at least one more time.)

But I was intrigued by the attitude on display. I was going to describe it as "complete contempt for Main Street", but really, it wasn't even contempt. It was more like a sociopath's incomprehension of the idea that other people exist as anything but means to either gratify or thwart his desires. You mean, the USA, the taxpayers of the USA, have some other function beyond serving as a dwindling but not-quite-sucked-dry source of dosh to keep the global pyramid par-tay rolling? Say what? "Protecting the taxpayers" was spoken as a meaningless formal phrase, like "good morning", to be exchanged on the way to the real business of the day: arranging things completely to the satisfaction and benefit of The Important People. Sherrod Brown's amusing line of inquiry with Bernanke suggested what should be an obvious question: if Dayton and Cleveland have to pay to stop the hurtin' on Wall Street, since they're joined at the hip and disaster on Wall Street means pain for Dayton and Cleveland, ain't it funny how Wall Street, in other circumstances, doesn't suffer for not giving a rat's when the squealing starts in Dayton and Cleveland?

Posted by: Moira Breen on September 24, 2008 11:19 AM

A nice passage from Robert J. Samuelson:

"What we are discovering is that all the complex securities, combined with ever-greater international investment flows, have created a global financial system "so arcane that few people can understand its workings," David Smick writes in "The World Is Curved: Hidden Dangers to the Global Economy." The difference between now and two years ago is that financial managers then thought they understood the system; now they know they don't."

I guess it's nice that the masters of the universe are feeling a little humble these days. But, still: We've apparently gone and created a financial system so complex that it's now completely beyond anyone's comprehension.

Samuelson makes some other good points in his column. For instance: it isn't just about mortgages ... Scary!

Posted by: Michael Blowhard on September 24, 2008 12:50 PM

BTW, is the contrast really between "heavy regulation" and "no regulation"? That seems to me 'way off. Who on earth would say that the financial industry isn't heavily-regulated? Isn't the better contrast between "bad regulations" and "good regulations"? As I understand it (via people like Dean Baker), it's not that the industry got deregulated, it's that it got re-regulated in such a way that the sharpies could fleece the rest of us ever more efficiently and cleverly. Which would seem to confirm Samuelson's point above -- they made the game so complex (because only they could understand it) that it's now flown completely out of control.

But I don't think that has anything to do with "no regulations." Always eager to learn better, of course. But the idea that we have a "free market" in financial services seems silly to me, let alone the idea that the "free market" is the problem, let alone the idea that regulations of almost any kind are a solution, just because regulations are good.

Incidentally, I'm all for sensible rules and regs, as well as clean and honest umpires and refs. But how does/can such a situation arise?

Posted by: Michael Blowhard on September 24, 2008 12:56 PM

One should be wary of the error "I can't think of a good reason for you to be doing X, therefore you are foolishly doing X for no good reason."

MB, your link to Samuelson is broken.

Posted by: Alex J. on September 24, 2008 1:01 PM

Tks, link to Samuelson now fixed.

Posted by: Michael Blowhard on September 24, 2008 1:10 PM

Who on earth would say that the financial industry isn't heavily-regulated? Isn't the better contrast between "bad regulations" and "good regulations"? As I understand it (via people like Dean Baker), it's not that the industry got deregulated, it's that it got re-regulated in such a way that the sharpies could fleece the rest of us ever more efficiently and cleverly. Which would seem to confirm Samuelson's point above -- they made the game so complex (because only they could understand it) that it's now flown completely out of control.

This is of course very true, and a good point. The thing with contemporary financial regulation is that it tried to have it both ways -- preserve the freedom to devise ever more complex and opaque financial "innovations" that generated huge profits, and accounting rules that supposedly made those instruments OK. The intersection of those two made for both complexity and ineffectiveness.

Posted by: MQ on September 24, 2008 1:35 PM

also, it's hard to exaggerate how dysfunctional the financial regulation system became because of ad hoc patchwork deregulation from the New Deal system followed by patchwork accounting reregulation in response to Enron, as well as the inability to create relevant oversight rules for new institutions and financial instruments that were developed during the great go-go period of the 80s and 90s. The appearance of heavy regulation was in part due to the swiss cheese structure of multiple regulators, with some institutions having multiple overseers to report to and other key institutions having effectively no oversight at all.

