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Wednesday, October 08, 2008

Bailout no solution for the credit crisis

We need to examine the most fundamental of questions: is there a crisis? Before trying to understand the craziness unfolding in Washington about what to do about the nation's credit crisis, it's worth affirming that there does indeed exist a crisis. In these days of a faux (or at least endless and unwinnable) War on Drugs, and War on Terror, it's well worth the effort to maintain a healthy dose of skepticism about any potential problem that the government feels it must resolve.

Yes, the crisis means that corporations have a harder time borrowing. Higher borrowing costs are a natural consequence of widespread defaults.

Interconnectedness is a concept at the heart of a credit crisis. It's like when word of a highly popular student getting a venereal disease spreads around school. All of a sudden those who've had relations with the star come forward, to tell partners about the past liason, and the need to get tested. Calling former sex partners is hardly an enviable task, but it is an important one that all those who've been with the affected person need to do, so they don't unknowingly pass on the Sexually Transmitted Disease.

The debt crisis is a communicable disease which is perhaps unknowingly spread by companies and investors in insurance companies and banks, as well as indirectly through hedge funds, mutual funds, and even money markets. Investor money may have gone into buying subprime mortgages or--worse--into Credit Default Swaps, the high school slut of financial derivates.

Dancing to the Dow

While the Dow's day-to-day swings don't accurately reflect the economic strength of the nation, they do serve as a barometer of general sentiment and level of investor confidence, looking forward about six months or so. In this regard stock performance tells us more about how the economy will do in the future. If someone is buying and selling based on today's events, they've missed the trends and the news that impacts the stock valuation six months or more in the future.

As a forecasting tool, a Dow decline signifies considerable weakness in the near future. In other words, $700 billion of Federal money sent to help flailing financial services firms won't stabilize the economy, or so conventional market wisdom has assumed.

Naturally, the response of many early advocates of the bill's passage is to lay the blame for a slumping Dow on the failure to get the bill passed quickly enough. Now if indeed investor confidence can be so easily shaken as to drive the Dow down so quickly, we really do have a problem.

The next question is how relevant the bailout bill is in resolving the crisis. We now have the benefit of hindsight in looking back on the bailout, which was passed by the House on Friday. Criticism of the plan has morphed into a critique of its effectiveness, a post facto summary of the effects of federal intervention.

The Dow fell hard Monday, at one point eclipsing the previous week's record 777 point loss. Somehow the resilient index bounced back to just under 10,000. In my last post, I'd talked about the shadowy President's Working Group on the Financial Markets, more commonly known as the Plunge Protection Team, which had been brought up in the original bailout bill of all places. Could they be active, propping up the Dow? We wouldn't know what they decide or what they do on a day-to-day basis, as the meetings are secret. If we can't trust government to clean up a mess their policies made inevitable, how can we trust a secretive group of political appointees to act in the public's best interest? Working beyond accountability to any outside body, the PPT is likely part of the same nexus of cronyism and political authority which has emanted for the past eight years and directly contributed to the crisis. Any solution elevating the role of the PPT will contribute to the problem, or constitute some exploitation of the solution, which the bailout might be.

Politicians typically measure the state of the economy by how well the stock market performs. The Dow is a mix of blue chip companies that represents a gauge of overall economic activity. It does not, however, measure the availability of credit, nor can it capture the impact of a trade deficit or inflation. Nonetheless, when the Dow goes down, politicians respond to the fear stimuli felt among their constituency, and when the Dow goes up, the crisis lessens, albeit on only a superficial and temporary basis.

Next steps

With a credit crisis apparent, the next question is whether or not the government can correct the situation. The libertarian perspective which I often hold in regard to government size is correct in assuming governmental meddling is the largest cause of the current crisis. Unlike the position espoused by adherents to the Chicago School of Economics, I don't believe that government regulation is the greatest inhibitor to economic growth. This case shows that--contrary to a pure ibertarian philosophy, some regulation is vital in order to keep the markets functioning.

The Milton Friedman solution might be to further de-regulate the markets, but the trickle down theory of wealth creation hasn't worked. Yes, taxation is an inherently destructive device, but politicians advocating Friedman's call to lower taxes have neglected the consequences of massive borrowing, a habit that Friedman would certainly have viewed as irresponsible and destructive economically in the long term.

Politicians attempting to make economic decisions doesn't make sense, but we Americans have grown accustomed to expected the government's help in a crisis. This has limited our independence.

The New Deal-style response to crisis--knee-jerking, swift response with financial assistance--has become a central political battlefield. Once politicized, the concept of smaller government has become a joke, preached though it is on the eve of the election by Republicans who've passed inflated budget after inflated budget, and by Democrats, who just ignore the Republican's hypocrisy in order to strap even more pork onto bills like the bailout.

