Once they’re out of the way, better-run firms will be able to take their place, and free enterprise will no longer come with a government warranty.

TO BE NOTED: From US News:

"How Bailouts Can Butcher Capitalism

March 27, 2009 04:54 PM ET | Rick Newman | Permanent Link | Print

We have a new F word: failure.

One unhappy hallmark of the Great Recession is a dramatic spike in financial distress. Moody's predicts that the default rate on corporate debt--which helps foretell bankruptcies--will be three times higher this year than in 2008. Home foreclosures are already at record highs, and going higher. Defaults on credit cards and other consumer debt will crest right behind mortgages.

The Obama administration is on the case, bailing out banks and homeowners and aiding dozens of industries either directly, through a financial-rescue scheme that could top $2 trillion, or indirectly, through the $787 billion stimulus bill. Automakers, furniture companies, real estate developers, and even porn magnates have their hands out.

[See a tally of the bailout efforts so far.]

Those efforts ought to help soften a sharp recession. But the unprecedented aid to the private sector may also unleash new problems, the way antibiotics have generated stronger strains of bacteria. "There's something fundamental about the need for failure," says Syd Finkelstein, a professor at Dartmouth's Tuck School of Business and author of Think Again: Why Good Leaders Make Bad Decisions and How to Keep It From Happening to You. "We're tinkering with the genetic DNA of a capitalist society."

Before “failure” became an unspeakable word, entrepreneurs understood that most business ventures in America fail--producing acute lessons that have helped make America fabulously prosperous. In the 1870s, for instance, there was a five-year depression, followed by a historic era of mechanization that destroyed old industries and generated new ones at a pace nobody had ever seen. "It was a time of terrific insecurity," says James Grant, founder of Grant's Interest Rate Observer. "It was also a golden era of dynamism." Landmark companies like IBM (started in the 1880s), Johnson & Johnson (1885), and General Electric (1892) date from that time.

[See some well-known companies that could fail this year.]

Other familiar companies have their roots in failure--either their own or somebody else's. Upstarts Nike and Reebok gained a foothold in the 1970s because their established competitors--Converse and Keds--failed to foresee the boom in running and aerobics. Toyota has relentlessly exploited the failure of Ford and General Motors to satisfy their customers. IBM went through a near-death experience in the 1990s after betting wrongly that the old mainframe would dominate the PC--a painful experience that the company's leaders now tout as a crash course in adaptation.

Failure is personally enlightening, as well. "Ask 100 people, 'What have you learned from success?' and most of them will just look at you," says Don Keough, former CEO of Coca-Cola and author of The Ten Commandments for Business Failure."But ask what you learned from failure, and you'll get lots of answers." One of Keough's most painful failures was the 1985 introduction of New Coke, which market researchers predicted would be a hit. It was an instant flop. "The whole process made me a professional skeptic," he recalls. "I learned to look beyond data and apply common sense."

Saving companies from their mistakes short-circuits that kind of learning. Chrysler, for instance, got its first government bailout in 1980. It recovered, but it is now burning through another $4 billion in government loans–and asking for $11 billion more. The unseen harm of floating weak businesses is the "opportunity cost": What might have happened if more nimble, innovative companies got a chance. "The American [auto] industry would be much stronger today if Chrysler had been allowed to go out of business in 1980," insists Jack Nerad of kbb.com, a car research site.

[See 6 upsides to a GM bankruptcy.]

Banks are a special case, since the capital they provide is the lifeblood of capitalism. But billions in aid to huge, struggling lenders like Citigroup and Bank of America might be counterproductive. A recent study by New York University's Stern School of Business, Restoring Financial Stability, argues that the government has been too generous to bailed-out banks, giving them up to $70 billion more than necessary. A better approach, the study argues, would be to plump up healthier banks, while letting market forces determine the fate of sick banks.

The bank-rescue plan unveiled by Treasury Secretary Tim Geithner–the Public-Private Investment Partnership--seems to go in the opposite direction. Under the plan, the government would heavily subisidize private purchases of so-called “toxic assets” from banks. It could restart the market for these assets and help banks clear them out. But because the government will bear most of the losses if it doesn’t work, “it amounts to yet another subsidy to banks,” says Dirk van Dijk, director of research for Zacks Investment Research. And even then, he says, the government may still have to nationalize some of the most troubled banks.

[See how secrecy could wreck Geithner’s bank-rescue plan.]

There’s another mechanism for dealing with insolvent companies--bankruptcy protection. Once failing companies like GM declare Chapter 11, the NYU study contends, the government could offer loans to help them restructure. Bankruptcy judges have broad power to boot existing management, cut executive pay, and order sweeping changes. And if liquidation looks like the best option, the company probably went too far astray to be saved.

That’s clearly what happened at AIG, where disastrous bets made by a small financial trading division essentially wrecked a conglomerate built mostly of healthy insurance businesses. But AIG is considered too important to consign to an indelicate bankruptcy process. Since it insures hundreds of the world’s biggest institutions–and held nearly $3 trillion worth of derivatives contracts with trading partners worldwide, as of last fall–its collapse could have triggered a chain reaction of institutional-level bank runs. So instead of letting AIG fail, the government executed the biggest corporate bailout in American history, totaling $180 billion so far. The outrage over $165 million in bonuses for executives of that very same division may mark a turning point in Americans’ tolerance of bailouts.

