"this is a systemic crisis to be solved through hands-on remedies such as the partial nationalisation of the sector. "

From the FT:

"On Wall St: The battle to save the banks

By Francesco Guerrera

Published: January 23 2009 17:31 | Last updated: January 23 2009 17:31

“You can’t win them all”.

The much-abused phrase has long been a safe haven for losers. Defeated politicians, beaten sportspeople and fired chief executives have all found solace in its convenient blend of fatalism and statistical truth.

I always preferred the adage’s flip, sunnier, side: the reassuring concept that you can’t lose them all either.

But the US government’s response to the financial crisis is challenging that belief. Far too many of the actions taken by the authorities in aid of the financial system have run into trouble( TRUE ).

From the collapse of Lehman Brothers and the nationalisation of AIG, Fannie Mae and Freddie Mac, to the double-dip bail-outs of Citigroup and Bank of America/Merrill Lynch, Washington’s decisions have had an uncanny knack for backfiring.( YES )

The result is that we are still grappling with the same problems as when the crisis started 18 months ago: frozen capital markets, financial institutions in poor health and banks’ unwillingness to help the economy with new loans.( YES )

The fact that the latest “cure” – the creation of a “bad bank” to buy toxic assets – looks suspiciously like the “super-SIV” that bombed in November 2007 is testament to the lack of a cogent plan. ( IT'S CRAP )

Before quick-witted readers wheel out cliches about hindsight, 20/20 vision and, for the US contingent, “Monday morning quarterbacking”, I will let bygones be bygones.

Former Treasury Secretary Hank Paulson, the hitherto New York Federal Reserve president Tim Geithner, now ensconced at Treasury, and Fed chairman Ben Bernarke had to take rapid decisions during a once-in-a-generation turmoil.

They did their best in incredibly challenging circumstances( TRUE ). But it was not good enough, at least judging by the devastated share prices, battered balance sheets and broke consumers that currently make up the “financial landscape” of the world’s largest economy.( I AGREE )

As the Obama administration takes charge, it should learn from past mishaps.

Here is my personal, hindsight-enhanced list.

1) If you can’t stand the heat get out of the kitchen. The government’s decision to buy stakes in dozens of banks without demanding board seats and management influence has been counter-productive. It blurred the lines of accountability and left taxpayers and share- holders in doubt as to who runs the companies.( THIS IS CALLED A HYBRID. IT'S ESSENCE IS TO BE MESSY AND COSTLY. )

2) No strings attached is not cool. Without a formal requirement to report to the government, banks have all but ignored pleas to lend more. Instead, they used the federal money for a variety of self-serving purposes, ranging from buying their own debt to boost profits (Morgan Stanley) to paying billions of dollars in bonuses (Merrill Lynch).( A HYBRID )

3) Bigger is not always better. True to his past as a Goldman Sachs banker, Mr Paulson took a deal-making approach to saving troubled institutions. A flurry of takeovers (JPMorgan/Bear Stearns, BofA/Merrill, Wells Fargo/Wachovia) ensued. The result was much larger banks with an even higher concentration of risk. Wouldn’t a break-up of some institutions into more easily digestible pieces, have been worth a try?( YES )

4) Inconsistency is not a virtue( IT'S A CURSE ). Each ailing institution got a bespoke bail-out and share- holders and debtholders received widely- diverging treatments. In some cases, chief executives of bailed-out companies were fired (AIG, Fannie), but spared in others (Citi, BofA).

The confusion has unnerved investors and prompted them to hammer companies’ share and debt at the first signs of trouble. But perhaps the biggest flaw in the authorities’ response to the crisis has been the refusal to treat the problems as system-wide.( I AGREE. BAGEHOT. )

Their preference for ad-hoc measures, their hope that one more deal would do the trick of restoring confidence to the markets, had the opposite effect. As Bear Stearns snowballed into Lehman, AIG, Merrill and Citi, investors came to abhor piecemeal solutions.(THEY WANT AND EXPECT A TOTAL GUARANTEE. HOW HARD IS THIS? )

The Obama era should begin with the admission that this is a systemic crisis to be solved through hands-on remedies such as the partial nationalisation of the sector.( HEAR HEAR )

The authorities were never going to win all the battles during such a drawn-out campaign but they should ensure they do not lose the remaining ones.( VERY GOOD POST )

francesco.guerrera@ft.com"

Of course, it isn't going to be easy no matter what we do.

"Private money will not pony up if they do not know the rules."

From Vox, Luigi Zingales:

"This Wednesday Mr Geithner will be confirmed as the new Secretary of Treasury. Never before in US history has this position been so important. Mr Geithner’s decisions in the next few weeks will have a dramatic impact on the length and the depth of this recession and will shape the financial sector for decades to come. This column offers the new arrival a few suggestions.

