Posted on 09/25/2008 8:30:07 AM PDT by Notary Sojac
Why We're Floundering And a better way forward. by Lawrence B. Lindsey 09/24/2008 7:45:00 PM
LAST THURSDAY NIGHT Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke stood surrounded by the bipartisan leadership of Congress to announce that a consensus had emerged that drastic action was needed to save our financial system. On Saturday the first vague details of that action began to emerge. By the time of the first hearings on Tuesday a groundswell of popular opposition produced some of the most broad-based skeptical questioning of the nation's economic leadership that I can remember. What happened?
First, it is now obvious that the Thursday consensus to pass a bill was not backed by the reality of legislation, or even a coherent plan of action. When Washington let Lehman Brothers fail (after a century and a half of operations), many in Washington said that Lehman had had six months to get its problems revolved--since being put on notice when its sister firm Bear Stearns was bailed out--and had not done so. Hence it was denied the assistance Bear had gotten. But what had Washington been doing in the intervening six months to get ahead of the developing financial crisis? By the weekend it appeared that the answer was: about as much as Lehman.
Second, when the first details emerged, the focus of the plan was for the government to buy the assets in the financial system that were not easily valued and therefore could not be sold. They were clogging up the books and thereby consuming most of the spare capital in the system. Those that could be sold were being sold out of desperation at fire sale prices. For example, Merrill Lynch had sold assets at 22 cents on the dollar, and had to lend three-quarters of that amount to the buyer. Trouble was, if the government bought at those prices, the financial industry would take massive losses and many firms might go under. That meant that the only way the plan made sense was for the government to buy assets at prices well above current market values. Not even the most talented wordsmith could find a way of getting around the word "bailout" for this type of action. This meant bailing out the same gigantic firms which government regulators and prosecutors had been saying for months had used shady accounting practices and paid their CEOs tens of millions of dollars per year. I'm just an economist, but that hardly seems like a political winner to me.
Third, to make these purchases the government would have to set a price on assets that are so opaque and differentiated that no market price had been determined for over a year. This opacity led Wall Street to employ some of the smartest people in the world to come up with computer models to determine these prices, and when they did, the prices were so subject to small changes in underlying assumptions that they proved wildly volatile. Passing the plan meant asking members of Congress, most of whom would have to ask a staffer what the formula was for compound interest, to either figure out a fair price or trust the same geeks who got us into this mess in the first place to figure one out instead.
The most likely end game of this approach is passage of a bill that hands the job over to the geeks with so many constraints and conflicting objectives that the entire enterprise runs up against Arrow's Impossibility Theorem. (Kenneth Arrow got a Nobel Prize for formalizing a way of saying "you can't get there from here.") The resulting process would be open to manipulation by private players who could hire their own geeks to figure it out, and therefore almost certain to produce instant billionaires in the process. But, this outcome will still allow congressmen to go home to campaign and tell voters that they have both solved the problem and protected the taxpayer. After the process collapses and the Congress returns in January, the blame will be dumped on the appointed officials who were supposed to oversee the geeks assigned to complete the impossible task. A new process will then be created in January by people with even less experience and with the deterioration in the system much further advanced.
One likely way the new folks could proceed is to stay away from the tar pit of trying to bail out institutions directly and instead opt for an indirect approach. Specifically, the government might choose to bail out homeowners instead. Suppose all homeowners were allowed to refinance their existing mortgage at some low subsidized rate that was also extended to all new buyers, say 4 percent. One catch--the government would have recourse to the borrower and not just the house in the case of default. This is a huge broadening of the plan originally suggested by Martin Feldstein. Not everyone would take this up because it would mean they would have to pay the money back and not just default on their mortgage. So, it would quickly separate the good mortgages from the bad ones that are creating problems in the system.
For those who did take up the plan, a wave of prepayments would begin that would trigger positive cash flow and reduce the risk to all that derivative paper the financial service industry now holds. Prices on that paper would quickly rise and firms would enjoy both more liquidity and more capital. For those who did not refinance, the expectation would be that the house was so far under water that it will ultimately produce a loss. This would help clarify precisely just how much the losses were in the system and on each of the many securitized products and mortgage derivatives as well.