[See 7 surprises buried beneath the AIG bonuses.]

AIG’s lengthy tentacles make it “too big to fail,” which is why Obama and Geithner are pushing for new laws that would allow the government to take over the biggest institutions if they become insolvent and threaten the rest of the economy. Another solution might be to downsize the biggest firms until they are small enough to let fail. Once they’re out of the way, better-run firms will be able to take their place, and free enterprise will no longer come with a government warranty."

"If everybody wants a bailout, that's a good indication that we're making some mistakes."

From James Hamilton on Econbrowser:

"Bailouts should be no fun( I SAID THIS ON SEPT. 22, 2007 )

If everybody wants a bailout, that's a good indication that we're making some mistakes.( TRUE )

Let's start with first principles-- why are we talking about huge potential transfers from the government to private companies in the first place? My starting point would be the observation that U.S. output is falling significantly below what America is capable of producing. The problem is not that labor and capital are physically incapable of producing more, but instead that certain key institutions have existing legal commitments that they are unable to fulfill. Foremost among these would be in the financial sector, where liabilities threaten to exceed the market value of assets, preventing the entire sector from functioning properly( TRUE ). But also prominent are other crucial industries, such as the domestic auto manufacturers with a very significant burden of debt and obligations to current and retired workers. We need an unambiguous resolution of this problem, allowing these institutions to return to productivity. The sooner those unpayable commitments can be resolved, the better off we're going to be.( TRUE )

How do you solve the problem of unpayable existing obligations of institutions that otherwise have the resources to make a productive contribution to total economic surplus? That of course is the function that our bankruptcy system is intended to provide. In a typical bankruptcy, the company's owners and senior management get wiped out, some crumbs are left for creditors and workers, and hopefully the most valuable underlying assets get reallocated to alternative productive use. But bankruptcy is a very clunky process with lots of deadweight costs in and of itself. We should have significant concerns in the present environment about the possibility of such costs leading to spillover effects, forcing other institutions into bankruptcy that otherwise might have remained solvent. There is a good case to be made for bringing the taxpayers in as a fifth player at the negotiating table along with owners, creditors, management, and workers. There are likely going to be instances in which a modest taxpayer contribution, in conjunction with substantial concessions from the other four parties, could end up preventing a much larger economic loss. I could easily believe that a judicious expenditure would leave the taxpayers as a group significantly better off than if we'd simply allowed the bankruptcy process to run its course.

The representative of the taxpayers in such negotiations would seem to have by far the strongest hand at the table. The threat point is to let the company go into bankruptcy, and the limit on what the taxpayers are willing to contribute should be the direct benefit to taxpayers (as opposed to benefits to the other four parties). If your company doesn't like our terms, fine, go your own way, and we'll prop up the next domino in line instead. If properly implemented, the taxpayers should leave the negotiating table pleased with the deal they achieved, and everybody else should leave battered, comforted only by the knowledge that, had they not made those concessions, things would have been even worse.

On the other hand, if everybody and their grandmother is lining up for a bailout, and pulling political strings ([1], [2]) to make sure they get it, I read that as prima facie evidence that the taxpayers' interests are not being properly represented."( I AGREE HERE )

I'm not sure that we allow banks to go bankrupt. Wouldn't that add a bank run to our problems?

"What it shows is that next year, 2009, there will be a massive bulge in the value of bonds issued by European companies that have to be repaid."

Robert Peston on BBC with an interesting post to begin the day:

"The transformation of the years of easy credit into a financial nightmare for many big companies is illustrated by the Bank of England in its Quarterly Bulletin, which was published overnight.

This transition from credit feast to credit famine is depicted in a chart of the maturity profile of outstanding European corporate debt (stay awake, this matters to you).

What it shows is that next year, 2009, there will be a massive bulge in the value of bonds issued by European companies that have to be repaid.

Or, to put it another way, about $1000bn of "old world" companies' borrowings in the form of tradable debt has to be paid back during the next 12 months - with something like $800bn of this owed by financial companies and $200bn by non-financial companies.

That would be a colossal sum to pay off at the best of times, and is equal to about five times what's been repaid in 2008.

It is a disturbingly huge amount, at a time when even the bluest-of-blue-chip companies are finding it difficult and expensive to raise money by selling new corporate bonds.

More or less every chief executive and finance director I know is agonising about how to obtain debt finance - and is having very unsatisfactory conversations with banks.

Here's the Bank of England's characteristically euphemistic account of the implications: "a large volume of corporate debt matures towards the end of 2008 and over 2009, which presents significant refinancing risks for firms".

What's likely to happen is that Europe's biggest and strongest companies will vacuum up whatever meagre credit is available from malfunctioning wholesale markets and banks.

And that, in turn, means that weaker businesses, those most desperate for credit, are going to find that conventional sources of credit are simply not available to them.

Their desperate plight - their almost complete inability to raise vital finance - is shown by another Bank of England chart. It plots the market price of European leveraged loans - banker-speak for the debt of companies with big borrowings - which has collapsed to 65 cents in the dollar on average.

To translate: companies with large debts are only expected to pay back two thirds of what they owe, which doesn't make them a sound banking proposition in our harsh new world of tighter-than-tight credit.