Posted by: MQ on September 24, 2008 1:48 PM

It seems to me that this debate is akin to getting the WWF and hulk hogan try to wrap their head around the Iambic pentameter.

None of you (all the yous in the debate are economists, nor do you seem to want to take your cues from economists.

barbarians are truly at the gate.

Posted by: Ramesh on September 24, 2008 3:02 PM

Michael, from my VERY limited understanding of this issue, I get that in a way, you're correct when you say the markets are already heavily regulated in the sense that there are lots of regulations on the book. The "more regulation" crowd is opposing those regulations that stripped away oversight. So perhaps a better way to put it is "more oversight."

Posted by: JV on September 24, 2008 3:44 PM

I'll double that "limited" and raise you a "clueless."

Posted by: Michael Blowhard on September 24, 2008 5:09 PM

Capitalism's stabilising mechanism is failure; if you make a dumb investment decision you suffer the consequences. Wall St's greatest financial innovation was the instutionalised ability to reward incompetence. Freidrich's right, these bastards have run the greatest capital misallocation scheme in history for massive personal reward and now expect to get bailed out. Furthermore, according to the Financial Times they have the funds to save themselves, but don't want to risk their own money in the deal.

Oh, and by the way, hasn't Buffets reputation gone down the toilet? He's joined ranks with the pigmen, such a shame. I've lost a lot of respect for the guy. He still a good businessman but I'm not sure anymore of what type of human being he is.

Banking isn't rocket science, half a brain will do. Freidrich's idea is perfectly reasonable. Let Wall St wither.

Posted by: slumlord on September 24, 2008 6:32 PM

Some helpful (or so I hope -- obviously over my head here) articles from the right:

American Spectator

Nice passage:

"We were told less than six weeks ago by the Congressional Budget Office that the taxpayers may have to spend up to $25 billion dollars bailing out Fannie Mae and Freddie Mac. Secretary Paulson and Federal Reserve Chairman Bernanke assured us that beyond that, all was well. Why is anyone still listening to Paulson and Bernanke?"

Funny comment from a commenter:

"If it takes $700,000,000,000 to avert a crisis, how big is the crisis?"

And maybe the time has come to check in with Ron Paul?

Posted by: Michael Blowhard on September 24, 2008 7:09 PM

The crisis is 65 trillion dollars big.

noone plans for a tsunami.

stop blaming the skipper foo' !

Posted by: Ramesh on September 24, 2008 7:49 PM

The world GDP economy, btw is about 55 trillion per year big

Posted by: Ramesh on September 24, 2008 7:53 PM

For some firebreathing liberal populism, check out Marcy Kaptur .

Congress is actually making some progress -- it looks like CEO pay limits will make it and increasingly it appears that stock in exchange for $ will get in too.

Posted by: MQ on September 24, 2008 8:04 PM

What many of these bankers seem to be saying (albeit not explicitly) is that they were forced into this by political pressure and had to provide loans to persons who were not financially viable. They will whine that "everyone" is to blame and that "everyone" is going to have to suffer. Thus the attempt to fob this off on taxpayers. But I have news for these bozos. Many of us were warning about this crap as far back as the 70s when the Carter administration got the affirmative action banking loans put on steroids. Did the banking sector try to get those laws changed? Not to my knowledge. Certainly not on Wall Street where liberals and greenbacks mix freely. It's been downhill all the way. Few politicians of late have had the guts to point the finger and banks have been more than happy to swill this kool-aid while they could make money. As far as I'm concerned, I'd be happy to see both financiers and politicians end up on the same pyre.

Posted by: Charlton Griffin on September 24, 2008 8:38 PM


Your proposal would be yet another example of failed regulation leading to more oppressive regulation, leading to socialism.

Those who think this catastrophe was caused by the "free market," please read this. This is I believe the direct opposite of the truth.

Posted by: Lester Hunt on September 24, 2008 8:44 PM

Youre not going to get exec compenseation ceilings. you'll probabaly get celings on whats paid to OUTGOING ceos of loss making banks as well as in salaries of government owned banks(so that they may act against the interest of these banks and jump to multi billion salaries to european hedge funds).

Posted by: Ramesh on September 24, 2008 9:28 PM

On the absurd and extremely hazardous idea that the current disaster was caused by this "free market" that we have, see also this.

