Sunday, September 21, 2008
Crisis: a stage in a sequence of events at which the trend of all future events, esp. for better or for worse, is determined; turning point. Pandemonium: wild uproar or unrestrained disorder; tumult or chaos.
The banking sector is now in a pandemonium, driven by lack of investor confidence, where its impact on the future of the banking system is widely speculated, and unless Hank, Ben, George, or Congress have resumes that include “extra sensory perception” in their previous experience sections, future events are not known; hence, a crisis cannot be determined until the event is over. However, by intervening, I believe that the government is creating a crisis, where future events are guaranteed to change with the passing of each day.
In one big swoop, the U.S. government has changed the financial system for decades to come over the course of just 2 weeks. Are they acting on theory and rational decision making? Or are they acting on pure instinct –like investors in the late 1990’s, described by Greenspan as irrational exuberance – and acting before thinking. It looks like the latter to me.
It was certainly easy to get caught up in the moment last week. I even found myself thinking irrationally once or twice, questioning all of the posts that I’ve written over the last several months regarding the state of the U.S. economy. The U.S. government took the path of least resistance without knowing what is waiting at the finishing line, and all the while, risking big bucks…bucks that belong with U.S. households and firms. How can the Treasury expect to slap a $1 trillion dollar band-aid on top of the financial system, pledge to regulate the system, and think that things are going to be okay? It is wrong for the Treasury to buy up the bunk debt in order to stabilize confidence in the U.S. financial system, especially since it doesn’t seem logical that the government can restore confidence with money. Can confidence really be bought?
Confidence: full trust; belief in the powers, trustworthiness, or reliability of a person or thing. Confidence will not be restored by flooding the system with $700 billion, buying truckloads of securitized assets off of the hands of those who brokered them in the first place, selling them off using an as-of-yet undetermined pricing mechanism, and then expecting the system to be healed. As Paul Krugman states in his Op-ed piece in the NY Times regarding the very tentative rescue plan:
“Here’s the thing: historically, financial system rescues have involved seizing the troubled institutions and guaranteeing their debts;… The Treasury plan, by contrast, looks like an attempt to restore confidence in the financial system — that is, convince creditors of troubled institutions that everything’s OK — simply by buying assets off these institutions. This will only work if the prices Treasury pays are much higher than current market prices; that, in turn, can only be true either if this is mainly a liquidity problem — which seems doubtful — or if Treasury is going to be paying a huge premium, in effect throwing taxpayers’ money at the financial world.
And there’s no quid pro quo here — nothing that gives taxpayers a stake in the upside, nothing that ensures that the money is used to stabilize the system rather than reward the undeserving.”
If you haven’t read David Wessel’s Wall Street Journal article, In Turmoil, U.S. Capitalism Sets Course on Uncharted Waters (they changed the title since Saturday to "In Turmoil, Capitalism in U.S. Sets New Course," but I liked it better yesterday), then you must; if you can’t get it, email me, and I will make sure that you can. He lists two weeks worth of government strong-holding that actually brought tears to my capitalistic eyes:
“But in the past two weeks, the U.S. government, keeper of the flame of free markets and private enterprise, has:
-- nationalized the two engines of the U.S. mortgage industry, Fannie Mae and Freddie Mac, and flooded the mortgage market with taxpayer funds to keep it going;
-- crafted a deal to seize the nation's largest insurer, American International Group Inc., fired its chief executive and moved to sell it off in pieces.
-- extended government insurance beyond bank deposits to $3.4 trillion in money-market mutual funds for a year;
-- banned, for 799 financial stocks, a practice at the heart of stock trading, the short-selling in which investors seek to profit from falling stock prices.
-- allowed or encouraged the collapse or sale of two of the four remaining, free-standing investment banks, Lehman Brothers and Merrill Lynch;
-- asked Congress by next week to agree to stick taxpayers with hundreds of billions of dollars of illiquid assets from financial institutions so those institutions can raise capital and resume lending.” There you have it: We are talking about government intervention the size of a supernova, certain to lead a wave of bad regulation. According to Stephen Quinn, an economic historian at Texas Christian University, “Smart regulation looks forward to prevent the next regulation-circumventing ... idea from turning into a bubble without stymieing the flow of new ideas. Dumb regulation looks backward. You can guess which kind of regulation most crises produce.”