This Wednesday Mr Geithner will be confirmed as the new Secretary of Treasury. Never before in US history has this position been so important. Mr Geithner’s decisions in the next few weeks will have a dramatic impact on the length and the depth of this recession and will shape the financial sector for decades to come. Mr Geithner comes to this job with the best qualifications. But in the last several months he has constantly been in the eye of the financial storm and thus he might benefit from an outside perspective. Given that the prosperity of our country is at stake, I hope Mr Geithner will allow me a few suggestions.

Get a strategy

To begin, you need an overall strategy. Even a mediocre strategy is better than an ad hoc approach( TRUE ) that confuses markets and fuels the perception of playing favorites( CRONYISM, BECAUSE SEEMINGLY ARBITRARY ). Legendary portfolio manager David Swensen (who in 23 years transformed the $1 billion of Yale endowment into $23 billion) in reference to the government intervention in this crisis commented “the government has done it with an extreme degree of inconsistency. You almost have to be trying to do things in an incoherent and inconsistent way to end up with the huge range of ways they have come up with to address these problems.”¹

The cost of ad hocery

The cost of this inconsistency is that it has forced the private capital to stay on the sideline. Short of a complete nationalization( MY PLAN ) of the financial sector (which we hope is not in the plan), the problem cannot be resolved without the help of private capital( PRIVATE CAPITAL CAN'T DO IT. NO ONE WOULD BELIEVE THEIR GUARANTEES. ). But a necessary condition to attract private capital back is a consistent and predictable strategy by the government( WRONG. GUARANTEES ARE NEEDED. WITHOUT THAT, NO RULES WILL WORK. ). Without it any other effort is in vain.( THAT'S TRUE ENOUGH )

Beware special pleading by the banks( THAT'S MY POINT ABOUT LOBBYING )

In designing this strategy it is important to keep in mind the interest of the country does not necessarily coincide with the interest of the banks( HYBRID APPROACH. I'VE SAID THIS SINCE OCTOBER. ). Charles Erwin Wilson, who became Secretary of Defense in the Eisenhower Administration after a long career at General Motors, declared in his confirmation hearings that the interest of the country and that of GM were one and the same. Nobody would dare to say it now. The problem is that an excessive familiarity with one interest may distort the judgment of even the most well intended people. Please do not fall into this trap Mr Geithner.

What makes this distinction difficult is that well capitalized banks are in the interest of the country. I agree that we need to fix the banking sector and we need to do it fast. But I disagree that this implies bailing out investors and bankers( I AGREE ). Not only is this extremely costly for the taxpayers, but gets in the way of a speedy resolution. And it sows the seed of the next crisis( I AGREE ). The current crisis is the direct consequence of the Long Term Capital Management bailout orchestrated by the Federal Reserve of New York ten years ago. It was the conviction that the Fed would always intervene( HEY. THIS HAS BEEN MY MAIN CAUSE ALL ALONG! ) to rescue traders in a liquidity squeeze( A CALLING RUN ) that induced banks and financial institutions to leverage up to and take increasingly aggressive gambles.

The fact that the interest of banks does not necessarily coincide with the interest of the country can be appreciated from the first phase of TARP( I AGREE ). After an initial surprise (they could not believe their ears) bankers were delighted to receive the government money( I AGREE ). Without it Vikram Pandit would no longer be the CEO of Citigroup and former Secretary of Treasury Rubin would have faced the risk of seeing the more than $115 million earned at Citigroup clawed back in a bankruptcy proceeding. So it is clear they like it and they want more( YES ). But what is in it for taxpayers? The first round of equity infusion and debt guarantees transferred to banks’ investors $108 billion. This is not the cost of the investment, it is the size of the gift taxpayers made to banks’ investors, as a reward for the good job done running their firms and monitoring their managers.( TRUE )

What have taxpayers received in exchange? Nothing( TRUE ). As reported by the New York Times, bankers privately admit that they do not use the TARP money for new loans, but only to consolidate their balance sheet and survive longe( TRUE )r.² This is also consistent with our findings that the intervention does not create aggregate wealth, but only transfer it from taxpayers to financial investors( TRUE ).³ In the second bailout of Citigroup, where no systemic effects are likely, taxpayers poured $60 billion into Citigroup, increasing the value of Citigroup financial claims by only $44 billion, with a net loss of $16 billion. It means that each dollar donated to financial investors cost $1.36 to taxpayers. This is hardly an attractive proposition( I AGREE ).

This outcome was easily predictable. If in the middle of a hurricane you help a damaged cargo ship to stay afloat, you cannot expect it to restart its shipping route immediately afterwards. For that to happen, either the boat should be completely refurbished or the hurricane should have passed or both.( I AGREE )

Avoid wishful thinking on bank bailouts and kick starting the credit markets

Hoping that bankers who saw the writing on the wall might restart taking risks because they were offered a life line is wishful thinking. If the government really wanted to use the banking wreckages to restart the economy, it should have taken over these banks and directed the flow of credit( MY PLAN ), or should have poured an amount of capital so large that even scared bankers would consider restarting the lending process. Either way it would have been tantamount to a nationalization of the banking sector, with the problems this implies( SUCH AS? ). And it would have required a massive amount of money. In October my rough estimate was $600 billion in equity just for the top ten banks.⁴ I am afraid I was too optimistic. Is there any limit in the subsidy taxpayers have to provide to bail out bankers( NO. NOT REALLY. )?