But the biggest advantage is that it avoids the quagmire in which the political class now finds itself. No need for direct bailouts, no need to warehouse paper, no need to hire geeks to figure it all out, and no instant billionaires who simply gamed the system. Better yet for those up for election, no political complaints since it is the voters themselves who were being bailed out.
Lawrence B. Lindsey, a former governor of the Federal Reserve, was special assistant to President Bush for economic policy and director of the National Economic Council at the White House. His most recent book is What a President Should Know . . . but Most Learn Too Late (Rowman and Littlefield).
Do Nothing - Paulistas, Randians, and the gold'n ammo crowd.
Do Something, but not THIS something - the vast majority of conservative commentators, true conservative legislators, owners of successful and well managed banks, and objective economists.
Do the Paulson Plan Right Now - George Bush, Ben Bernanke, Hank Paulson, Chris Dodd, Chuck Schumer, and people who have profited/intend to profit from the leverage/derivatives shell game.
Flouder? Sounds fishy..............
Simply not true for Paul. He supports radical action to abolish/audit the Fed, scale back the size of government including our unsustainable world empire as well as deregulate.
Maybe the Putin the American hatin’ Russkie could spring Kodurovsky on us. He could get his office at AEI and then play this “market” and become an oligarch again. Next thing you will know Krauthammer will be pimping for his parole from the bad old Russians.
Nice catch!!
Then all you need is for all the banks to get the same treatment where collateral is concertned that BofA is getting and the crisis goes away the minute the window opens.
No 700 Billion needed.
Of course, this will also mean that you'll have to do something about Fannie and Freddie ...
It was in my sole.......
Oh please---when I'm reminded of that pukeneo stupidity about "American Empire," I want to heave. The stupid pukes led us over a cliff into the abyss of Iraq. Their con game worked----they continued the massive transfer of US wealth to Mideast hellholes and snake pits and into the pockets of waiting war profiteers.
Isn't it nice that the blood od American youth and trillions of US tax dollars made the region safe for Richard (puke) Perle to go into the oil business.
GET OUT YOUR BARF BAGS According to the Wall Street Journal, US gov't infiltrator, Richard Perle (a self-described "Republican," former Pentagon official, Lieberman buddy, and Giuliani flacker) is plotting to establish an oil business in Iraq. Yup--Iraq. Perle was one of the phony "security experts" who schemed and colluded to make the case for the US invading Iraq (later found to be based on false info manufactured by Douglas Feith on his home computer). The WSJ says the Perle oil deal is being discussed with officials of northern Iraq's Kurdistan regional government, including its Washington envoy, according to documents. It would involve a tract called K18, near the Kurdish city of Erbil.
NAUSEA ATTACK Nothing in US history compares to spilling the blood of young Americans and raining trillions of US tax dollars into Iraq to pave the way for Perle's business plans. Nothing.
Heh----Krauthammer pimping---that I'd like to see.
So what do Sojacians believe?
Preventing financial collapse appears to be time critical. Your preferred option “Do something, not this” will cost enough time to guarantee we miss the narrow window of opportunity to prevent that financial collapse.
But I hear a lot of the pro-Paulson folks on and off FR saying that "This might not work. Who knows??? But we gotta try it and try it pronto."
This leads me to the conclusion that many who are advocating it (NOT necessarily you) are just trying to buy a short window of time to liquidate their positions before the s--- hits the fan.
I would be strongly in the second camp.
I absolutely hate it when the liberal Democrats do something just to do something. An extreme and obvious example is say, banning assault weapons to reduce crime or prevent passion murder/suicide killings. You can study case after case and see that assault weapons are rarely used and laws banning them doesn’t prevent their use in any event.
My point: we know it doesn’t work, so it is wrong to just do something to do something.
Now there are some very bright people like yourself here who have been way out in front on this entire crisis and who believe the bailout is not going to solve the problem, will make it worse, or is just a giveaway to fill the coffers of the pigmen before the crash, so they ride it out in comfort.
I can’t dispute any of those claims. I have no evidence to dispute them. But I can find NO consensus if the plan will work or fail among the people I read and listen to and trust because they have been predicting the collapse of this Ponzi scheme for years now, long before I got on board, and WAY longer than the masses here who were saying “you’re just a liberal troll talking down the economy.”
