Plan B: Last chance to avoid financial system failure

www.itulip.com ^ | October 13, 2008 | Luigi Zingales

[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.

[Toddsterpatriot]

You want "free credit", as in very low rates from Greenspan and now Bernanke.

I think he means free credit as in the opposite of "unfree credit", not government mandated low interest rates.

But you don't care if that "free credit" raises systemic risks and leads to a meltdown

How did that "unfree credit" that government (CRA) demanded banks provide for poor risk home buyers work? How did that "unfree credit" provided by the AAA stamp Fannie and Freddie added to those mortgages work?

Maybe not as well as it would have gone if those men were really free to make their own decisions.

I'm sure Jason can defend his statement better than I have.

[palmer]

How did that "unfree credit" that government (CRA) demanded banks provide for poor risk home buyers work?

Market distortion by politicians isn't good either. The intentions of the politicians is to divert some of the funds off to their favorite parties. That may enhance bubbles or not. The credit distortion affects bubbles more generally and powerfully. The proof is fairly simple, the vast areas of empty tract mansions were not created by CRA. Likewise securities, hedge fund leverage, etc. Those are effects of excess credit.

[Attention Surplus Disorder]

Frickin call of the year: RRPIX and RYJUX

http://stockcharts.com/h-sc/ui

http://stockcharts.com/h-sc/ui

I wish I could convey to you how hard I lobbied for this among the members of my family all of whom have LT bonds, with no luck. Ugh, ugh, ugh. Those bonds are IMO in one of the biggestr bubbles of all time, they’re set to lose 30% and over their term they’ll lose 80%-90%.

[palmer]

the days of buy and hold are done with for at least a decade

Yep, 1970's upside down U markets

[B4Ranch]

In the 70’s I was chasing skirts not cheap stocks.

[B4Ranch]

unfree credit?

Hmm?

Does that mean that we will be receiving predeclined letters of credit?

[Attention Surplus Disorder]

I am not sure if the charts I linked came out right, but enter the symbols RRPIX and RYJUX. Pwned.

http://stockcharts.com/h-sc/ui

[Uncle Miltie]

"The only reason that didn't continue straight down is the bailout measures approved then and seconded by the EU over the last weekend." - JC

"Only 30% of the house burned down because we threw gasoline on it to quench the flames." - UM

If you don't get the analogy, I can't help you any further.

[Uncle Miltie]

"Think you reduced the role of government?" - JasonC

http://www.freerepublic.com/focus/f-chat/2093481/posts?page=1#1

In that post, I believe JasonC was attempting to make the point that opposition to, and the defeat of, the Bailout would not reduce the role of the government in the economy. The obverse would presumably be that the passage of the Bailout would not increase the role of the government compared to the non-Bailout.

Now that the Bailout has passed, and Banks have been effectively Nationalized, I wonder if Mr. C would like to rejoin the argument and state again for the record that the Bailout somehow reduces the role of the government in comparison to the non-Bailout.

Moral Hazard is like heroin. When the patient is convulsing on the floor in withdrawal symptoms, the cure is not to double the dose.

[Toddsterpatriot]

And this bailout will lead to more subprime lending?

[B4Ranch]

Watching Ben on CNBC telling us that too many businesses have become too big for them to be allowed to fail.

Remember back in 1990, when the IRS seized the Mustang Ranch in Nevada for tax evasion? Then as required by law, they tried to run it. Yes, they failed and closed the doors.

So now we are trusting our nations economy to a bunch of idiots who couldn’t even figure out how to make money running a whore house.

No wonder people aren’t sleeping well.

[Swing_Thought]

JasonC,

Regarding post #115:

Surely you don't think FReepers are THAT dumb.

You're the one defending the current monetary system, rife with government intervention causing all sorts of trouble.

I'm the one proposing more free market capitalism and removal of government intervention.

I'll trust the readers to decide for themselves who is the more consistent capitalist.

You should reserve your "defense of capitalism" vitriol for those to your left, to those who don't know what capitalism means.

Regarding this statement:

Seriously, you make a fetish of understanding which I have in spades but make so fetish of.

I am a husband, father and (hopefully someday) a grandfather. And I am a citizen of the republic. As such, self educating myself on the causes of the current crisis, and attempting to influence others to support what I have come to believe are the right solutions, is hardly a fetish.

Finally, regarding this statement:

You are too stupid to understand your own ideology, let alone its errors, let alone the world.

Wow. You're adept at slinging insults too, I see. Our first conversation started when you called me a traitor. Is this what makes you a capitalist?

[Uncle Miltie]

No, this bailout will lead to another unknowable (so far) consequence of Moral Hazard.