Only in the absence of any feasible alternative to restart the lending process would this massive bailout be in the interest of the country. This is the way Secretary Paulson presented it to the nation. Ironically, however, he kept changing the solution that had no alternatives. Mr Geithner, please do not fall into this trap. We can save the banks as institutions and restart lending without a massive transfer of money from taxpayers to investors and bankers, and here is how.

How to restart the lending

One solution is the one I advanced last Fall⁵. It requires passing a new piece of legislation introducing a new form of bankruptcy for banks, where derivative contracts are kept in place( WHAT DOES THIS MEAN? ) and the long term debt is swapped into equity( I DON'T SEE THIS STOPPING THE CALLING RUN AT ALL. ). As Pietro Veronesi and I have shown in a recent article, such conversion will fully recapitalize the banking sector and bring down the level of risk of debt (as measured by the credit default swaps level) to pre-crisis level.⁶

When I proposed it in September they told me that there was not enough time.⁷ When I re-proposed it in October they told me that there was no chance to reconvene Congress after the election. But time has passed and the Congress has been reconvened after the election, but there has been no discussion of this alternative that can save hundreds of billions of dollars to taxpayers.

Other plans

That is not the only possible plan. An alternative would be to allow banks to divide themselves into two entities, a bad bank with all the toxic assets and a good bank, with lending etc. Ownership of these two entities will be allocated pro quota to all the financial investors as a proportion of the most updated accounting value of these assets( HOW ARE YOU GOING TO VALUE THEM? ). So a bank with 30 billion of bad assets and 70 billion of good assets will see its debt divided 30-70 and its equity divided 30-70. Each $100 debt claim will become a $30 debt claim in the bad bank and a $70 debt claim in the good bank. The same would be true for equity.

On the face of it, it looks like a useless exercise. If each investor receives pro rata the two parts of the bank, what difference does it make? The answer is very simple. After the spin off, the toxic assets will not contaminate the lending part of the business anymore( WHERE'S THE MONEY TO FUND THE CALLS GOING TO COME FROM? ). On the one hand, bad banks would simply be closed-end funds holding the toxic assets. If these assets turn out to be worth more, the original investors will be rewarded. If they are worth less, the most junior claimants (common and preferred equity) will be wiped out.( THIS HAS CONSEQUENCES FOR THE CALLING RUN. NOT EVERYONE IS A BANK. )

The good news is that these entities could be allowed to fail, because their failure would only be a rearrangement of their liability structure with no negative consequences on the economy( NOT IF THE COUNTERPARTIES SUFFER HUGE LOSSES ). On the other hand, good banks will have a clean balance sheet and will be able to raise private capital without too many problems( WITH THE SAME BUFFOONS RUNNING THE COMPANY? ). If private capital is nowhere to be seen is because sovereign wealth funds that tried to take advantage of the situation experienced enormous losses( THAT'S BECAUSE CITI WAS IN WORSE SHAPE THAN WAS THOUGHT). In November 2007, for instance, when the Abu Dhabi’s sovereign wealth fund took a stake in Citigroup the stock was trading at $29 per share, while today is worth only $3.5. After these bad early experiences all the smart money stayed away( IT WAS A STUPID INVESTMENT.).

By eliminating the uncertainty on the magnitude of the losses in good banks, the spinoff will make it appealing for private capital to invest in these banks( HOW DOES THIS STOP THE CALLING RUN? IT DOESN'T. ). Even if private capital would not flow back (which I doubt), a government equity infusion in the good banks would be cheaper and more effective. Cheaper because the value of debt in the good banks would be close to par and thus an equity infusion will not go to bail out the existing creditors, but only to promote lending. More effective, because instead of trying to improve the capital ratio of a $100 billion entity (in the example), the government will do it only with respect to a $70 billion one.

The easy way and the right way

If the solution is so simple why has it not be done before? First, because it is much simpler to get money from the government than to obtain it through hard work. So no bank would consider doing this spinoff if it hopes to receive extra TARP money. Second, because most bank debt has covenants prohibiting exactly these splits. Even if the liabilities are shared equally between the two entities, the equityholders tend to gain from this split and the debt holders tend to lose. If the shortfall in the value of toxic assets is large enough equity in the whole entity would be entirely wiped out, while with the two split entities equity holders will retain some value in the good bank, at the cost of a lower overall repayment for the debt holders.⁸

This problem, however, can be dealt with by giving debt holders of the bad bank a warrant on the equity of the good bank, increasing their payoff at the expense of the equityholders. Furthermore, the creditors have benefited so greatly from all the government infusions of money so far that it would only be fair that they will share some of the pain for their bad investment. To allow banks to spin themselves off in two units, however, we need to pass a new law. As in October the “nay sayers” will say it is impossible. It was possible to write a $700 billion check to Paulson, it is possible to approve a $825 billion stimulus package, why it is not possible to pass a very short law allowing banks to spin off?