So lots and lots of companies won't be able to raise the finance that would keep the bailiffs away, unless taxpayers step in as the lender of last resort.

Taxpayers have already done that to the tune of £600bn and rising for British banks (see my note "How much will taxpayers finance economy?"). And, as I've been pointing out for some time, we are being asked to provide life support to a swathe of the real economy, from steel makers to car manufacturers.

The Government will succumb and will lend taxpayers' money to non-financial companies.

In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out.

But many will urge that companies which borrowed recklessly in the good years - often to generate unsustainable growth in profits that triggered bonus payments or to finance excessive special dividends - should not be bailed out.

Though in punishing imprudence we would be foolish to punish ourselves.

The trick for government, therefore, would be to rescue fundamentally viable businesses, while somehow leaving feckless management to swing in the wind."

Peston is someone who has been getting this right. The Government is going to have to essentially Guarantee large portions of the economy. In this sense, John Quiggan is correct, in that Government Intervention in the economy is going to grow larger and more intrusive in the next few years. Paradoxically, the Hybrid Plans like TARP assure this fact. The Dual Nature invites Government into a partnership from which neither party easily extricates itself.

This problem of Coroporate Debt is why I have been calling for Tax Relief for Coroporations. We can focus on Investment, or simply try and free up more cash for these businesses. If we don't do that, the government will have to, as Peston says, intervene to save Viable Companies. There is no way out of this messy situation that doesn't involve government incentives or intervention. I would rather give incentives to businesses to handle this debt problem on their own than have the government essentially micromanage winners and losers.

I give you then "Peston's Promise":

"And, as I've been pointing out for some time, we are being asked to provide life support to a swathe of the real economy, from steel makers to car manufacturers.

The Government will succumb and will lend taxpayers' money to non-financial companies.

In a way, there's no choice, because we'll be hobbled for years as an economy if our few remaining manufacturers and exporters are wiped out."

"namely get the automakers the loans they need, and avert another Lehman Brothers-scale collapse."

Since I believe that the markets and investors are counting on government bailouts, I agree with this assessment by James Surowiecki:

"I think this is a mistake, and that, in fact, the market has held up fairly well today precisely because investors believe there’s a reasonable—though by no means certain—chance that the Treasury Secretary, Henry Paulson, will do what needs to be done, namely get the automakers the loans they need, and avert another Lehman Brothers-scale collapse. Literally within minutes of the market opening, both the White House and the Treasury Department issued statements saying that they were considering using TARP money to help the automakers, and their language was unusually forceful. Treasury said it “will stand ready to prevent an imminent failure until Congress reconvenes,” while Perino said, “given the current weakened state of the U.S. economy, we will consider other options if necessary—including use of the TARP program—to prevent a collapse of troubled automakers.” That’s not a firm commitment and, given past history—including the decision to let Lehman Brothers fail and Congress’ failure to pass the first version of the TARP—there’s no guarantee that what needs to be done will be done. But, to me, it certainly sounds as if the Bush Administration is serious about acting now that Congress has dropped the ball.

I don’t think I’m the only one who feels that way, either. Look, for instance, at what happened to the auto stocks today. Ford was as low as $2.12 a share in the opening moments of trading, but as news spread that the bailout might still happen, it rocketed upward, and at one point it reached $3.21. In other words, it rose forty-five per cent in a couple of hours. G.M. needs the government’s money more than Ford does, and so its upward spurt was even more impressive: after being as low as $2.66, its shares reached $4.23. That’s a sixty per cent move. It’s simply implausible to believe that this would have happened if investors were not expecting some form of government intervention. And it’s no coincidence that the rest of the market also rose from its early-morning lows after the Administration spoke. Investors may be wrong to think that the Treasury Department will end up stepping in, but the hope that it would clearly averted a massive sell-off today."

I also think this expectation is a major reason that the Treasury is trying to step in. They and the Fed now understand this.

"Auction rate securities investors at Citi and UBS will be made whole under today’s settlement with the SEC…

Cate posts on Shopyield about Citi and UBS being made whole:

"Made whole…

Thursday, December 11, 2008

Auction rate securities investors at Citi and UBS will be made whole under today’s settlement with the SEC…

$ 30 billion of making whole… that’s lots of wholeness…

These ARS settlements represent the first time that the major dealers have had to pay an onerous penalty for shoddy fixed income practices… there have been multi-million dollar fines previously but there were never substantial penalities relative to the fees and spread that the firms were making… this is more than a slap on the wrist… this is incentive to improve and tighten fixed income practices for retail customers… right on!

From CFO.com ~~~~ ” … “Today’s settlements are the largest in SEC history, and represent the largest return of customer money in the agency’s 75 years,” said SEC Chairman Christopher Cox.”

The settlements with Citi and UBS will restore about $7 billion in liquidity to Citi customers who invested in ARS, and $22.7 billion to UBS customers who invested in ARS, according to the SEC. Under the settlement, Citi will offer to purchase ARS at par from individuals, charities, and small businesses that purchased those ARS from Citi, even if those customers moved their accounts. Citi also will “use its best efforts” to provide liquidity solutions for institutional and other customers, including facilitating issuer redemptions, restructurings, “and other reasonable means.”