Under the neo-liberal Clinton administration, we saw a general dismantling of large social programs. Revenues grew as the middle class invested and shared in the economic expansion. Under Bush, government expenditures have more than doubled and the deficit exploded. Alongside a massive increase in the money supply-the aftereffect of "adding liquidity"--we've seen incomes erode as inflation climbs. Now we can't blame Bush if Presidents aren't in charge of the economy, which they aren't, despite their constant calls for immediate action on the bailout, as if their responses would be the cure. Presidents can however set the tone and provide leadership for our economy, as well as pursue fiscal discretion--if they chose to.

Often the response to the threat or issue is far worse than the problem. Many open-ended massive entitlement programs have begun as temporary fixes. There could be more bailouts--if the bailout doesn't work and credit crisis continues, there will be at a minimum massive lobbying to get more public monies out to help teetering financial entities.

We Americans seem destined to demand more even as the deficits expand--like some glutton eating more and more, getting fatter and fatter, thus hungrier and hungrier. Nowhere is this more evident in our gluttonous use of energy. Now how we can afford health care in the future is anyone's guess.

The fundamental disconnect between what we're spending and what were taking in is just like any chronic overspender. Interesting it was in tonight's second Presidential debate to hear about the need for a strong economy, posed under the issue of just how strong we can remain militarily without a strong economy. Of course when the candidates refer to all their glorious plans for the future, "we" will do this, and achieve it together, despite the fact the government is an acting wholly independently of the people, and not limited or constrained by them, but rather imposing its will on the people as a master would a slave. We are simply to pay for the bailout, accept its wisdom, even as we see the Dow plummet and economic conditions deteriorate along with the tax base and our monetary credibility.

Administratively, our government has proven itself inept in handling large distributions of revenue. I was surprised to hear that the administrative bodies which were create to purchased homes during the Depression actually made money over time.

The bailout has been posed by both Presidential candidates as an opportunity to potentially earn some profits. Don't wait for the check in the mail-whatever is made will surely be spent, if not by the huge administrative costs likely associated with the bailout, then by other pressing needs which, if the candidates are serious about, would involve hundreds of billions more either in tax breaks or new spending. Meanwhile the massive interest costs will be left to future taxpayers, accompanied by unfulfilled dreams of profit.

The Fed has opened a number of new discount windows through which Federal Reserve member banks (and perhaps some others) may trade in mortgage-backed debt securities in exchange for US Treasuries. Certainly some degree of arbitrage goes on now, among actors buying worthless bonds and trading them in for AAA-rated public debt. We can only speculate how much bad debt financial companies will keep on, hoping to pawn off on the Treasury later.

Typical of a government intervention, the meddling has a unforeseen impact--potential relief from the bailout discourages the liquidation of bad debt. Debt which can't be sold is hoarded for later. With nothing to buy or sell, the market for debt (ravaged though it may be, these debt securities do have some value) dries up and none is bought, which of course further lowers the market value, which presents a big problem when financial institutions are required to "mark-to-market."

Safeguards inserted into the revised bailout bill may have made this practice less lucrative. One rule stipulates that companies which exchange over $300 million of debt must offer warrants or some level of ownership to the government. Still, until the holders of bad debt know how they'll be able to liquidate these "assets," wild gyrations in the debt markets will continue. Why would any purchaser of debt eat a loss by "marking to market" (an accounting change that cotnributed to the crisis) when they can just wait for a bailout and get perhaps 100 cents on the dollar?

As long as the Treasury is unconditionally dolling out good debt, the private sector is "crowded out." As a private investor, why take the risk on buying debt that could be worthless when you can buy Treasuries instead?

The main point with the lending windows is that banks can exploit the security of the US Treasury for private corporate profit, or at least to forestall massive losses. I'd been shocked to read that banks had exchanged over $140 billion of their bad debt for good PER DAY a few weeks ago. This is basically the equivalent of giving money to our banks because they lost so much--the exact opposite of letting the markets punish wrong-doers. The bailout may only be a distraction from the real plumb which is the exchange of bad debt for good at the Fed window, a process which could continue free of any monitoring, transparency, or oversight.

Cronyism in the Department of the Treasury means that Paulson has sheltered his pals on Wall Street from the consequences of their excesses, and greed. The average American will pay trillions in additional taxes as a result. The net transfer of private liabilities into public debt is an achievement of the highest order for the vested interests of the financial services market. Nonetheless, company shares have tumbled and the contagion effect will worsen the crisis to the point no bailout could be large enough to help.