Concluding comment

Mr Geithner, incumbent bankers and their lobbyists will always make you believe there is no alternative to the plan that benefits them the most. You cannot fall for this old trick.
The alternatives I outlined above are not only possible, but also fair. They penalize who invested poorly and help provide loans to businesses in need. On top of this, they achieve these goals at zero cost to taxpayers (no small feat in a time of ballooning deficits). Yes, we can Mr Geithner, … if you lead us there.

---

1 http://www.youtube.com/watch?v=RsnXZgEPMSg
2 Mike McIntire, 2009, “Bailout Is a Windfall to Banks, if Not to Borrowers” New York Times. January 18, 2009.
3 Veronesi Pietro and Luigi Zingales, 2008, “Paulson’s Gift”, University of Chicago working paper,
4 Zingales, Luigi 2008b, "Plan B," The Economists' Voice: Vol. 5: Iss. 6, Article 4.
5 Zingales, Luigi 2008b, "Plan B," The Economists' Voice: Vol. 5: Iss. 6, Article 4.
6 Zingales, Luigi 2008b, "Plan B," The Economists' Voice: Vol. 5: Iss. 6, Article 4.
7 Zingales, Luigi, 2008a,"Why Paulson is Wrong," The Economists' Voice, 2008: Vol. 5 : Iss. 5, Article 2.
8 More technically, since equity is an option on the value of the underlying assets, the option on a portfolio of assets is worth less than a portfolio of options on the same assets."

This approach does fulfill Fisher's laissez faire approach. The idea that investors will invest in these new banks defies belief. Why should they? There are plenty of solvent banks. Why has money been going into government guaranteed entities if investing in crap and poorly run banks is such a great idea? Without government guarantees, no one will invest in these banks. I also don't understand his point about bankruptcy. Reading that story about unwinding Lehman, I can't see this as a great option. It sounds like a fantasy.

Here's John Hempton:

"Luigi Zingales has it right

Luigi Zingales knows a few things about how the new administration shoudl behave.

He may be a little too jaundiced about nationalisation - but here is the money quote:

Get a strategy

To begin, you (Mr Geithner) need an overall strategy. Even a mediocre strategy is better than an ad hoc approach that confuses markets and fuels the perception of playing favorites. Legendary portfolio manager David Swensen (who in 23 years transformed the $1 billion of Yale endowment into $23 billion) in reference to the government intervention in this crisis commented “the government has done it with an extreme degree of inconsistency. You almost have to be trying to do things in an incoherent and inconsistent way to end up with the huge range of ways they have come up with to address these problems.”

The cost of ad hocery

The cost of this inconsistency is that it has forced the private capital to stay on the sideline. Short of a complete nationalization of the financial sector (which we hope is not in the plan), the problem cannot be resolved without the help of private capital. But a necessary condition to attract private capital back is a consistent and predictable strategy by the government. Without it any other effort is in vain.

I should note I disagree with a lot the rest of Zingales paper - and will explain why in a later post.

I do not oppose nationalisation - but I would prefer that private money came to the fore. Private money will not pony up if they do not know the rules( WRONG. IF THERE ARE NO GUARANTEES, THEY WON'T DO ANYTHING. WHAT DOES NOT KNOWING THE RULES MEAN? ).

The way to do nationalisation is nationalisation AFTER due process. Due process( WHAT DOES THIS MEAN? ) (anywhere) does not seem to have been a hallmark of the Bush administration.

Confiscation without process (WaMu springs to mind) guarantees that there will be a private capital strike.( THE GOVERNMENT IS BEHOLDEN TO THE TAXPAYERS, NOT THE INVESTOR CLASS. BY THE WAY, THE PRIVATE INVESTORS IN THESE DEAL HAVE DEMANDED GOVERNMENT GUARANTEES.)

With a private capital strike everything eventually needs the government to bail it out( NO. JUST A GUARANTEE. ). Everything - JPM and Goldies included.

Investors have been putting money into government guaranteed investments. The idea that a Calling Run can be stopped by private money without government guarantees seems wrong. Just read about the Lehman negotiations. There is no solution without a total government guarantee. That will stop the Calling Run. Short of that, this Calling Run continues to go on.