It is like the deflation/inflation question. I can’t find any consensus if the financial meltdown ends in catastrophic 1929 style deflation, or massive inflation that makes the 1970s look like a cakewalk.
I don’t lightly disregard anything you say because I find your posts detailed and credible. I freely acknowledge this could be a power play final parachute for the pigmen. I just don’t know.
But I do know the credit markets are frozen. I know a financial panic will not merely hurt Wall Street, as many here think or hope, but I believe it will spread like a chain explosion through every sector of the economy. You think housing sales are dead now. Wait until you need a 50% down payment and a 760 Fico to get a loan. What is that going to do to the economy when housing sales halt dead in their tracks?
I agree completely that this may not work and Travis McGee may be dead right that this will delay the inevitable and the eventual depression will be even worse. I just don’t know. Maybe I am too trusting and too hopeful. But I want to avert a panic, whereby we lose ALL CONTROL of the reforms in the economy. The market forces unleashed will be uncontrollable. It is obvious that, like an aircraft in stall, when deflation is out of control, you can pay people to spend and invest and it doesn’t happen. Hell, we are seeing that now, with lenders hoarding every dollar they are getting rather than lending it out.
So I’m very scared of the possibilities to come. And I can’t find any guidance from experts. This is unprecedented. Nobody has a certain fix. As far as I’m concerned, this $700 billion fix is the line in the sand for me. I think this is the last chance to find out if catastrophic deflation and market collapse is do-able. If this bailout doesn’t work, then I am completely in McGee’s camp to bring on the collapse now, because nothing will work.
And I am uncomfortable in my conviction. There are people here saying, “Bear didn’t work, F&F didn’t work, AIG bailout didn’t work, $700 billion won’t work.” That is a compelling argument I can’t dismiss out of hand. For me, the $700 billion is the line in the sand. If it doesn’t work, I’ll be out and front saying, “the game is over. We are toast.”
That said, as much as I hate the massive cost and as much as I hate more creeping socialism piled onto the soaring heap I’ve seen since my birth in 1958, I just don’t see $700 billion as a back breaker. Maybe I’m blind, but Bush crashed the dollar causing hundreds of billions of debt from trade deficits. The Iraq war is up to $600 billion off the books, and not a squeak from the peanut gallery about that cost.
Your arguments are sound and I can’t dispute them. Maybe I am only hoping this thing works, but I’m not willing to embrace a possible 1929 style depression following complete panic and hysteria that causes people to withdraw all their money from the banks today, or causes all commercial paper and other lending/borrowing to cease. Money is the blood of the economic body, we can’t afford to lose the weak pulse we have or we go down the tubes, economically.
Remember that the economy has been on a benzedrine high (stoked by both Democrats and Republicans) for the last fifteen years (interrupted just briefly by the dotcom crash and 9/11). A lot of this high was based on borrowing money to sell assets back and forth to each other at ever-ratcheting prices.
Given that, there is simply no way this ends in a soft landing.
The best possible solution is a period of moderate deflation until the excess leveraging gets squeezed out of the system.
No one seems to have presented a way to do that. (I sure don't have one!) But I do believe that the Paulson plan as originally presented, and as modified by the Democrats, does nothing to help that process.
Maybe I missed it but I have seen no evidence that lenders are “hoarding every dollar”. They are not lending to companies that are insolvent, Freddie, Fannie, etc. which in a rational world would be a good thing.
Correct me if I am wrong - my impression is that the Democrats in Carter and Clinton’s time deregulated or loosened the terms of mortgages to provide greater access to home ownership. This invited people who were unable to afford the mortgages to purchase homes in excess of their ability to pay. At the same time, new mortgage types- other than fixed rate - became popular which encouraged house flipping speculators. Attempts were made in Congress to tighten oversight and regulation of Fannie Mae and Freddie Mac, but were unsuccessful. McCain authored one of these bills. In the meantime, Chris Dodd, Chuck Schumer and Barrack Obama were recipients of large campaign funds from these institutions.