Unfortunately the first-time, experimental nature of the intervention means that no one knows how long before the so-called "solution" will be implemented. The bureaucratic inertia alone could be enough to delay whatever response the government can muster in the near term. Of course, the plan supporters have exploited this aspect of typically ineffective government intervention in order to hurry the bill's passage and cry out for more aid. Giving Paulson unlimited discretion in how to distribute the funds was a notable failure in the initial bill, but expanding Congressional oversight can hardly be a expediter either, even if it is warranted.

Back to reality

We are seeing tons of market volatility. A one-day performance of the Dow shouldn't be used as a barometer of the economy. Last Tuesday, the Dow recovered half its losses from the preceding day, suffered as the House voted down the proposed bailout. The sky apparently hadn't been falling as we'd been led to believe by the bill's sponsors.

I'd gotten it right--that fear peddling wouldn't work, at least with the House of Representatives on the first run-through. Unlike the Senate, who serve six year terms, every Congressman must face the voters every two years. In this respect, the House is far more accountable to the American people.

The House leadership, both Republican and Democrat, supported the bill. This raises the question of whether or not the leadership of the parties is all that different.
Bottom line: the financial services company have "invested" a lot of political contributions to members of Congress. Now is the time to clean up. If indeed the Bush administration and industry insider Hank Paulson represent the best opportunity to subsidize the industry's losses, they needed their representatives in Washington to act before Bush leaves office.

The media cartel parrotted the need for action now, as if the crisis could be stopped by virtue of Washington willing it so. The media reflects a Washington consensus which overwhelms any notion of fiscal prudence with the need to act now, and do something--based on the haughty assumption that there are no limits to Washington's power.

Most networks did cover the point of view that states the bailout might not resolve the crisis, sandwiched between Stuart Little, the-sky-is-falling commentary from financial services employees, rattled investors, and panicky talk about the massive drop in the Dow, even if it had been mostly erased within a few days. This week we've seen the Dow collapse another one thousand points, so maybe the Dow's fall is not in reaction to Congressional action but rather reflects a deeper, more disturbing economic reality: we are no longer able to borrow in order to finance economic growth.

The media echo chamber glazed over any rational and deliberate reasoning to any attempt to resolve the problem. As is their habit, the media tries to squeeze all solutions into a thirty-second sound bite. What can't be easily sold isn't even proposed. We were told there is a crisis--yes, there is--and that Congress must do something, as if they could do something and it would automatically work. Well, the intervention, a one-time deal for now, hasn't and probably won't work, although I'm sure politicians will scartch and claw amongst themselves trying to retool and modify the bailout as it fails to work, even if progress isn't made proportional to the size of the bailout. No amount of pork and supplemental expenditures will be enough to fix the credit crisis.

No matter what the cause, there is a problem with credit, one which has been building and now only reached a crescendo when the government feels compelled to intervene, which of course sends a huge warning out to all markets and investors not to assume any risk. Meanwhile, huge job losses grow, for structural reasons perhaps not tied to the credit crisis, although arguably less consumer spending is driving down prices and sales: an event that was certain to happen anyway as we've tapped out all our credit.

The economic woes we face going forward may or may not be due to the scarcity of credit--overpriced homes fall in value in response to lower demand, a simple truth. Lower prices were inevitable, and that day has come. I guess you could argue that the decline in home prices has come because people haven't been able to borrow. Well, last time I checked, people with good credit are getting mortgages. Maybe some people with lower credit can't get credit, but maybe that's not such a bad thing. Maybe the best response to lending too much is to lend less! Profound in its simplicity is our capitalist system, at least the one that trusts in self-corrective remedies independent of the government and more taxation, which any bailout based on borrowing money really represents.

If indeed there's a rescue in pumping $700 billion into the financial credit markets, I suspect it will be transient. The larger problem is derivatives and credit defaults swaps, not subprime mortagges. As much as blaming Freddie and Fannie might make sense, it was the bundling of mortgages and securitization process, coupled with de-regulation and too much cheap credit, that's at the root of the crisis. At over $140 trillion, derivates present a far greater risk, and if the bailout doesn't prevent a worsening of credit, could lead to a blowout no amount of federal intervention could resolve--unless we want to use Federal Reserve Notes as wallpaper.

Excuse me, but I thought we were capitalists. Monetary capitalism is about letting free markets set prices, and corporations profit according to their efforts, which in the case of most financial services companies, has been appalling. They deserve punishment, but too much destruction and they'll cease to lend, which is their true value to society. Controlling the issuance of money as they do, we tolerate their profits simply because the alternative is even more overspending by Congress.