More On Arbitrary, Inefficient, And Creative Destruction

I want to return to Krauthammer's post which David Boaz references, because I feel that I can make a clearer point about it:

"First, the arbitrariness. Where do you stop? Once you’ve gone beyond the financial sector, every struggling industry will make a claim on the federal treasury. What are the grounds for saying yes or no?

The criteria will inevitably be arbitrary and political. The money will flow preferentially to industries with lines to Capitol Hill and the White House. To the companies heavily concentrated in the districts of committee chairmen. To clout. Is this not precisely the kind of lobby-driven policymaking that Obama ran against?"

See, what makes him think that time began with the financial sector? It never occurs to him that anything preceded TARP, say. So that, TARP itself appears arbitrary, stupid, and based on cronyism, as I've listed these qualities myself. So, the first question is: Was TARP itself arbitrary? Was it created ex nihilo? Does the word bara figure into its wording? Or is it on a continuum of government actions, and needs to be analyzed as such? It isn't enough to declare, "Let's begin with TARP".

Now, one way to create at least the semblance of a principle out of TARP is to say something like the following: We declare that we will intervene when the financial sector is in trouble, because it's more important than any other sector. Fine. What's the financial sector? How does it work? And you can't mean by it something as vague as that it's banks, loans, etc. How about just giving me your explanation of how Lehman failed, and why the markets reacted as they did. I'm not asking you to blind me with science or be Willem Buiter, but you have to show me at least that you've some real idea of why TARP was necessary and how it was supposed to work. Otherwise, you're not really in a position to judge if it's more important than the automotive industry or not.

My disagreement with Krauthammer is not about the importance of principles and reasons in these decisions to intervene, I simply believe that TARP itself was abitrary, stupid, and reeked of cronyism, or, at the very least, since I'm in the finacial sector, I damn well know how important it is. There's nothing wrong with his worries, only about his analysis of the current crisis.

Consider this post:

"Sunday, October 19, 2008

"It's all very Rube Goldberg-esque,"

A great post by Peter Whoriskey and Zachary A. Goldfarb in the Washington Post called "Financial Rescues Can Set Off New Problems":

"Every action the government takes has cascading effects on the market, and they're not always easy to predict," said Jim Vogel, an analyst at FTN Financial. "The government has to have time to catch up."

Follow the bouncing ball of unintended consequences.

"Further into the future, some economists predict even more profound consequences from today's interventions.

By fostering the belief the government will rush to the rescue whenever a major financial institution begins to falter, federal officials may be creating what many economists call a "moral hazard." That is, those institutions may be more willing to undertake risky investments.

"It's all very Rube Goldberg-esque," said William O'Donnell, the head of U.S. interest rate strategy at UBS, referring to the cartoonist famed for devices that work in indirect and convoluted means. "You're never quite sure what any one action will do."

Really. Who'd of thought it?"

The real question is the following: Given how TARP has been planned, marketed, and implemented, can one make a case for intervening in the automobile industry based on this precedent? I say that there is. I'm not saying that it's conclusive. There are good reasons to oppose it, but the case is far enough along that it needs to be argued out, and there is a viable argument for such intervention. It is not as Krauthammer and Boaz have argued. They haven't risen above the level of worries and nostrums to approach anything amounting to analyis. For example, at least compare this case to other similar government loans.

Okay, here's his second point:

"Second is the sheer inefficiency. Saving Detroit means saving it from bankruptcy. As we have seen with the airlines, bankruptcy can allow operations to continue while helping to shed fatally unsupportable obligations. For Detroit, this means release from ruinous wage deals with their astronomical benefits (the hourly cost of a Big Three worker: $73; of an American worker for Toyota: $48), massive pension obligations and unworkable work rules such as "job banks," a euphemism for paying vast numbers of employees not to work.

The point of the Democratic bailout is to protect the unions by preventing this kind of restructuring. Which will guarantee the continued failure of these companies, but now they will burn tens of billions of taxpayer dollars. It's the ultimate in lemon socialism."

Okay. Here it is clear that some businesses do survive bankruptcy. So, he seems to be claiming that the government intervention will keep the employees from the onerous terms of bankruptcy. This is a factual question. It isn't a question of principle. I have demands that I would include in any government intervention. Absent them, I would agree, they'll have to declare bankruptcy. But that's an argument about the conditions of the bailout, not whether one would favor a bailout or not. So, Krauthammer could be correct, but it's not obviously so.

"Democrats are suggesting, however, an even more ambitious reason to nationalize. Once the government owns Detroit, it can remake it. The euphemism here is "retool" Detroit to make cars for the coming green economy.

Liberals have always wanted the auto companies to produce the kind of cars they insist everyone should drive: small, light, green and cute. Now they will have the power to do it.

In World War II, government had the auto companies turning out tanks. Now they would be made to turn out hybrids. The difference is that, in the middle of a world war, tanks have a buyer. Will hybrids? One of the reasons Detroit is in such difficulty is that consumers have been resisting the smaller, less powerful, less safe cars forced on the industry by fuel-efficiency mandates. Now Detroit would be forced to make even more of them."

