Posted on 10/14/2008 12:55:09 PM PDT by Freedom_Is_Not_Free
After pointing a gun to the head of Congress, threatening a financial meltdown in case his plan was not approved, Treasury Secretary Hank Paulson has finally arrived at the only logical conclusion: his plan will not work.
Desperate for a Plan B, Paulson is slowly warming to the suggestion of many economists: inject some equity into the banking system. Unfortunately, it is too little and too late. The confidence crisis currently affecting the financial system is so severe that only a massive infusion of equity capital can reassure the market that the major banks will not fail, recreating the confidence for banks to lend to each other. The piecemeal approach of 100 billion today, 100 billion tomorrow used with AIG will not work. It will only eat up the money, without achieving the desired effect—without reassuring the market that the worst is over. Simply stated, nothing short of a 5% increase in the equity capital of the banking system will do the trick. We are talking about 600 billion. Unfortunately, even if the government is willing to spend this kind of money, there are three problems.
(Excerpt) Read more at itulip.com ...
And they do that spontaneously? It has nothing to do with failed speculation so that my hedge fund levered 10:1 now owns nothing but still owes the borrowed money?
Thank you, I appreciate that. And you would agree that lowering rates now is a mistake as well?
But it isn't what you do or what is done to you, that is bothering you. It is the use other men are making of their own freedom.
JasonC, you'll find no stronger defender of individual freedom on FR than me. No, I have no problem with bankers making money by lending monies trusted to them by investors who KNOW that they are taking risks and that their money will be unavailable to them for the given time period.
But I DO have a problem with this: A banker making money by lending money belonging to a depositor who is told that his money can be retrieved at any time, but where the banker's promise - in the event of a bank run - can be fulfilled only by a promise from the government to repay that deposit by robbing the (innocent) taxpayer.
And I do have a problem with a central bank, via a banking cartel, inflating the money supply and thereby robbing money holders of their purchasing power.
And I also have a problem with the central bank (even with good intention) mistakenly leaving their money spigots open for too long, leading to innocent lenders and borrowers making bad decisions based on false interest rate signals, leading further to a boom and bust cycle with pain for all involved (and the innocent taxpayer again, to boot!).
I really am trying to understand your responses but quite frankly your prose is rife with phraseology that suggests that your main argument seems to be based on the idea that we mere mortals of slightly above average intelligence are just too stupid to understand the complexities of the modern banking system and the brilliance of it's governors and therefore should simply trust them to do the right thing for us.
Sorry, I'm not buying that one. But thanks for the dialog anyway... you've cemented my belief in the Austrians.
Regards,
Swing_Thought
Pols also encouraged loans to deadbeats in an attempt to buy their votes with other people's risk-taking.
Bankers also invented opaque new forms of securities and as usual priced these innovations for the near perfect conditions that attended their creation, instead of the whole-cycle robustness they actually require.
Consumers speculated on houses, including cash out refinancings and loans without amoritization, and lowered their savings rates, to live higher and to make bigger bets on house prices.
Lots of speculators bet that the whole thing would be inflationary and bid commodity prices to unsustainable levels - those prices attracted new supply which eventually reversed those rises. In a few of the stickest cases on the supply end, the high prices had to damp demand first and those peaked the latest (e.g. this year).
The bets of the speculators that it would end in an inflationary manner were in part based on analogies to the 1970s and in part based on their buying Paulean nonsense themselves. They were completely wrong, because the Fed refused to play it according to their inflationary script.
Instead, the Fed left the narrow money supply that it directly controls, completely unchanged from the spring of 2005 to the spring of 2008. There were no additional spendable dollars chasing all the higher prices.
But banks, private ones, acting on their private initiative and not directed by the Fed, in fact fighting its tightening, increased the broader money supply of savings and the like (which are not regulated by the Fed) by $2 trillion, over that period.
Mainstreet then defaulted on debts to those banks to the tune of $1.4 trillion and counting. Stiffed them and walked away, when their various speculations especially on housing did not grow to the sky.