The bank also will pay eligible customers who sold their ARS below par the difference between par and the sale price of the ARS. In addition, it will reimburse eligible customers for any excess interest costs associated with loans taken out from Citi due to ARS illiquidity.

UBS will offer to purchase at par from all current or former UBS customers who held their ARS at UBS as of Feb. 13, 2008, or purchased their ARS at UBS between Oct. 1, 2007, and Feb. 12, 2008, even if they moved their accounts. It will pay eligible customers who sold their ARS below par the difference between par and the sale price of the ARS. UBS also will reimburse customers for any excess interest costs incurred by using UBS’s ARS loan programs….” ~~~~

This interests me because way back when I predicted on a Henry Blodget post on Clusterstock that foreigners, while they were not guaranteed by the US Government, could certainly benefit from a bailout, which, although I felt that it might be avoidable, was certain to occur for Citi if it had to be saved. I am assuming, unless I find out otherwise, that foreigners are being made whole as well if they hold these investments. This is only important because foreigners can certainly profit from and bet on and even influence US Government bailouts, in my opinion. They are part of the equation, even if not falling under explicit government guarantees.

"This is the angry soil in which populist backlashes can take root."

Robert Reich gets the Political Economy of these bailouts right:

"The government is doing a lousy job helping distressed homeowners. And according to John Dugan, the Comptroller of the Currency, the little that's been done has had surprisingly little effect. Nearly 36 percent of homeowners holding mortgages whose terms were adjusted to give them more leeway defaulted on payments within three months, and almost 53 percent were behind on payments by six months.

What's going on? It's hard to know for sure, because the homeowners who have qualified for help so far were supposed to have been fairly good credit risks to begin with. My guess is the worsening economy is making it harder for just about all homeowners to pay their mortgages, and those who were teetering on the edge months ago -- although perhaps good credit risks before that time -- are now way under water. Two of the biggest culprits: Layoffs and fewer working hours. With far less money coming in, more and more people have to choose between paying their mortgages and trying to keep up with larger and larger credit card debt. They're trying to manage both while paying the medical bills and the food bills and energy bills, and they can't make it.

It wouldn't surprise me if many of these Americans were starting to look at the size of the bailouts of Wall Street and the bailout of the Big Three -- at the executives, well-paid professional employees, upscale creditors and shareholders, and even well-paid blue-collar workers, who are the major beneficiaries of this federal largesse -- and conclude that a fundamental principle of fairness is being violated.

These Americans aren't revolutionaries. To the contrary, they're deeply conservative. They've worked hard, but their hard work hasn't paid off. Some have tried to save, only to see their savings disappear. They're worried about the future and about their kids' futures. They never expected anything like this.

This is the angry soil in which populist backlashes can take root."

I think that this is the bottom line. A bailout of just the financial sector would be a political disaster, given how arbitrary and seemingly ineffective the actions taken so far have been for the general economy. That's why Felix Salmon was wrong about those figures of borrowers defaulting again. People expected that lenders would do more to help people than in normal times. As well, that's why the best argument for the Fannie/Freddie infusion is political. The Fed needs to be seen helping people in real life, as they see it.

I don't like big, fast, and clumsy political changes, and Populism leads to them.We need to harden the soil against such movements.

"about the only people who benefit from this new Treasury proposal are the homebuilders, who have been lobbying for a bailout."

Roubini and I basically agree on this ( I'm sure he was waiting to hear my view ) as well, but I want to talk it out. Via Clusterstock:

"From TechTicker: A new Treasury plan to lower mortgage rates won't solve the housing crisis and is a "essentially a direct bailout of the homebuilders," says Nouriel Roubini, economics professor at NYU Stern School and chairman of RGE Monitor.

Homebuilding stocks like Toll and Lennar surged early Thursday, a sign Roubini is not alone in sharing this view.

Using Fannie, Freddie and other GSEs, Treasury will "encourage banks to issue new mortgages at lower rates by offering to purchase securities underpinning the loans at a price equivalent to the 4.5% rate," according to the Wall Street Journal."

I'm not sure why he finds this so troubling. I'm not for it, but let's read on:

"The plan will be effective in lowering rates but interest rates aren't the key to resolving the housing crisis, Roubini says: "Prices went through the roof" and need to fall another 15% before housing bottoms and homes become affordable to the majority of Americans. (The new Treasury plan does nothing for Americans looking to refi but last week's Fed announcement was aimed, in part, to help existing homeowners and refi activity surged in reaction.)"

I don't disagree, but if people can buy houses at this price and afford them, then that's the price. Obviously, if interest rates are lower, then housing prices can be higher. But is that a law? When I bought my house, I got it for 10% less after bargaining.

"Furthermore, there's not enough Americans who are credit worthy and confident enough in the economy and/or their job security to absorb the record levels of unsold homes on the market, says the notoriously bearish economist. "For new programs you have to qualify. Very few people qualify," Roubini said. "If you are loosening the criteria then you are creating a credit risk for the government because you're creating mortgages people cannot afford and some of them are going to default. You create another fiscal problem down the line."