Now, I have no idea about this, and neither does he. For all I know, such a plan might work. To argue that it's not possible is beyond his knowledge. Time will tell, but it doesn't seem obviously unworkable, compared, say, to what auto makers have been doing up until the present. An idea stands or falls on its own. To argue otherwise, is poisoning the well, and fallacious. You can't simply say that it some people in congress favor it it's hopeless. Well, you can, but it's fallacious.

"Republican minimalism -- saving the credit-issuing utilities -- certainly risks not doing enough. But the Democratic drift toward massive industrial policy threatens to grow into the guaranteed inefficiencies of command-economy maximalism."

Slippery Slope Arguments are fallacious, as are Historically Inevitable Arguments, otherwise Marx would have actually been a scientist of history, but he wasn't, because there's no such beast.

Finally, one point about Brooks and Creative Destruction. This phrase has as much explanatory power as Effective Regulation. It's what we're looking for. Destruction might or might not turn out to be creative in a particular instance, and that is what actually occurs in the world. By and large, the ebb and flow of businesses does seem to work, but that platutude does excuse one from actually analyzing the case before you.

Some fires are indeed creative destruction, necessary for the proper maintenance of the natural world. Sadly, some are not. To walk to a fire, any fire, and proclaim aloud Creative Destruction, is pretty silly. So is claiming that same nostrum about the death of any particular business. Busineese do not all fail for the same simplistic reasons.

"First, the arbitrariness. Where do you stop?": In Politics, It Would Be Where You Agree To Stop

Here's an earlier post defending a bailout:

Sometimes posts are unintentionally humorous, especially when they're way behind the curve, or, have a view of human agency, and the politics based upon it, that is laughably theoretical. Here's an example from David Boaz on Cato:

"There have been plenty of criticisms here of neoconservatism and “national greatness conservatism,” but two of the occasional targets, Charles Krauthammer and David Brooks, have just published devastating critiques of the auto industry bailout. Here’s Krauthammer in the Washington Post:

First, the arbitrariness. Where do you stop? Once you’ve gone beyond the financial sector, every struggling industry will make a claim on the federal treasury. What are the grounds for saying yes or no?

The criteria will inevitably be arbitrary and political. The money will flow preferentially to industries with lines to Capitol Hill and the White House. To the companies heavily concentrated in the districts of committee chairmen. To clout. Is this not precisely the kind of lobby-driven policymaking that Obama ran against?"

The arbitrary gate was sauntered through quite a while back down the road. For one thing, these financial sector arguments are not obvious. Then, there have been so many changes of plan recently that arbitrary is a generous description, compared to say, oh, I don't know, frantic, say. There are a myriad of reasons that one could object to either the course of the bailout or even it's need on. I know that when people rank priorities in their own mind, they then seem obvious, but they aren't. In any case, politically you are into the realm of the arbitrary now, which means the power of constituencies matter. Oddly, in a democracy, if you spend money in one area, others are able to suggest that it would have been better spent in another. In other words, there's a kind of organic logic to the ebb and flow of politics in a representative democracy, that entails that the arbitrary knife cuts both ways, either we should stop now before it goes too far, or you cannot stop now because it will look arbitrary, stupid, and smack of cronyism, and , unless you're God, you will be suspect of having all of those human faults. To not understand the difference between politics and political theory, or economics and political economy, seems to be the common malady of pundits today. Here, for example, instead of running on about the reasons for this or that, as if you're writing a poorly thought out treatise, you should be surveying the political landscape and assessing whether or not, or, if so, you should compromise on the auto bailout to actually ease the political pressure for more spending. But no. You fancy yourself Kant, not a politician.

"Second is the sheer inefficiency. Saving Detroit means saving it from bankruptcy. As we have seen with the airlines, bankruptcy can allow operations to continue while helping to shed fatally unsupportable obligations. For Detroit, this means release from ruinous wage deals with their astronomical benefits (the hourly cost of a Big Three worker: $73; of an American worker for Toyota: $48), massive pension obligations and unworkable work rules such as “job banks,” a euphemism for paying vast numbers of employees not to work.

The point of the Democratic bailout is to protect the unions by preventing this kind of restructuring. Which will guarantee the continued failure of these companies, but now they will burn tens of billions of taxpayer dollars. It’s the ultimate in lemon socialism."

In political economy, efficiency is only one variable. It can be trumped by ethical, political, even theological reasons. Besides, in a free market sense, if employers agreed to terms that were ruinous, astronomical, and massive, that's their right. They own the place. All a free market generally tries to do is limit the damage of businesses going out of business, as thousands do every year, to the things actually owned by the proprietor. There's no guarantee of sagacity involved. I'm constantly amazed how teleology creeps in to every kind of explanation. In general there is more efficiency in the private sector as opposed to the public sector, but it is actually an empirical question that needs to be answered each time. Otherwise, it constitutes an object of faith. In this case, one can surely wonder whether or not bailing out the automakers is worthwhile, but there are more reasons to be considered than arbitrary, which was a wash at best, and efficiency, which, while probably true, needs to be measured. After all, these banking and automakers, such paragons of wisdom and virtue, were in the private sector. You need a little more evidence to prove to me that they're any smarter than people in government, but be my guest.