Four different tiers of private economic actors them broke their contracts wholesale - original borrowers, loan originators, insurance underwriters, and investors in those loans - and as each welshed in turn, bucked the collateral up the chain of creditors, to the major national banks.
Who were thereby asked to take the hit for everyone, on those bad debts, which are a manifestation of capital misallocation costs over the cycle.
They proceeded to take between half and two thirds of said hit out of their own resources, soliciting new private money, using their earnings and their capital reserves etc.
In the last 2 months, they reached their capacity to pay without cascading failure, as each additional write off destroyed more value through loss of confidence than it dealt with of the original loan loss problem. Concretely, the rate of interest banks had to pay on their own debts began to exceed those they can charge borrowers, but factors of 2 to 5.
The banks no longer being able to take the remainder of the hit, it falls to their own creditors, which is all of us, in our capacities as bank depositers and as taxpayers funding the FDIC, which guarantees said depositers against loss. The remaining question was not whether we would pay it, but how we would pay it and what would be destroyed in the process.
Intelligent men correctly decided that it would be preferable for everyone, without exception, to save the financial system rather than to destroy it, while paying the remaining losses. Populist ideologues (not Pauleans) intervened and attempted to stop this, in the hopelessly deluded belief that financiers could still someone be made to pay for it all. This raised uncertainty and accelerated the losses, to the point where the authorities decided to override and ignore such considerations and save the banks while allocating the remaining loss to taxpayers. They are now in the process of doing so.
That is what has happened. It is not in dispute.
I'd suggest that it's actually something simpler: a widespread and fundamental misreading of the signs of market friction.
The only way speculators in aggregate can make money (if the goods they're holding have no value except to resell) is by buying goods in time of low demand relative to supply, and selling them in time of high demand relative to supply. When speculators do this, they provide a very useful market function, and they can profit handsomely, individually and in aggregate, from doing it.
As more speculators enter the market, prices in the time of formerly-low demand will rise. This should be a red flag to speculators to stop buying, because the number of speculators is sufficient for market needs. Unfortunately, bulls see the red flag and they charge right in. As more and more speculators enter the market, the average profit starts to drop, then the aggregate profit starts to drop, then the aggregate profit goes negative. If speculators keep entering the market, the average profit will go more and more negative.
If people would simply learn that chasing rising prices is a fool's game, boom/bust cycles would be largely avoided. Any idea how to convince people of that?
Thanks you Travis - you are totally right about this. He's got lots of buzz words mixed with attitude - - and little else. It's tedious.
It seems that many of the simplest rules of economics have a habit of proving themselves, despite the efforts of people to come up with all sorts of advanced explanations for why the simple rules shouldn't apply. Something akin to the way "bioethics" is the study of how to pretend things are ethical when they aren't, and "Constitutional law" is the study of how to pretend the Constitution says things it does not and never did.
Your long historical narrative does not mention the hedge funds levered 10:1 to buy the opaque cycle-agnostic securities created by the investment banks using 5:1 leverage which were derived from mortgages that Main Street used to lever home purchases. You make a point of mentioning Main St. as the pivot point with $1.4T in losses. But the 50:1 leverage added by the combination of investment banks and hedge funds is what made those losses fatal to the financial system.
It seems that you want to lay significant blame on the small investor overextended on a house when in fact they added no systemic risk in a properly priced credit system. They also did not break their contracts wholesale, they broke them in relatively small quantities and mostly with reluctance.
The main factor you try to minimize is mispriced credit, the root cause of malinvestment (along with psychology). You say:
But banks, private ones, acting on their private initiative and not directed by the Fed, in fact fighting its tightening, increased the broader money supply of savings and the like (which are not regulated by the Fed) by $2 trillion, over that period.
Can you explain why and how they did that and also why that increased systemic risk or otherwise contributed to the crisis? Thanks, will read your answer tomorrow.
So the current low rates will not lead to any malinvestment?
I just purchased a brand new home today. The rate is 5.8, the seller came off a bit. Good or bad? The market is Nashville.