Posted by: Lester Hunt on September 24, 2008 9:55 PM

Charlton has a great point that's often missed; A la "The Tragedy of American Compassion", this crisis is the love child of the "War on redlining" and the hunger for high returns with low risk (sometimes referred to as greed).

Perhaps, if the washout is bigger than I expect, we'll also get the benefit of LESS expectation that the government protect us from risk, discomfort, insult, poverty, and so on. What did Spencer say? "The ultimate result of shielding men from the effects of folly is to fill the world with fools."

Posted by: Sam_S on September 25, 2008 4:55 AM

It was an interesting juxtaposition last night to be on-line reading about the financial crisis while hearing a radio piece on MBNA whistle blowers. The former employees of the credit card giant were talking about the way they were required by the company to aggressively market debt to customers. One talked about going home and crying as she thought about the wife of the soldier in Iraq that she'd convinced to take a five figure cash advance, knowing that eventually the interest rates, fees and late payments would catch up. But knowing that failure to close the deal would have, at the least, gotten her a reprimand and threatened her own job.

To see apologists for the mythic "free market" still whining about over regulation and attempting to suggest that this is a campaign issue on which the Republicans and McCain are in the right because the fault lies with Democrats using cronyism at Fannie and Freddie to insure that the unwashed hoi polloi get loans without being creditworthy boggles the mind.

Bundling mortgage accounts and flipping them from institution to institution, opaque hedge funds, fund managers, CEOs, et al taking obscene compensation bonuses and retirement packages for producing short-term gains without calculating long-term costs? Obviously these have little if anything to do with crisis. No it must all be due to those socialists in disguise who wanted the working class to buy homes when they should have continued to pay rent to their landed betters in the hopes of getting their votes.

Lest it be misconstrued, I find both parties culpable in creating and neither seemingly capable of solving this mess. The successful lobbying efforts of "free market" utopians has given us the system we now have, a system that has for at least three decades lined their pockets at the expense of the rest of society as a whole. They bear the most blame. The supposedly "fiscally conservative" right has been the political home for the dominant architects of the convoluted system that is now melting down.

Posted by: Chris White on September 25, 2008 8:33 AM

Dear Mr. Hunt:

What gives you the idea that I think "free markets" caused this problem? Since they don't exist except at the margins of American economic life, and finance is anywhere but at those margins, the main problem here is poor governmental policy. The policy, of course, was in flooding our economy with cheap debt via accommodating Asian investment and by systemically favoring borrowing over savings. Give financiers an apparently limitless supply of cheap debt, and just watch what they'll do with it. Asset prices will skyrocket, leverage will skyrocket, profits will skyrocket...for a while.

However, this doesn't mean the poor little financiers are completely blameless. Many of them agitated strongly for exactly this kind of policy, knowing that they, with far better and earlier access to credit, would be the ones making millions (tens, hundreds or even thousands of millions) off rising asset prices while the people farther down the food chain of credit would be the ones making the higher mortgage payments and credit card payments and eventually getting hit in the neck when the good times stopped rolling. And the financiers had the cash to make the campaign contributions and the lobbying campaigns to make sure that their position was listened to.

So who comes out well, here? Government regulation is both easily captured and corrupting to business (it's often easier to guarantee profits by buying favorable regulatory treatment than by competing). However, business, and particularly financial businesses, can find pursuing ultimately unsustainable strategies (say, betting on ever-rising housing prices) so extremely profitable in the short term ("got my $10 million bonus, Jack, what do I care if I get fired next year?") that it is rational to say the heck with sustainability, make your pile and then run for it. Neither is a recipe for sensible, long term growth.

I would prefer to go with something much closer to, um, capitalism than we currently have; but if we're determined to do the regulatory state thing, we got to find some much more effective way of dealing with the captured regulator problem (bad policy) AND the principal-agent problem (incentives to pursue unsustainable strategies in the private sector.)

Posted by: Friedrich von Blowhard on September 25, 2008 9:17 AM

The piece Lester Hunt links above is a really brazen attempt at propaganda and rewriting of history. Fannie and Freddie played a peripheral role in this entire mess. For those who don't know, the definition of sub-prime means: not meeting Fannie and Freddie mortgage standards. The "toxic" securities are those *not* backed by Fannie and Freddie. But Republicans are counting on public ignorance in trying to pin this on Fannie and Freddie, because that line fits most easily into their standard attack on government and the Democrats.