"Democrats are suggesting, however, an even more ambitious reason to nationalize. Once the government owns Detroit, it can remake it. The euphemism here is “retool” Detroit to make cars for the coming green economy.

Liberals have always wanted the auto companies to produce the kind of cars they insist everyone should drive: small, light, green and cute. Now they will have the power to do it."

Is it an a priori assumption that they're going to be wrong? What if it turns out to be efficient? What then? Oops. Didn't see that in my models or theories? This isn't a mechanistic realm of argument, although so many people think it is. There is good reason to believe that they will make a pig's breakfast of it, but you don't know that. How could you? Otherwise, you'd be investing in cars and be a billionaire. After all, you already know what's going to work. I wish I could see the future so clearly.

"And David Brooks in the New York Times:

This is a different sort of endeavor than the $750 billion bailout of Wall Street. That money was used to save the financial system itself. It was used to save the capital markets on which the process of creative destruction depends.

Granting immortality to Detroit’s Big Three does not enhance creative destruction. It retards it. It crosses a line, a bright line. It is not about saving a system; there will still be cars made and sold in America. It is about saving politically powerful corporations. A Detroit bailout would set a precedent for every single politically connected corporation in America. There already is a long line of lobbyists bidding for federal money. If Detroit gets money, then everyone would have a case. After all, are the employees of Circuit City or the newspaper industry inferior to the employees of Chrysler?

It is all a reminder that the biggest threat to a healthy economy is not the socialists of campaign lore. It’s C.E.O.’s. It’s politically powerful crony capitalists who use their influence to create a stagnant corporate welfare state."

Hear, hear. The intellectual case for the bailout–if there was one–surely can’t survive these two clear and analytical critiques in the nation’s most influential newspapers. But then, protectionism couldn’t survive the analytical critique of Adam Smith in 1776, and yet it persists."

I've read Adam Smith. Believe me, he understood the difference between economics and political economy. Creative Destruction. That means some businesses go out of business, and other businesses are created. That's it. Calling it Creative Destruction reifies a simple description into a mechanical principle. Not. Once again, once reified, it takes on a teleological quality, outside the ken of human agency. Everyone will be glad to know that if the earth were desroyed today, it would simply be a matter, from the point of the physical universe, of creative destruction. Some planets are created, some are destroyed. That's the beauty of it. I hope everyone will get some solace from that.

There is some truth to the precedent point, but for the fact that this question exists in time, which is a continuum, and there have already been precedents. It's as if by putting his foot down, Brooks can say, " It all begins here!". Sorry, you're not that powerful. The automaker's bailout exists on a continuum of precedents. No analysis can prove fruitful without comprehending that simple fact. I've already made that point. That's the difference between politics and political theory.

Finally, God save us from slippery slope arguments. They're fallacious. In order for them to work, the two terms in the deduction need to be indistinguishable. Got that. You can't tell them apart. Period. The organic logic I'm describing is not mathematical or mechanistic, but akin to the flow of actual discourse as opposed to linguistic theory. You have to be in it to understand it, it cannot be reduced metamathematically, or to another abstract language. Such reductions aid our understanding, but do not comprehend it.

So, here's an example of organic logic. Contrary to what has been put forth, that, if we allow this auto bailout, the world will be bailed out like a mechanical process, it might work in exactly the opposite way by being the compromise that allows the opposition to agree with you and settle here, in this place, for now. And the reason that this can happen, is because, unlike a mechanical process, this one involves human agency, which is in no sense mechanical.

So, let's recap:

1) Arbitrary: True, but where on continuum? Cuts both ways.
2) Efficiency: Empirical matter. Must be explained. Not a priori.
3) Moral Considerations
4) Political Considerations

My own opinion:
1) At least as intelligent as TARP
2) Probably true, but not certain
3) In this case, given TARP, this seems a worthwhile bailout
4) More likely to end avalanche than continue it, but, if the avalanche continues, more of the blame lies with TARP and how it has been handled and presented

Doesn't this involve qualifying principles? Yes, that's what makes it politics, as opposed to political theory.

Fact/Parody Jinx Being Verified

Remember, well, I have one reader, remember Patty when I mentioned the Fact/Parody Jinx being violated by Alphaville. Well, read this from Huffington:

"WASHINGTON — Three big city mayors asked the federal government Friday to use a portion of the $700 billion financial bailout to assist struggling cities.

They sought help with the pension costs, infrastructure investment and cash-flow problems stemming from the global financial crisis.