On a serious note, I won't be surprised if the total cost would be over 10 trillion dollars eventually.
You are wrong, you are attacking the freedom of other men to engage in free credit transactions, and I defend their right to do so. I am a strong defender of individual freedom than you are, and I am right here on FR. I deny that your Austrian position is libertarian. I claim it is a warmed over version of the classic populist hatred of finance capital as unearned income, that led ancients and medievals to condemn usury, socialists to condemn profit, anarchists to condemn property, and antisemites to condemn Jews. I claim that financiers are not thieves or counterfeiters or bloodsucking leeches, but honest free men providing valuable services and taking necessary risks, and that you and everyone who agrees with you is viciously slandering them without just cause.
"investors who KNOW that they are taking risks"
Sorry, that slander died with the gold standard, you haven't updated the slander manual in a timely enough fashion. Banks under fiat money are entirely capable of redeeming every dollar of their deposits for the only thing they have ever promised to deliver against it, a federal reserve note. And bank depositers in an FDIC insured fiat money system know exactly what risks they are running, and are not children or mascots that you can pretend to be protecting from evil financiers.
Has everyone forgotten that the average American owns real property and carries it with nominal debts, often at high leverage? Has everyone forgotten that going overboard in that direction, net *short* immeidate money claims to carry real property in expectation of higher inflation than actually occurred or was sustainable, is what got those speculators into their mess? Has everyone forgotten that the banks didn't stiff their depositers for a single dime, but speculators on high inflation *did* stiff the banks to the tune of $1.4 trillion?
These are not people unable to adapt to living in a fiat money system. They are people so adapted to it and so cynical about it, that when money instead remained broadly stable in both quantity and purchasing power, from 2005 to 2008, all their inflationary brainstorm adaptations collapsed around their ears.
All the money they ever wanted to withdraw was withdrawable throughout, and still is. There never was the slightest danger of anyone being unable to withdraw federal reserve notes from the banks, which is all they ever promised to pay. You really need to update your smears, they are too obviously just outdated lies this time around.
"A banker making money by lending money belonging to a depositor"
Bzzt, wrong answer, the money belongs to whoever it has been transfer to in the ordinary course of exchange. If the customers wants to own *money*, let him keep it in his pocket and he'll own money. But if he want to own a *bank deposit*, then he puts his money over the counter to the banker, and accepts the banker's IOU instead. Yes, because the banker promises to pay it back in banknotes on demand, and he can and he will and he has.
"can be fulfilled only by a promise from the government to repay that deposit by robbing the (innocent) taxpayer."
First, the innocent taxpayer is robbing the financial sector of $480 billion a year to pay for middle class entitlements, so his supposed innocence rings a little hollow. The finance sector is a huge net payer to the treasury and always has been, and will be.
Second, the bank can in fact meet the demand without the taxpayer's help if the Fed accomodates it by discounting its assets for reserves, which are exchangeable for currency. Whether the authorities want the Fed or the FDIC to do it is quite up to them, but either way the depositer is whole and the banker has performed what he promised. He has also received from the government only what he contracted and *paid* for, in either case. The banks made the Fed and capitalized it. The banks pay the FDIC insurance premiums every year for their guarantees, they are not a subsidy. And they also pay the government vastly more than anything it has ever spent on all of the above. Three times their share as workers employed, etc.
"a central bank, via a banking cartel,"
One, the Fed isn't the banks. Two, the banks aren't a cartel, there are about 3000 of them in this country and they are as free as you please. Three, you can join them tomorrow by buying bank stock if you have the guts for it. Bankers earn a profit long term compared to bank debt aka deposits, but they get nothing like the safety out of it. They can and they do lose 80% of their value in one year when things go badly, as a group, and individuals lose 100%.
If you think the banks have so great a deal compared to depositers that it is criminal, then take all your bank deposits and buy bank stock instead. The system cuts, but you choose. You are therefore not harmed in the least by the division of rewards and risks between bank depositers and bank stockholders. You can be in either position or blend them in the scale of their actual overall size and thus receive the society-wide average of the return and safety of banks and bank depositers. Entirely up to you. You are not robbed by any of it, in any way, and it is pure slander to say you are.