Political accountability was lacking in the Senate, which passed the bill last Wednesday. It's no coincidence that only one third of Senators are up for re-election next month. The bill received 25 no votes, and I'd venture that many of those came from Senators facing serious electoral challenges. Extraneous provisions were added to the Senate's bailout bill, including relief from taxes for certain arrow makers and a clause that would make mental illness treatable like any other disease.

Whether these items are worthy of passage or not, the fact that the Senate would add them to me indicates a failure to prioritize, if indeed the bailout needs to be accomplished now, as Paulson has complained. So why throw in irrelevant provisions, well-intentioned or not? The Senate should have constructed a bill focused exclusively on solving the crisis, this lack of focus shows the power of the corporate lobby and the open funnel of taxpayer money that Congress offers in return.

Unfortunately, Barack Obama has come out unconditionally in favor of the bailout. It's worth noting that financial services companies have donated over $25 million to his campaign. Last week, in a speech in LaCrosse, Wisconsin, he explained the situation as the neighbors--who smoke in bed a lot--whose house catches fire. We don't ask how it started--we put it out, he said. Good analogy but I don't think we'll be able to put it out, even with a $700 billion fire hose.

Essay on American happiness

This bi-polar manifestation to evaluating the state of the economy is perhaps the product of an America that wants to feel good at any cost. As a country whose state of mental health depends on its capital wealth, market declines signify a potential depressive episode. Market mavens typically respond by how rosy beaten down stock shares are in a bear, and extol the masses to stay positive. Meanwhile, when the market does go up, these cheerleaders fill up quite visibly with pride, and seem to overflow with child-like glee.

Perhaps these emotional responses to the market are a uniquely Americam affliction, something we can be proud of if not for their obsessive qualities than their uniqueness. No other society in the world is as keyed up about the state of its financial markets than Americans. We take pride in being number one; unfortunately, though, when things turn south, we take it to believe that there's something wrong, with us, collectively. Likewise when we do well financially, we tend to think all things are looking up and cast aside all our doubts. Our perspective on the rest of the world is like a prism bent and reflecting our moods. Our state of minds shapes how we see the world; if we're happy, everything's good. If we aren't happy everything is gloomy. With such a well-defined self-identity, we struggle with a definition of the world beyond our experiences. We want to shape our environment and feel helpless and depressed when we can't. Oh, gosh, I'm psycho-babbling.

Of course the antithesis of this hypersensitivity is the attitude that we need to maintain a stiff upper lip, like Churchill extolled of his fellow Englishmen during the Siege of Britain, or to have what the Japanese call "gaman." Gaman is the exercise of austerity or dispassion in the face of stress, harassment, or uncomfortable circumstances. So well elevated in the art of gaman are some Japanese that they seem able to endure any matter of discomfort for virtually endless period of time. Go no farther than a Tokyo subway during rush hour to know what it's like to exercise gaman, and how little of it you, the gaijin, have.

Rather than complaining, which most Americans have elevated to an art form, Japanese just deal with it. Another example of this might be in the popular Karate Kid movies, where the young American pupil was made to tolerate mundane activities like washing and waxing Mr. Miyagi's cars. Of course he complains, but later Mr. Miyagi will show him a circular arm block that he can use for his karate identical to the motion he used to wash and wax the cars. Every little bit of pain and tedium soaked up represents a lesson--learned at considerable cost--to the Japanese, and every little lesson represents a bit more knowledge which can be applied down the road, to solve future problems and challenges. Even the act of exercising gaman grants better self-control and self-discipline in overcoming one's environment (over which we really have very little control.)

In our need-it-now, don't-delay-gratification society, we forgo any future benefits for the immediacy of the present. Rather than see "denying the self" (in Zen terms) as a learning method through which we can build life skills, patience, and discipline, we take the slightest deprivations as infuriating issues worthy of our highest scorn, ugly episodes to be forgotten as soon as they mercifully end. By focusing on what we don't have, we get more easily aggravated by its absence.

We want to live as happily as possible, with as little as possible, which seems to commit Americans to a cycle of boom and bust, not only financially, in the collective, but psychologically as well, individually. By seeking endless happiness, we commit ourselves to even greater unhappiness when good times end, or at least when we can't be happy no matter how much we'd like to be.

Victor Frankl observed that most of Americans' greatest unhappiness emerges from being unhappy about being unhappy, rather than accepting our unhappiness and patiently waiting for it to end. Perhaps if Americans were better able to tolerate unhappiness, by accepting its inevitable appearance in our lives, we wouldn't be as terrified by the prospect of being unhappy.

