"Some companies are too powerful to fail": That's Our System

John Kay in the FT has interesting post this morning that echoes some of the points that I was using in talking about Yves Smith's post on the US fear of Nationalization:

"Great banks are “too big to fail”. The predictable consequence of governments accepting this argument is a queue of other companies “too big to fail” lining up at the front door of treasuries. Insurers were next. This week, the car manufacturers secured their subsidy."

It is predictable, but also, in some sense, necessary, because politically, it would be very hard for a bailout of just financial services to be accepted by the citizenry of the US.

"The failure of any business has ripple effects on suppliers, employees, distributors and customers. If the business is General Motors such effects are larger. But since GM is many times larger than most companies, the subsidy needed to keep going is correspondingly larger. There is no reason to think that the ripple effects are larger, relative to the size of GM, than the consequences of the failure of a smaller business relative to its size."

That's not the point, but he understands that.

"So the return on the taxpayers’ dollar is not likely to be larger if their largesse goes to a big company. Indeed, since the large company has readier access to a range of alternative funding options, a need for government support is more likely the result of deep-seated competitive weakness than temporary shortage of funds which can so easily cripple a smaller business."

Not exactly. The government is the implicit guarantor for these businesses at all times, and legislation has been passed favoring these businesses over time. It certainly can mean that they are competitively weak, but the system operates for the benefit of the weak and strong large businesses alike. It's a kind of insurance policy.

"That is true of the carmakers, whose problems are of much longer standing than the current downturn. In automobiles as in many industries, economies of scale are technological, the diseconomies of scale human. Human factors in business are generally more influential than technological ones in determining the long run fate of a company."

The automakers have been a major part of this system.

"The memory of a meeting in one of Britain’s largest companies – now no longer so large – is engraved in my memory. We discussed how best to persuade the regulatory authorities of the cost advantages arising from the company’s size. But the room was crowded with people who had nothing substantive to contribute. They were there to defend and advance their political position in the corporate hierarchy. The meeting itself demonstrated that the arguments we were presenting were false. Politics overrode productivity."

But Politics is important. So is Political Economy, which includes this kind of messy exchange between politics and productivity.

"As has been true in Detroit. Arrogant, complacent and only belatedly sensitive to competitive pressures and changing customer needs, the big three have been in relative decline for half a century."

True. That's why they've been lobbying congress throughout this period.

"But there really are economies of scale in political lobbying. The cost of presenting your case is independent of the size of the benefit you seek. The larger the business, the more likely that legislators will see constituency interest or political advantage in being helpful. Big companies have government affairs departments but for small groups the cost of access is prohibitive. Only large companies have access to the sharpest shooters."

That's the system.

"Too big to fail, but big enough to exert political influence. The malign consequences are evident in many areas of public policy. Large media and software companies write intellectual property rules, while the interests of users go unrepresented. Big pharmaceutical and defence companies employ thousands of lobbyists. Consumer interests come a distant second to producer interests in the formulation of trade policy. In the past two decades the financial services industry has become the most powerful and effective lobby of all. The cash contributed to political campaigns has now been repaid many times over from the public purse."

That's because lobbying is an investment.

"But few things corrode business efficiency and effective markets more insidiously than the discovery that it is more profitable to win the favour of politicians than to win the approval of customers. In Italy, and in some other European states, an inefficient large-business sector is parasitic on the vibrant small- and medium-sized enterprises, which are the mainstay of the economy."

That's true.

"The problems are worse in Russia and in many potentially emerging economies. In these countries, the nexus between the political and business elite undermines both democracy and business efficiency."

That's not good to hear.

"The populist trustbusters who framed anti-monopoly legislation more than a century ago feared that the cost and technical advantages of large companies would be more than offset by damage to economic efficiency and pluralist institutions from the political power they might acquire. These early trustbusters were right."

I agree. But the work to be done to dismantle this current system is going to be long and arduous because, again, that is and has been our system, and it seems very resilient and impervious to challenge and change at the moment. We need to plan and prepare for the the long run, and seek small victories that will allow us to get some important things done under the radar, so to speak, and before the system realizes that, this time, it really has a challenge from people who want a smaller and more effective and efficient and representative government. But anyone who says that they're surprised by the government response in this crisis needs to get out a bit more into the real world of Politics and Political Economy.

"Paulson did it quietly and in the background": Then How Did I Know It?

I wonder how many times that I have to read this. From 124 Monkeys:

"I had completely missed this story by Amit Paley until Michael Scherer put up a blog post about it. Basically, the Treasury Department completely bypassed Congress and the Constitution* to revise Section 382 of the U.S. Tax Code. The why of it is pretty obvious on its face. Paulson believes that we’re on the verge of another Great Depression and he intends to not make the mistakes of letting banks fail and contracting the money supply that caused the first one.