"robbing money holders of their purchasing power."
You don't own a purchasing power, you own some asset or other, that fluctuates in value like everything else in existence. Nothing you own has a stable exchange value, and every action of everyone else changes the value of everything you own. If someone buys a peppermint latte instead of a newspaper it changes the value of some of your assets. Shall you chase them all down and demand that the government put a gun to their head and force them to use their freedom in the way you think will benefit you? And then have the gall to call that demand "libertarian"?
You are responsible for your own chosen asset position and for anything that happens to it. Grow up. Nobody ever guaranteed you an exchange value of anything, and nobody ever could while other men are free.
"to innocent lenders and borrowers making bad decisions"
No such animal.
Free men are responsible for their bad decisions. They aren't "innocent" if those decisions are bad. They aren't criminal either, to be sure, but they take the consequences. More, if their screw ups are big enough, their neighbors take the consequences, too. Law of nature.
Now you want to demand that the government restrict men's economic freedoms so as to make all "innocent" lending and borrowing decisions *correct*. You just about said so above. Sorry, can't be done, government isn't God, the demand is ridiculous on its face and doubly so in the mount of anyone who pretends to support human freedom.
"based on false interest rate"
They aren't false, they are offers. If you think they are wrong for the long term, you take the side of them you think will benefit you. Again, the system cuts but we all choose, in every cycle. Every investor can fade the cycle and trade it countercyclically. If enough did, the cycle would be smoothed to nothingness, by their action alone. Again you are objecting to other men's use of their freedom, that it isn't infalliable enough for you. Tough toenails!
"I really am trying to understand your responses"
Simple, I am a post-Austrian who understands that theory cold but also knows its errors, who comes down for *free credit* not the abolition of credit, precisely for the Hayekian reason, that economic security is not to be had and the attempt to achieve it by government restrictions on economic freedoms is dangerous and destructive of economic liberty, but won't produce any actual economic security anyway. I am on the side of capitalists and merchants throughout history, on the side of their freedom, even when they screw up. I deny they are oppressing people or stealing anything - they are producing most of the value around us and their chaotic but successful freedom is in fact the reason we aren't still living in the middle ages.
I am not going to go back to the time when men campaigned against profit as unearned or property as unjust or usury as sinful, and I am not going to go back to a time when bankers can't make loans if they think the borrow can pay it back, and investors can't back them, and depositers can't trust them. I am not going to give up my bank credit cards and flexible money that expands in a panic.
I deny any of it oppresses me in the slightest particular! Got it? I am *satisfied* with modern capitalism, I *like* it, I *support* it, I think it is *great*, the most successful economic system in human history and the freest. And I don't support it because I buy some nonsense story about its perfect efficiency or its infallibity. I don't support other men's freedom only when they use it perfectly, I support other men's freedom when they screw up. I support them when it cost me tax dollars and I support them when the value of my 401k goes down.
I don't give a tuppenny damn about your slanders of other men who have never oppressed me in the slightest and in fact render me wonderful services all the time - while you have never done a thing for me. I don't give a rat's rear about a drop in a market or a change in the value of what I own, whether money or stock. I am a free man in charge of my own finances, and I don't need your ideology riding in to save me. Got it? I decline to be a mascot! I decline to sell my support for other men's freedom for a 1% lower rate of inflation over the next 25 years, about which I care next to nothing. (Sure I'd take it, but I won't give up a single economic *right* and *freedom*, mine or anyone else's, to supposedly further that end).
"we mere mortals of slightly above average intelligence are just too stupid to understand the complexities of the modern banking system"
You are too stupid to understand your own ideology, let alone its errors, let alone the world. But that is not crime, and it is overwhelmingly common, the rule, I don't hold it against you. Seriously, you make a fetish of understanding which I have in spades but make so fetish of. That is not your problem. Your problem is that you are unjustly attacking other men with vicious slanders, and you think you are somehow a support of economic freedom in doing so, but you aren't. That is an intellectual error yes, but it is also a susceptibility to a hateful moral appeal that you ought to see through and resist, regardless.