For example, when Paulson buys banks, he opens the door for Congress to take control of Bank Balance Sheets for the purposes of government spending.

Where will that lead? Who knows!

But as Friederich Hayek points out in “The Road to Serfdom,” there is no way a Bureaucrat can know enough to displace the collective wisdom of the market, and the Bureaucrat cannot learn from his mistakes because he is not punished for them.

Knowing that is enough to know that the government intervention in the market will not end well.

[Toddsterpatriot]

For example, when Paulson buys banks, he opens the door for Congress to take control of Bank Balance Sheets for the purposes of government spending.

It could lead to the government spending bank money on subprime lending? I hope you're wrong.

Knowing that is enough to know that the government intervention in the market will not end well.

You got that right.

[GOPJ]

His writing style is 10th grade as opposed to the more comming 6th grade style we tend to write in for clarity and to reach the widest audience. That 10th grade writing style can sound pretentious. Sorry, if your reading comprehension is not up to 10th grade...

You must be very young. Or easily impressed. Or drawn to the superficial.

[supercat]

Benefit the market in general yes, but benefit them in particular, no. The whole reason to sell shares to get money to invest in new production. When the next recovery comes I would want my company to be ready. For a manufacturing company that really means investing in new production now, not buying back shares.

I should have been clearer; I didn't mean to imply that all such businesses should buy up stock though I can certainly see how you could read things that way. If a company needs to keep a certain amount of cash for a particular purpose, then it should do so. On the other hand, if the company can buy up 5% of the shares using 4% of its net cash, then then even if the company's profits get reduced by 4% as a result of the transaction the per-share dividend would still increase.

While there may be some circumstances where using 4% of net cash to buy up shares would end up reducing profits by more than 5% (e.g. if it means a company can no longer afford to buy a machine that would have increased profits by 20%, or if it subjects the company to an undue risk of insolvency due to possible liabilities) I would think that in most cases spending 4% of net cash buying stock would reduce profits by less than 5%.

[Uncle Miltie]

I see the markets had another beautiful day of reacting to the vaunted Bailouts (off 9%).

A few more excellent JasonC-Approved-Bailouts(tm), and we’ll be rich!

[Texas Songwriter]

Travis,...were you aware that during the negotiations on Sept 15,2008, the day Lehman’s failed, prompting a sudden deal with AIG that the only people in the room for that negotiation was Hank Paulson, the CEO of AIG, Bernanke, and, oh,yes, the current CEO of Goldman Sach’s Bank. For his trouble, of the $85 billion Berhnake paid for AIG, $15 billion went immediately into the coffers of Goldman Sach’s to underwrite Goldmans derivitive risk which AIG had written. I heard Newt Gingrinch speaking of this on Hannity and Colms. There was also an article in the New York Times.

[Travis McGee]

It's a GS world. A few of the rubes are catching on, but not many yet.

"The logic of the conspiracy theorists in this regard is, of course, impeccable: Goldman alumnus Josh Bolten runs the White House, while his former boss, Hank Paulson, runs the Treasury. They both speak regularly to former Treasury Secretary Bob Rubin, now over at Citigroup, who ran Goldman before Paulson and who keeps Paulson and Bolton dangling like puppets on a string. They all supposedly touch base with the heads of the Italian and Canadian central banks—both Goldman alumni—and with Robert Zoellick, head of the World Bank, ex Goldman. What's more Paulson is now getting his advice on how to handle the crisis from Ken Wilson, the recently retired Goldman partner and financial-institutions M&A banker, who Paulson just recruited to Washington to help him out. Already at Treasury were Goldman alumni Dan Jester, Anthony Ryan, David Nason and Bob Hoyt, the department's general counsel. And—the conspiracy crowd can't help but point out—Neel Kashkari, 35, a former vice-president at Goldman who Paulson recruited as assistant secretary of international affairs in 2006, has just been appointed—by Paulson—to run, on an interim basis, the new $700 billion bailout fund."

~~William Cohan, "Does Goldman Sachs Really Rule the World?" October 2008

“Gentlemen, I have had men watching you for a long time, and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the eternal God, I will rout you out.”

~~President Andrew Jackson, on the 2nd National Bank

[Toddsterpatriot]

The logic of the conspiracy theorists in this regard is, of course, impeccable: Goldman alumnus Josh Bolten runs the White House, while his former boss, Hank Paulson, runs the Treasury.

And my favorite piece of evidence that Goldman rules the world, former Goldman partner Jack Ryan easily defeated Barack Obama in 2004 for the open U.S. Senate seat in Illinois.