Well, loosening the criteria would truly be insane. If that's what will happen because of this plan, then it's a disaster in the making. However, I don't believe that. In fact, I don't think that this program is worth the money. It simply won't do what it's supposed to, precisely because there aren't a large number of people who are going to qualify, and those people who do would be better off waiting for housing prices to decline, unless you believe that mortgage rates are going to immediately shoot up.

"That being the case, about the only people who benefit from this new Treasury proposal are the homebuilders, who have been lobbying for a bailout. Unfortunately for the rest of us, it looks like their efforts have paid off."

Now I see what he's worried about, and I agree. Bailing out homebuilders is not enough of a reason for this plan. I understand the political pressure to do something about housing, but this is not, in my opinion, the way to deal with this problem.

Plan B Is We're Screwed

ChumpChanger gets the picture:

"The consensus wisdom emerging about the Big 3 automakers is "Let 'em fail." There are some awfully good arguments for this. Yes, what's happening with the automakers is their own fault, the consequence of decades of bad decisions. Yes, to extend the bailout beyond the financial industry invites every ailing business in the country to run to the bailout trough. Yes, the shock therapy of bankruptcy may be the only way to make the US auto industry viable in the long run.

But what other choice is there? This is not a rhetorical question. I really don't know. It's easy to say that we should let them fail. But if John Dingell stares down at you (and I've sat in the audience when Dingell's stared down from his elevated perch--trust me, you can go many years without seeing a stare as blood curdling as his) and asks what your plan is for all the autoworkers who are going to be displaced, what's your answer? It seems to me that at the moment we have none. And anyone who says we should just let the industry go bankrupt and let it sort and downsize itself out had better have some answer to this.

PS: If you want to get some historical perspective on the dialogue here, check out A Step Toward Feudalism: The Chrysler Bailout, a paper from back in 1980 that the Cato Institute has put online (points to them for not just throwing out the sillier stuff when they were digitizing the archive). We bailed out Chrysler and the nation survived -- though it did mean years of listening to Lee Iacocca's turnaround story. "

Well, you and Cato both have a point, because that's how the world works. On the one hand, we aren't the USSR, on the other hand, government intervention leads to more government intervention. In the case of Chrysler, the terms should have at least been more onerous, including a vow of silence from Iacocca, even though I don't believe in vows for myself.

So, in this case, you're right again. There's no Plan B for any of this, because everyone's been working under a system of implicit and explicit government guarantees, based partly on the past government interventions. We're in a huge bind because of this, and are having to intervene to attempt to lessen an outright panic against risk.

On the other hand, Cato is right. We need to get out of this government guaranteed system, or at least radically alter it, because those guarantees made this outcome more likely.

So, you're both correct again, because that's the way the world works.

``They are only encouraging institutions to take more uncalculated risks.''

Via Yves Smith, this from Bloomberg:

"Nobel Winner Aumann Says Bernanke, Paulson Steps `Not Smart'

By Tal Barak and Alisa Odenheimer

"Nov. 2 (Bloomberg) -- Robert J. Aumann, the Israeli economist who won the 2005 Nobel Prize in economics, said the steps taken by Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson to save financial markets ``weren't smart.''

``The intervention by the regulators to save the U.S. economy will lead to further bankruptcies of banks and insurance companies,'' Aumann said at a rabbinical conference in Jerusalem yesterday. ``They are only encouraging institutions to take more uncalculated risks.''

The crisis in the financial markets was caused by the incentives provided to managers of banks and other financial institutions that caused them to act to their own benefit and not the banks', he said. Bonuses were given on the basis of loan sales, without considering who the borrowers were, he said."

Here's my comment:

Don said...

" Nov. 2 (Bloomberg) -- Robert J. Aumann, the Israeli economist who won the 2005 Nobel Prize in economics, said the steps taken by Federal Reserve Chairman Ben S. Bernanke and U.S. Treasury Secretary Henry Paulson to save financial markets ``weren't smart.''

``The intervention by the regulators to save the U.S. economy will lead to further bankruptcies of banks and insurance companies,'' Aumann said at a rabbinical conference in Jerusalem yesterday. ``They are only encouraging institutions to take more uncalculated risks.''

I'm not qualified, but here goes:

1) Moral hazard has to be enforced from the start, otherwise there's a cascading effect from letting the first few get passes. Actions have effects as do words.
2) Acting for your own benefit and not the firm's or customer's is a breach of fiduciary responsibility.
3) The situation's of the U.S. and Israel are not the same.

Don the libertarian Democrat

November 3, 2008 12:08 PM

Now, I want to make my position clear. I agree that moral hazard is a serious issue. In my mind, it's the most important issue in the crisis, with fraud coming in second. But, in this situation, although the Fed and Treasury could have done a better job, they were correct in assessing the uselessness of moral hazard in this current situation finally. In my opinion, we'd have been dug too far done this time without government action, because the investors, the people with the money, would have take us there.

As to:
1) Uncalculated risks ( I say ignored )
2) Unwise incentives ( I say negligence, and, in some cases, fraud )
I agree with Aumann. But the idea that the government will not intervene in a crisis of this size in the U.S. as our government is now structured and committed, seems crazy to me, even though Aumann and Buiter seem to believe that.