Why do you talk as though you are oppressed and robbed by the existence or actions of bankers, when you manifestly aren't? You can be a banker tomorrow if you think it a great deal; if you don't, you can see it isn't so easy or all safe as houses (sic). You don't need to be a rocket scientists to see you are kicking men when they are down, men who have done more to make the prosperous world around you work, than you ever have. In other words, your unjust hatred and your ingraditude scream to high heaven.
And there isn't any libertarian anything, in that.
They actually said it ticked up to 7 so I hope I timed it right. I got the builder to bring 3.5 to the table. I feel good about it. The Phoenix market got whacked if that’s the one your talking about and would expect huge values there.
Take a concrete example. The builders were not wrong that there will be a net population movement to the sunbelt from the northeast as populations age and more retire, as taxes remain high in the former and land cheap and weather nice in the latter, and as technology makes it easier to find work farther from traditional industry concentrations around old transport hubs for bulk commodities, etc. Therefore, they were right to build new subdivisions around Phoenix. OK, now how many? For how long?
It was of course profitable in a personal sense for someone to sell an expensive older house in the northeast to buy a bigger brand new one in the sunbelt that cost less, "arbitraging" the existing price difference between northeast and southwest housing. OK, how many people would want to do that as a way of cashing out of the housing price boom in the northeast? How mobile are modern workers? Well, also, what portion of the jobs being offered in the Phoenix area were just tied to construction?
Once the prices stop rising, they know they've gone far enough, maybe too far. But in fact they went way, way too far before prices stopped rising. As a result, there are some entire subdivisions in south Phoenix built in 2004-6 that never filled up, that have been standing nearly vacant since completion, some of them going to seed as a result (squatters and stripping, no maintenance and damage, etc) and that won't sell now even at 1/2 or 1/3 what it cost to put them up.
But yeah, if enough people traded cycles *anticyclically*, they'd smooth it out. Heck, if enough people just reacted to the Fed's own moves - trade against the cycle gradually in 2004 and firmly from 2005 on, e.g. - then it would have had half the amplitude it did, and the losses might have been a fourth the size they were.
In case everybody is just forgetting it, though, we are all a lot wealthier now than we were before the boom, in the aggregate. Household net worth is higher, home prices are higher even with the drops, there is more real property in existence, the national income is higher, etc. Misallocation effects lose *some* of the value added in the boom. But lots was added, and will be again.
Builders reacted correctly to the market signs. When price goes up, increase supply. The only problems from their perspective were (1) a time lag between the decision to build a house and its availability for sale, and (2) the fact that a significant portion of the housing demand was artificial, and could disappear within the builder's time lag. Misallocation effects lose *some* of the value added in the boom. But lots was added, and will be again.
There are lots of philosophical issues involving boom/bust cycles (which are related to, but distinct from bubbles). I'm a fan of the Atari 2600 Video Computer System (even written a few games for it). In the early 1980's, many companies saw that video game cartridges were becoming popular and were good money makers. They figured that if they could manage to take in even 1/10 of the 1980 market revenue they'd turn a good profit. Unfortunately, it really isn't possible for dozens of video game companies to all manage that many sales. Consequently, the market crashed.
On the one hand, the crash meant a lot of people spent money producing games that did not turn a profit; their money could have been better spent elsewhere. On the other hand, there are a lot of good and interesting games from that era which would never have been written had the authors known they wouldn't turn a profit. I'm glad that most those games are available today(*), often quite cheaply (many game cartridges from the era are available for $5 or less) but I fully acknowledge that my ability to pick up good games at such prices is a result of market inefficiency.
(*) There are some games the world would probably be just as well off without. Sssnake and Skeet Shoot deserve credit, I suppose, for maintaining a stable scan line count, and Froggo's Karate cart does deserve some credit for the ease of replacing the ROM with a 2764 containing something better, but there are a lot of games with something to offer.
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