The mayors _ Michael Nutter of Philadelphia, Shirley Franklin of Atlanta and Phil Gordon of Phoenix _ made their request in a letter to Treasury Secretary Henry Paulson.

Nutter said cities are facing an economic crisis not seen since the Depression and need help just like financial institutions.

"I want to make sure that cities and metro areas are at the table, that their voices are being heard, that our challenges and problems are well understood, so that we can get relief," Nutter said.

President-elect Barack Obama has also called for some sort of aid to state and local governments so they don't have to raise taxes or lay off workers while the federal government is trying to revive the economy, but he hasn't proposed or endorsed a specific aid plan.

The three mayors proposed providing loans to help cities pay pension costs. They also want $50 billion in loans for investment in infrastructure, and additional one-year loans to cities unable to borrow cash because of the tight credit markets."

Now, I want to make it clear that some of this money going out the door probably makes sense, but this is now a deluge . It become:

1) An If you don't help me as well your plan will look arbitrary, stupid, and like cronyism

2) I'm more important than him/her. This one is Talmudic. How much the more so...

So, every business and government entity in America, and foreign banks, and a stimulus, are coming to the Federal Government of the U.S. for help. Alphaville has some explaining to do.

"Why didn’t policymakers think to look at these, instead of relearning everything again? "

Interesting post by Felix Salmon. He interviews Citibank chairman Bill Rhodes:

"A Citibanker since 1957, few bankers have racked up more air miles than Bill Rhodes over the course of their careers, and probably none have done so in the cause of resolving so many crises, from Jamaica to Nicaragua to Korea to Uruguay, with many in between. His name is especially associated with the resolution of massive Third World debt problems in the early Eighties.

But Rhodes freely admits that he’s never seen a crisis as big or as dangerous as the one we’re in now.

FS How did we get to this place?
WR Confidence disappeared and was replaced by fear, all of which was exacerbated by the policymakers’ incremental approach to problem resolution – we’re letting one company go, but not letting the next one. The decrease in market confidence was seen in the interbank lending market. When liquidity started to become scarce, the lack of confidence grew worse. Liquidity, capital, and then deposits have become king, all in that order. First you need to have liquidity. Then you need capital. Investment banks suddenly realised that they needed to have a deposit base and that they couldn’t go to the markets easily and cost-efficiently to raise funds.

FS You say that policymakers exacerbated the problems. Were they too complacent?
WR We’ve had two false dawns here. The first one was the period around November, because the initial hit to the system in August was assuaged by the tremendous amount of liquidity that the Fed, the European Central Bank and others put in the system. But in spite of those actions, we never got the confidence back in the interbank market and among counterparties. We got into December and January, and the problems started to become more apparent. The cost of LIBOR and the monoline insurance company problems were indicators that the problems in the markets hadn’t been resolved.

Then we suddenly had Bear Stearns in March. People thought once that bail-out was complete, the worst was over. I remember attending meetings where some of the seniors of major investment banks were saying, ‘The worst is over in the credit markets because the investment banks and brokerage houses were given access to the Fed window.’ And that’s what you also heard in Washington. I was hearing all sorts of comments of reaching the ninth inning of a nine-inning baseball game. And all this was being said in spite of the credit markets still being unsettled and the housing markets continuing their decline into what amounts to the worst housing crisis since the Great Depression."

Read the whole interview. Here's my comment:

Posted: Nov 04 2008 01:51am ET

First of all, thanks for the Rhodes interview. That's just what I was looking for when asking for asking people involved.
Second, here:
"Confidence disappeared and was replaced by fear, all of which was exacerbated by the policymakers’ incremental approach to problem resolution – we’re letting one company go, but not letting the next one.'
This is what I believe was the main cause of the crisis. The uncertainty over the implicit and explicit assumptions about government involvement, and the belief that it would intervene.
Third,here:
"Financial institutions need to do a much better job of risk management and corporate governance. The regulators have to do a better job on the regulatory oversight. You’ve got to look at both the buy-side and the sell-side of the market. In many cases the sell-side was pushing paper that they probably shouldn’t have, but at the same time, the buy-side wasn’t properly analysing the investments being taken on to their balance sheet. So it cuts both ways.

On the regulatory side, what we don’t need is a lot of over-regulation which is what we may be headed for – what we need is smart regulation that is properly enforced.

Where the ratings agencies are going to come out of all of this is not clear. I think there was an over-reliance by individual institutions on rating agencies. I also think in some cases there was an over-reliance by the regulators on ratings agencies."
I believe that some investments were fraud or negligence,and this was the second big cause,but there was some lack of knowledge by investors.
Third, I agree about regulation.
Fourth, I've already said that I thought that ratings agencies were another real problem,but you reminded me that these banks, etc., had done some of their own rating.
Great article from my point of view.

By DonthelibertarianDemocrat