"Abdullah Hajeri led a march on the Emir's palace in Kuwait last week"

Speaking of the Gulf. Bloomberg, again:

"The region's rulers are under pressure from citizens to shore up investors, not just banks, as they try to fend off what may be the worst economic crisis since December 1998, when oil at $10.35 a barrel forced them to slash spending. Crude prices have fallen 50 percent from a record $147.27 in July, and stock indexes in Dubai and Saudi Arabia are down by as much this year.

Gulf economies are more susceptible to financial turmoil than in the past because of their greater dependency on international expertise, investment and tourists to diversify away from oil. While Dubai, home to the world's tallest building and the man-made Palm Island, is considered most at risk, no part of the Persian Gulf will go untouched."

Where have we encountered this conundrum before? Citizens who don't like only the banks getting a bailout? Now that's globalization. We're all alike.

"There aren't many international investors left in the region, he added.

Regional competition to attract investors and tourists from around the world led to a surge in record-breaking projects."

Put those on hold, just like everywhere else, there's an economic credit hoovering back home going on.

"The emirate has almost 8 percent of the world's oil reserves and a sovereign wealth fund with assets between $250 billion and $875 billion, according to a range of estimates compiled by the International Monetary Fund. Even with its decline, oil still averages $110 a barrel for the year.

Residents of the region are used to government intervention. All Gulf countries are run by unelected rulers who maintain political power through tribal allegiances and marriages. Generous state welfare programs have traditionally damped demands for more political participation.

How the region's rulers cope with the turmoil may define relations with their people in the future, as they try to wean their subjects off state handouts and encourage them to find jobs and embrace market capitalism.

``There's no question that it sets back the move from socialist, paternalistic societies toward more modern capitalist states,'' said Gabriel Stein, a director at London's Lombard Street Research, which provides economic analysis to investors and companies. ``It is a trend that we have seen all over the world. The immediate reaction is that you told us to do this, so now things are going wrong it's up to you to help us out.''

Ah yes, governments will grow larger for the near term. However, helping citizens through economic downturns needn't be seen as a rush towards socialism. Nor, apparently, massive government interventions in the economy. So don't go all marxist quite yet.

``The U.S. financial crisis has ramifications for all countries, including the Gulf,'' U.S. Deputy Secretary of Treasury Robert Kimmitt said this week during a speech in Dubai, where he met representatives of sovereign wealth funds. ``Our capital markets are more integrated than ever before, allowing opportunities, but also financial difficulties, to spread rapidly across borders.''

We did some good before, look at all your wondrous buildings, so please don't blame us for this financial crisis which we started.

"Of the Gulf states, Dubai may be hardest hit by a global economic slowdown because it has borrowed more to finance its transformation from a Persian Gulf trading post to a financial and tourist hub, and has only 4 billion barrels of oil reserves.

Government-controlled companies owe at least $47 billion, more than Dubai's gross domestic product, and they will continue to accumulate debt faster than the economy grows, Moody's Investors Service estimated in an Oct. 13 report. It concluded that Dubai may need financing help from Abu Dhabi."

Let's change that from 'may' to 'will'.

" But as the Fed cuts rates, the liquidity supply becomes more viscose. "

From Alphaville, a post about addiction:

"Artificial markets: the bailout isn’t working

Or at least, it’s not working in the way that it’s being made out to.

If the objective - or rather, objectives - of the world’s governments through their suite of emergency financial measures is to sustainably normalise markets and stabilise the world economy, then they are palpably failing.

What the bailouts are doing is bailing out: at an incredible rate. The headline result of that is a normalisation, but of course, it’s artificial. The real test of the success of the bailout would be working out what would happen if you took it away again.

_______

Consider, for example, the launch - and apparent success - of the Fed’s commercial paper facility. On Monday, new issues of longer-term CP soared ten-fold: 1,511 issues with a value of $67.1bn."

The drug's not working as planned, but it is creating an addict.

Here's my comment:

ov 01 18:28Posted by Don the libertarian Democrat [report]

"Here’s a part philosophical, part-hypothetical and part-sincere conclusion:

The problem with all of the current liquidity measures - in the US and abroad - is the same as that with the Fed’s other lending facilities: those like the TAF or the PDCF, which have been in operation for over a year. The facilities do not restore confidence, they simply nurture dependence.

To wit: the Fed isn’t de-risking the market, it is merely undercutting the risk appetite of all the market’s other participants, and in doing so only further damaging the likelihood of them participating again.'

I agree with you, but why keep flogging ourselves? This was noticed at the time. We're way down the moral hazard/addiction road.

We've supplied the needle, supplied the drug, and, if you consider Paulson's forcing 9 banks into TARP, injected the drug ourselves. All that we haven't done is cause an overdose, but there's still plenty of time for that.

"“It simply beggars belief that the car lobbyists now come cap in hand "

This is getting hilarious. Check this out, from the FT:

"European carmakers could get up to €40bn ($52bn, £31bn) in “soft loans” from the European Investment Bank to the industry to help develop more fuel-efficient technologies, a top EU official said on Wednesday.

Günter Verheugen, industry commissioner, said that loan subsidies could be provided through the EIB in an effort to develop greener cars and meet EU environmental targets, although he pointed out that it was ultimately a matter for the bloc’s member states and the EIB to decide."

Car makers asking for cushy government loans because of problems complying with environmental standards. Did we export this too?