Not that Fannie and Freddie are blameless, tho -- their management has been pushing as hard as they can for years to get into the higher-risk activities that they were excluded from by their regulations, not to mention playing games with their accounting. I would argue the reason is the original deregulation of Fannie and Freddie in 1968, which allowed the gradual introduction of profit motives for their management. Profits and government guarantees don't mix.

And in a larger sense -- yes, this scandal is about the free markets, or about capitalism. Saying that high finance is not a genuinely free market is an evasion, since as FvB says American capitalism (like all modern capitalisms everywhere) is a mixed system in which there are no pure free markets. (Indeed, I would argue that it's naive to think there are ever truly free markets of any size, markets only function through regulation). But this scandal was driven by private actors left free to pursue their own profit, and who did so at the expense of the public interest. The point is the potentially deep conflicts between profit motives and the public interest, which our pro-capitalist ideologues consistently deny.

Posted by: MQ on September 25, 2008 2:33 PM

Actually, FvB above said it better than I could, especially in his third paragraph.

Bubbles, manias, crashes, and the resulting short-term thinking are inherent to financial markets, including free financial markets. This has been known for centuries. Even if institutional self-interest should lead to long-term thinking, institutions are made up of individuals. And individuals can take their money on the bubble upswing and diversify out before the crash, so self-interest dictates short-term thinking. The credit system is too central to the economy to leave entirely at the mercy of these phenomena.

Posted by: MQ on September 25, 2008 2:39 PM

Thanks for the compliment, MQ, but remember my final point: granted, to the chagrin of the right, markets may be (at least temporarily) inherently unstable, and highly compensated employees may be able to pick the pockets of stockholders, but that doesn't automatically mean it will be easy to regulate our way to a better outcome. Regulators are easily captured and influence easily bought. This often results in policies that make markets even more unstable (e.g., Easy Al Greenspan's cheap debt orgy along with a certain, um, regulatory laxity) and employee-stockholder relations even more conflicted (e.g., every decision ever taken by the Delaware Supreme Court, just about.)

It's easy to say, "deregulation is the problem, regulation is the answer" until you start realizing how much bad regulation has to answer for here, and how little influence you and I have over the quality of regulation compared to the influence of the regulated industry itself.

Pause and think. This is a central dilemma that both left and right constantly talk past, because it bites both ways. As the Romans asked, "Who shall guard these selfsame guardians?" The real problem, I think, lies in the way our government is susceptible to influence and functions, as I once remarked, as an auctionocracy. If you don't change that, you'll keep having these problems.

Posted by: Friedrich von Blowhard on September 25, 2008 5:53 PM


What you're suggesting is what the Federal Reserve does through it's discount window. It provides credit to banks that need it. Indirectly, you're hitting the nail on the head. Why doesn't the Fed make the $700 billion available at the discount window? It accomplishes exactly what you suggest.

Wall Street can be helped by simply suspending the "mark-to-market" requirements with respect to their portfolios. Mark-to-market is a recent notion and is the major cause of the current crisis, causing temporary losses to be recorded on their books, losses that will never be realized. These phantom losses erode a bank's equity, thereby reducing their ability to produce new credit.

Posted by: Bill on September 25, 2008 10:37 PM

Sure, FvB. I think a crude polarity between "regulation" and "markets" misses the point, since as I said above all markets have a regulatory structure and in modern economies almost all regulated systems have a market element. What's really needed is a broader social shift away from an uncritical faith in and deference to private profit motivation. I would argue that this deference has infected our regulatory systems at a pretty deep level. This is true even in cases where the regulatory systems stayed "bureaucratic" or outwardly complex (it can actually be more complex to run a regulatory system that makes a big space for profit-driven competition -- e.g. "deregulated" electricity privatization was much actually much more complex to administer than the public utility model was).

Check out this post by the economist John Quiggin. Somewhat snarky, but funny. It makes the point that just as pure Communism can never be disproven because no actually existing system is really ideally Communist, so the pure "free market" can never be disproven since no actually existing system incarnates the pure free market ideal.

Posted by: MQ on September 26, 2008 1:56 PM

Why don't we just repeal the restrictions on gun ownership in NYC and see if the outer-borough masses develop a taste for long pig?


Posted by: SFG on September 27, 2008 9:34 AM

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