Economically, we see this attitude manifest in our decisions of what to buy, and our sense of urgency in granting ourselves our every desire, no matter how financially unwise the purchase may be. This is in large part due to the hyper-commercialization of our culture. We can hardly get through an hour of every day without being barraged with messages to buy, to shop, to satisfy our wants, which are magnified into needs by the incessant consumer culture in which we live. To be truly happy, it seems we need to shop.

Owning what we buy gives us pleasure, yes, but it is a highly transient pleasure. Most of what we buy ends up in attics gathering dust, and the memories of the pleasure given us by material possessions tends to quickly fade. Looking at the Europeans, we see a people with lower incomes, which means they have less to buy. But are they less happier than we are? With a strong health care (delivering far mor value relative to overall expenditures) and retirement safety net, I'd argue that Europeans have far less to fear as they age than we do.

Tying our standard of living to volatile stock market accounts as so many Americans have means we rely on day-to-day swings in the performance of the stock market. With so much of our individual financial status dependent on the stock market, it should come as no surprise that we are hypersensitive to swings in the market.

The wealthy in the US do have more, but a remarkable Pew Center study showed that social mobility--the measure of how likely your standard of living is to surpass that of your parents--is actually higher in Europe than the US. As medical care insurance, college tuition, and costs of living rise, we are likely to see the children of many middle class people lose any ability to advance. Perhaps by slowing economic growth, a brighter future can be realized, but this entails bottoming out, and enduring considerable hardship.

We seem to deal with a potential economic downturn by attacking, charging ahead, and trying to work harder, longer hours, even if it means giving up time with family and less enjoyment of the wealth we do manage to accumulate and keep. Collectively, we Americans seem to grasp at some instinctual level the fact that we must consume more to grow more, that we must produce and buy more in order to have more. For a span of time not that long compared to other societies, Americans have been able to adopt an attitude of endless growth and limitless opportunity. Perhaps these periodic market calamities are what limits this naivete.

Our nation's economy must in time slow from an uninterrupted pattern of growth. We saw the first of these limitations in the twentieth century occur as the result of resource scarcity. The availability of undeveloped resources shrank and the economy contracted. Blessed though we are with greater resources than any other nation, we can't grow forever. We need to catch our breathe, to not grow, to perhaps focus more on the things we can't buy, produce, or sell. We need to enjoy the immaterial more and make the accumulation of material goods, and even monetary capital itself, not the end goal of our existence, but rather the means to an end.

If America as a culture is to mature, we are going to need to do a better job managing our expectations. Of course we need to avoid setting any limitations on what future generations can achieve, as often we have nothing to fear but fear itself, as FDR said in the wake of another crisis, the Great Depression. We jsut can't expect to offer an America that we always have without being willing to give up on some of our excesses. One of those chief excesses is clearly the belief that de-regulation is a pure good. Another is the concept that government can intervene and prevent market-based crises. Government does have a role to play in mending the damage, and forestalling it by limiting greed and the ability of ompanies to take on too much risk. Yet if we remove the downside, we ultimately are instituting communism and a command control economy. Yes, government can and should purchase failed financial institutions, and perhaps nationalize comapnies in times of extreme crissi like war, but we aren't there yet.

To expect preemptive moves by government this late into the crisis to actually forestall the effects of previous mistakes is a wholly unrealistic assumption. While most Americans want to see the worst unhappiness (defined as monetary deprivation) prevented, and politicians respond to that stimuli, the fact remains that we have chosen a system of government that transcends us, our time, and yes, even our pain.

We need to leave to future generations of Americans a system of government that transcends our generation. One key method to achieve this aim is to quit saddling Americans with more debt. The only way we can quit borrowing so much is to quit spending so much. And if a reduction is spending signifies a reduction in our present standard of living, then we need to accept the trade-off. We need to accept our responsibility to provide for future generations, and not spend now for our benefit at their expense.

Now in times of crises, with an eager chorus chanting "bailout," the temptation to spend our way out of the crisis may be too much. But we all need to understand that the economic cycle is part of living in a capitalist system (an unregulated system even more so.) If we are to give future generations the opportunities we had, we need to let the system cleanse itself. We need to refrain from overspending, curtail our borrowing, and let the excesses of the past purge themselves. Whatever the cost in the short-run, piling on more debt will simply delay and exacerbate the magnitude of the problems we are facing.


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  • At 2:23 AM, Blogger jbpeebles said…

    Naomi Klein spoke at the University of Chicago about the bailout and neo-liberalism. Her speech is here--it fits in precisely with what I've tried to say on several levels.


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