*you know, that pesky document that spells out and specifically states that Congress and only Congress shall have the power to tax the people and pass laws about taxation

Paulson’s original plan was to buy up the bad securities and encourage the credit markets to start trading and lending again. Part of that scenario would definitely involve banks buying up other banks that had tons and tons of losses and bad assets on their books. In order to encourage such behavior, Paulson ordered a roll back of Section 382 to make buying companies with lots of losses - either on their books or waiting to be declared - more attractive.

Paulson did it quietly and in the background because he knew the top down nature of his plan, which essentially was “save Wall Street, let the solvent banks carry the overall economy through the crisis, screw the little guys” would go over very, very badly with Congress who would need votes from all those little guys to get re-elected in a month.

What I don’t understand is why this roll back wasn’t rolled back when the TARP plan changed to bank nationalization. Plus, its like totally unconstitutional and stuff."

Here's my post from, read it carefully:

Saturday, October 4, 2008

Not Really Free Market After All

Paulson's stimulus plan:

"Treasury Secretary Henry Paulson’s plan, which is now law, is fiscal stimulus that will be injected directly into the banking system to supplement almost nonexistent private-sector lending with government cash and determination. Mr. Paulson may be shooting the right weapon at the right time because it will help rescue the banks while restarting corporate and consumer lending.

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Your government's dollars at work.

And this post:

Saturday, October 4, 2008

Are Regulators Always Wise?

On the Wachovia sale:

"Lawyers not involved in the battle said that Wachovia could defend the Wells Fargo deal by arguing that it is better for its shareholders. Wachovia is likely to claim that its fiduciary obligations — its responsibility to protect the interests of its investors — required it to consider the Wells Fargo bid and, given its higher price, to accept that bid.

The litigation could put regulators in a difficult spot. The Wells Fargo deal may be better for taxpayers, but if it succeeds, in the future other financial institutions may not be willing to help the government, as Citigroup did, because of the risk that they might not reap the anticipated benefit."

You think?

And this post:

Monday, October 20, 2008

“One purpose of this plan is to drive consolidation.”

Score one for Surowiecki. From the NY Times:

"As the Treasury embarks on its unprecedented recapitalization, it is becoming clear that the government wants not only to stabilize the industry, but also to reshape it. Two senior officials said the selection criteria would include banks that need more capital to finance acquisitions.

“Treasury doesn’t want to prop up weak banks,” said an official who spoke on condition of anonymity, because of the sensitivity of the matter. “One purpose of this plan is to drive consolidation.”

I understand this as a temporary move, but don't find consolidation, or creating very large banks, a positive development in the long run.

As well, I don't think that a credit stimulus plan that doesn't stimulate lending to be very useful.


Okay. These three posts explain everything. Citigroup had a deal to buy Wachovia brokered by the government. When the TARP was passed, which included the provisions that I knew about at the time, and that people are claiming were hidden, Wells Fargo took advantage of the new law to put a better bid in to buy Wachovia. This put the government in the odd situation of brokering a deal with Citigroup, only then to pass tax subsidies that led to Wells Fargo making a better deal. A suit by Citigroup then ensued.

Also, the TARP plan was designed to acquire toxic assets from banks, not recapitalize them as happened. So, the original plan for recapitalization was to pass these tax subsidies so that banks could merge, making recapitalization easier, and, hopefully, making the banks more profitable, hence more able to pay us back and survive, since there was less competition.

Now, if you followed the Wachovia deal, or tried to understand how TARP could actually work and what it said, these provisions were obvious from the beginning. So, these stories are not news. The only news I can find is that some people claim that it's unconstitutional. But, I believe that is was in the bill that passed, so I'm missing something about this argument. It could be correct, but I need to understand it better.

But, if an amateur blogger like me knew this, how could all these experts not know it?

Not Really Free Market After All

Paulson's stimulus plan:

"Treasury Secretary Henry Paulson’s plan, which is now law, is fiscal stimulus that will be injected directly into the banking system to supplement almost nonexistent private-sector lending with government cash and determination. Mr. Paulson may be shooting the right weapon at the right time because it will help rescue the banks while restarting corporate and consumer lending.

But Mr. Paulson’s fiscal-stimulus work didn’t end with the bailout bill.

With hardly anyone noticing, on Wednesday he pushed through very technical and obscure changes to tax regulations that provide a “tax subsidy” for acquirers of troubled banks. Just as automakers stimulate car sales through rebate checks, the Treasury is providing a form of tax rebate to acquirers of troubled banks. Everyone can thank Hank Paulson and his stealth tax-driven fiscal stimulus for the astonishing news that Wachovia was being acquired by Wells Fargo and not Citigroup. It was Mr. Paulson’s tax subsidy to Wells Fargo that provided the fiscal grease to make this deal happen. Pundits who point to the deal and proclaim that the “free markets work without government help” don’t understand the motivating effect of several billion dollars of tax benefits to Wells Fargo."

Your government's dollars at work.