"The €40bn low-interest loan package is one of a number of measures being pushed for by European carmakers, who claim to be facing a particularly challenging environment in the wake of the credit crunch and economic downturn."

Hey, did you know that's happening in the U.S. as well?

"Several environmental groups blasted the automakers on Wednesday, accusing them of seeking subsidies to comply with measures they have repeatedly resisted. “It simply beggars belief that the car lobbyists now come cap in hand to the European Union asking for handouts to develop the fuel efficient cars they should have built long ago,” said Jos Dings, directors of Transport & Environment, a pressure group.

But industry officials argue that they have already been making substantial investments to improve their fleets, and will need assistance to continue them at a time when their market is collapsing."

What do you know? Where have I heard this before?

Thursday, September 25, 2008

Auto Makers Deserve Loans From Government. Not!

Today, I did a Diary on the proposed auto bailout on the Daily Kos. It didn't go well. The responses I got illustrated to me differences between liberal Democrats and libertarian Democrats.

Here are some of the arguments I got in favor of the bailout:

1) It was passed by congress. Of course, the Paulson Plan is before Congress as well. Also, I questioned whether it was passed in the light of day or slipped into larger legislation.

2) It's a loan, not a bailout. Of course, the AIG bailout is also a loan. And, according to William Gross, the Paulson plan is an excellent investment. I tell you what, I respect William Gross of Pimco more than auto executives about the financial viablity of their plans. Also, given that they've been losing money for years, one wonders why they would be smart enough to start making money now.

3) It will employ people. You've heard of too large to fail. Now we have too many jobs to lose. Of course, there's no guarantee these auto makers will deal fairly with their employees.

4) It's hard to get credit now. Of course, then maybe you should favor the Paulson Plan, and deal with the credit crisis first.

5) It will help the environment. This is rich. The auto makers have made a point of not preparing for more energy efficient cars, and they are now being rewarded by, in essence, blackmailing the taxpayers by saying we're not ready.

This is a bailout, pure and simple, for businesses that have thumbed their noses at energy efficiency, government, their employees, all the while being unable to turn a profit.

If liberals are for that, count me out

"Howard Baker famously called Ronald Reagan’s tax cuts a “riverboat gamble"

I'm worried about David Boaz having a meltdown himself:

"And if you tax Americans to bail out as many Americans as we’re now talking about helping, eventually you’re going to be taxing people to bail themselves out. In fact, the government is likely to borrow some of the money and have the Federal Reserve create more of it. That process seems to be under way, as Greg Mankiw and Jeff Hummel have discussed. How can that astounding and unprecedented increase in the monetary base not lead to inflation, even hyperinflation? We’ve already decided to tax the prudent and thrifty to bail out the imprudent and irresponsible. Now the prudent may face a danger even worse than taxes: inflation that erodes their hard-earned savings."

The only good news is that the government guarantees are going to prove to be not acceptable going forward. For the time being David, you might want to take a riverboat ride and enjoy the view and relax. That Old Man Bailout is going to keep rolling along.

" the US plan the flavour of a $50 billion subsidy, and is almost fully government-reliant"

A very interesting post on Vox about the different approached between the U.S. and U.K. on guaranteeing loans by Viral Archarya and Raghu Sundaram. Please read it:

"The pooling outcome, in contrast, may keep the system reliant on government guarantees for a longer period since it does not facilitate a better pricing by banks and markets of individual banks’ credit risk. It effectively gets healthy banks to subsidise the borrowing of unhealthy ones and does not impair capital-raising ability of the latter. The US scheme is best characterised as a bailout that transfers taxpayer funds to the banking sector. "

In other words, the U.K. systems weeds out the poor banks, while the U.S. system keeps them afloat. I prefer the first in the short term, but there are reasons for backing the U.S. plan, for example, keeping more competition. However, I feel the really poorly functioning banks needed to be let go, including for the reason I call Bagehot's B of E point, don't reward poor decisions unduly.

Here's the difference:

The UK scheme has the flavour of a small tax, and is partly market-reliant; the US plan the flavour of a $50 billion subsidy, and is almost fully government-reliant. The UK scheme is likely to lead to a separating equilibrium, in which banks whose credit risk is lower than the market’s perceptions opt out. The US scheme will force a pooling outcome wherein all eligible banks – regardless of their health – participate because it is not possible to re-enter later. Which scheme works better depends upon the depth of the coming recession. The UK scheme assumes that following the recent capital infusions, even the unhealthy players are now solvent and are unlikely to fail. If the financial crisis worsens, this may prove incorrect.

Whither Libertarianism?

ka1gu1a on Freedom Democrats with a provocative post:

With all due respect to Lane, now is the time for libertarians to actually be picking up their manifestos, not putting them down. Low-tax liberalism now is about as much a pipe dream in the US as it would be in one party states such as China or historically, in Mussolini's fascist, corporatist Italy. I'm sorry, libertarianism is not about providing the swing vote for which party gets to select the puppet masters from the same pool of ruling class overlords.

Here's my comment:

You've written an interesting and provocative post. I disagree, but want to raise just one point here. The market's reaction after the Lehman refusal showed that the markets and investors were expecting a bailout. In other words, there was an implicit government guarantee to intervene in a crisis such as this. In this instance, to try and go against the expectations of the market would be very hard and complicated. On the other hand, going forward, it will be clear that this implicit guarantee, which will now be explicit, was partly responsible for this crisis. I believe that this will come to be widely understood. Contrary to what you are saying, the moral hazards of this arrangement are more widely understood and accepted, and will finally have to be addressed.