These questionable mortgages were bundled in with good mortgages and sold as a bundle. Investment houses such as Lehmann bought them. Since the housing market has tanked and the value of houses has declined, more people have defaulted on their variable rate mortgages and people have walked away from mortgages that exceeded the equity in the home. So the bundle has some rotten apples and it is now uncertain what its worth is. No one wants to buy the bundles anymore. This means that investment firms like Lehmann’s and loan companies are stuck with questionable assets. Since these assets can no longer be turned into money, they lose their loan or investment capability as they have no cash to lend or invest. In turn, businesses and families can’t borrow money to expand, buy homes, or buy large items like college educations and cars. The stock market has less liquidity to rely upon for trading and can also suffer from sympahetic pains. This could affect retirement investments as well as those who speculate in the market.
So this is the crisis. As I understand it, we are going to rely upon Dodd and Schumer and the like in Congress to come up with legislation that will print mass quantities of additional money (causing a good sized devaluation of the dollar) so that the federal government can buy these bundles.
As I understand it, the $7 billion bail out is the equivalent value of the estimated 5% of rotten apples in the bundle. (This is supposed to be an impact of about $10,000 per household.) It is estimated that these properties can be sold to recoup part of the loss - maybe even at a profit. The rest in the bundle will pay their mortgage. I assume these motgages can be rebundled and sold. But this is a bit fuzzy.
So what does it mean to those of us who pay taxes, pay our mortgage, don’t flip houses, don’t plan on borrowing large amounts of money, but do have retirement funds in the market? Will the dollar devaluation or tax cost offset our exposed risk or will we be taken to the cleaners to bail out those who made poor decisions, speculators and wealthy investors?
What kinds of reforms will be imposed to make sure it doesn’t happen again and that bad actors are not rewarded? Who in Congress wil be held accountable for bad policies? How do we shoeld th innocent public from holdin the bag? Is it worth the resultant dollar devluation and integenerational debt? Is it true the Democrats what to take this opportunity to also bailout bad student loans and credit card debt at the taxpayer’s expense?
Anyone who uderstands better than I do please jump in and exlain.
No, credit has tightened up considerably and even good projects are not getting loans because there is too much demand for money but limited supply. The Fed slashed the fund rate and lenders borrowed the money, but they are generally hanging on to it right now to meet reserve requirements and to hedge against future insolvency if their loans get called in.
I apologize for not providing back-up articles for this but I don’t have time right now to dig and I’m not finding these stories through Google right now.
None whatsoever. Once the Paulson plan is passed reform will be off the table until it's time to use it as sucker bait for the next quick fix.
Who in Congress wil be held accountable for bad policies?
See previous answer. Wash, rinse, repeat.
How do we shield the innocent public from holding the bag?
Turtle Wax, maybe, or Crest toothpaste.
Is it worth the resultant dollar devaluation and intergenerational debt?
Absolutely, as long as you're childless.
Is it true the Democrats want to take this opportunity to also bailout bad student loans and credit card debt at the taxpayer’s expense?
You betcha, Bunky.
Good post, but again, my point is that brilliant honest experts can’t predict the end game from any scenario presented in this crisis. You give them all the data, but even then, half say we deflate hard and half say double digit inflation/stagnation.
There is no consensus. That is my point. There is no source out there for me to read or to present to you that we can try to deconstruct and make an educated guess if we deflate hard or inflate hard. Similarly, there is no source that we can point to that seems to know if this massive government expenditure will prevent an imminent financial crisis.
I fully agree with Travis McGee that if we spend a trillion dollars to buy all the bad debt, thereby pulling wall street’s chestnuts out of the fire (as well as your insurer, your local pension fund, your local school district, etc., through every facet of Main Street...), and we do nothing to reform the system, the greedy bastards will go back and blow a bigger bubble, motivated by the expectation that Uncle Sugar will just bail them out again.
IF this bailout works to prevent imminent worldwide systemic financial collapse, then we can throw the bastards in jail, back charge lenders via taxes to get some money back, force transparency, limit risk through new regulations.
I know you believe the bailout is damaging, just as you know I believe the bailout is helpful in averting financial meltdown. My problem is, I can’t find article written by intelligent, trustworthy people who agree on this. You have John Stossel against the bailout and Thomas Sowell for it. If people that wise can’t agree on it, how the hell are you or I supposed to know with certainty? We simply can’t.
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