We depend on individuals that were elected into office, or nominated by ones that were elected into office, to both restore confidence in the U.S. financial system and to regulate it so that future generations will not find themselves at a similar crossroads...now that’s a sobering thought.
Why I think that the U.S. Treasury, the Fed, Congress, and Bush are on crack:
- Bailing out Bear Stearns set a precedent that, going forward, will lead to broad-based moral hazard across all industries, not just finance. On the second page of Saturday’s Wall Street Journal, but resting daintily at the bottom, a troubling headline reads: “GM to Tap Rest of $4.5 Billion Credit Line”. Capital problems should lead to default, but now the government must add to its already long list of activities, the task of determining whether or not GM should fail. Are they too big or too small? Who knows, but since equity is ueber important to the U.S. Constitution, expect GM to tap the Fed, the U.S. Treasury, or both in the future.
- What happened to autonomous fiscal and monetary policy? The fiscal (U.S. Treasury) and monetary (Federal Reserve Bank) sectors are too close on this one – nowhere in the Fed’s mandate does it call to stabilizing the financial system; actually, it was written to leave out such a goal. The un-anchoring of financial stability can bring obvious economic disarray in the near term, but it also brings a stronger long-term financial model. I appeal, once again, to the evolution metaphor: Only the fittest will survive, and that is a positive for long-term economic growth.
- By intervening in the securitized asset market, which is what they are about to do at the cost of an additional $700 billion (at the very least), financial stability in the U.S. is far from certain. The government is assuming a truckload of bad assets in order to sell it off, and all the while, default rates that determine the value of the assets are not even falling a tick, so why in the heck would anybody rational investor buy it from the government unless the price was sufficiently low (likely lower than what the government paid for it)? Does the government really believe that a “backed by the U.S. government” sticker on top of a securitized asset will woo investors? We’re not talking about the U.S. dollar here.
- And this is where is gets a bit blurry for me. $700 billion for the >>>> bill, $85 billion for AIG (which I read that they are in talks to prevent the government from assuming the 80% stake, which is funny), $120 billion in overnight repos on Tuesday and Wednesday (I believe), $180 billion in currency trades with Europe, Canada, and Japan, the $29 billion for Bear, and we are well over the $1 trillion mark. And that is just at the top of my head….there is more, especially in the repo market! How in the heck can we afford this without footing the bill to our children, grandchildren, great grandchildren, great great grandchildren, etc. It is simply mind-boggling, what the government will risk in order to prevent a fallout that may be un-preventable. Eventually, push will have to come to shove, and the U.S. economy will pay for it. See the U.K. Bubble for The US housing bail-out tab so far.
- Which brings me to another thought: Where the heck is the Federal Trade Commission? Are no, and I stress no, anti-competitive laws being broken? It seems like the Fed, in its calm state of hallucination, has forgotten that the Bank of America, or any other merger (vertical or horizontal), may now have an anti-competitive share in some banking practice (take your pick). The government is promoting an auction by showcasing troubled banks (Citigroup and WaMu, for example). Anyone can bid, and the good old days of protecting competition has all-but faded away. Again, acting too quickly.
So where does this leave the rest of the U.S. economy? Should I expect that when I go bankrupt, the U.S. government will step in and save my ass? Well, if all of you out there believe in the essence of equity, then you better believe it. Tomorrow I will vow to spend every stinking dollar that I earn. I will go into debt and be happy, leading an awesomely hedonistic life, just because I know that the U.S. government will always be there to bail me out. Well, if I was GM or Washington Mutual, or even Barney’s, then I would be thinking this.
Now the precedent has been set. In the history of government interventions, this is the one that really defines the U.S. government as slightly, no ridiculously, crazy. No government should have such a broad-based stake in finance – money supply, insurance, investment banking, mortgages, taxes, spending – it’s just not the American way.
Did you [U.S. Treasury, Federal Reserve System, Congress, and the current Administration] ever stop to think – just once – that the pain associated with financial disarray would do more for the markets than your one-stop shop of government intervention? Hank says, “If it [the $700 billion bailout of Wall Street] doesn’t pass, then heaven help us all,” Well I say, If it does pass, then heaven help us all. You are playing with fire here boys – I hope that we are all wearing armor.
P.S. Hi Kashamere – does this do?