All Bailout Can Do Is Shift The Loss From Some People To Others

Here's David Friedman:

"What is happening is the failure of lots of firms. The failure of a firm doesn't wipe out wealth, except to the extent that the firm itself—its firm culture, web of relationships and such—has some value. When a firm fails, that is at least some evidence that that value was negative, which is why nobody chose to buy out the firm and keep it going. The ordinary assets of the firm—its buildings, land, stocks, bonds, mortgages, and whatever it owns—don't vanish when the firm fails, they get sold to someone else.

The bailout is not a way of preventing the loss of value. The loss (or transfer) of value occurred when people made bad mortgage loans. What happened more recently was the recognition of that loss. All the bailout can do is to shift the loss from some people to others, from the stockholders and creditors have firms that are now effectively bankrupt to the taxpayers.

All of which comes back to confusion over the meaning of "money."

Read the whole post entitled "The Price Of Money And Other Errors".

Sen. Obama On The Bailout

Ezra Klein has an excellent post today entitled "Obama On The Bailout Plan":

"Obama's speech on the bailout plan is pitch perfect, one of the best statements he's given on the crisis thus far:

Even with all these taxpayer protections, this plan is not perfect. Democrats and Republicans in Congress have legitimate concerns about it. I know many Americans share those concerns. But it is clear that this is what we must do right now to prevent a crisis from turning into a catastrophe. That’s why I’ve been reaching out to leaders in both parties to do whatever I can to help pass this plan. That’s why I’ll be flying back to Washington today to cast my vote to safeguard the American economy. And to the Democrats and Republicans who have opposed this plan, I say – step up to the plate and do what’s right for the country, because the time to act is now.

I know many Americans are wondering what happens next. Passing this bill will not be the end of our work to strengthen our economy – it’s just the beginning of a long, hard road ahead. So let me tell you exactly how I’ll move forward as President."

Read on.

Do I agree with everything that Sen. Obama says? No. But, given political realities, Sen. Obama is proving himself to be ready to lead. There is no sense of undue panic, and a real emphasis on getting things done. The contrast with Sen. McCain is clear.

Can A Bailout Be Punitive?

Meteor Blades on Kos posts the following:

"Democrats, in general, and Senator Barack Obama, in particular - as the new head of the Democratic Party - should trash this outrageous dictatorial bailout and stop listening to the advice of those who led us into this mess - including some fellow Democrats of prominence. They shouldn't tinker on the edges of the administration's proposal. Their substitute plan should put the pain on the pin-striped grifters where it belongs instead of on those Americans who have been repeatedly victimized by them."

Here's my response:

"If It's A Bailout, How Can It Be Punitive? (0+ / 0-)

I'm just asking.

Trying to make the libertarian Democrat a reality

by Don the swing voter on Mon Sep 22, 2008 at 11:23:13 AM PDT"

Can We Really Avoid Some Regulations?

Nick Gillespie has a good post on Reason called "McCain On AIG". Here he quotes Tyler Cowen:

"There are two ways to view this history. First, with the benefit of hindsight, one could argue that we needed only a stronger political will to regulate every corner of finance and avert a crisis.

Under the second view, which I prefer, regulators will never be in a position to accurately evaluate or second-guess many of the most important market transactions. In finance, trillions of dollars change hands, market players are very sophisticated, and much of the activity takes place outside the United States—or easily could."

It's a good point, but here's my response:

"Don the libertarian Democrat | September 17, 2008, 2:34pm | #We'd better come up with a way to avoid these kinds of crises, otherwise there will more bailouts and more regulations. That's the real world. I say that we should try and develop some decent and minimal regulations. But,hey,if the world changes, that's fine with me."

Two points:

1) I agree that we can't regulate every corner of finance, but would like to try and set up some minimal, but suitable, rules to avert future crises like the current one.

2) I'm not sure that we can't have regulators focus on a few well thought out regulations or aspects of the most important market transactions.

Still, I take the point. I just don't see any other real option than some regulations.

Bailouts Are Here To Stay, I'm Sorry To Say

Bob Barr gives a libertarian reaction to the current bailouts on the Huffington Post.

Here's my response:

ModerateDon See Profile I'm a Fan of ModerateDon I'm a fan of this user permalink

Bob, Get this through your head. Our government is always going to do bailouts. Period. As a libertarian Democrat, all we can do is set in place a minimum of rules, and protect as much freedom and require as much personal liability as possible. It is in crises like these that government over-reaction often occurs. There's going to be regulation, the only question is how much and will it work. Of course, that's why I'm a Democrat. I want to help shape my party, which could, actually, get things done, and do things right."

The only way to avoid bailouts, which are horrendously costly and lead to excessive regulation, is to have a set of minimal regulations that precludes meltdowns such as the current one.

I understand his position, but it's not a real world solution.

I understand that many in my party will propose regulations that I don't agree with, and I need to be specific on where I, as a libertarian Democrat, disagree.

Right now, I not seeing a lot of specifics, but will talk about them when I do.