Monday, October 12, 2009
Government Leaders Said Bailouts Were Needed Because "The House Next Door Was Burning Down" . . . Were They Right?
Government leaders said that massive bailouts were necessary. Were they right?
Bullying Congress
The New York Times wrote on July 16th:
In retrospect, Congress felt bullied by Mr. Paulson last year. Many of them fervently believed they should not prop up the banks that had led us to this crisis — yet they were pushed by Mr. Paulson and Mr. Bernanke into passing the $700 billion TARP, which was then used to bail out those very banks.
In his latest trend forecast, Gerald Celente writes:
It was the familiar fear tactic — one that had worked in the past and would work again — an economic version of the Bush/Cheney argument for the Iraq War. The people were told that Saddam Hussein had weapons of mass destruction and ties to Al Qaeda. If he wasn’t stopped, the next cloud would be a mushroom cloud.Celente is over-the-top, right? Tin foil hat time, right?
The pretense was different but the game was the same: instill fear in a panicked public and they will follow their leader, regardless of how shallow the reasoning or how big the lie.
Just as the nation was hurried to war before it could be proven that Saddam Hussein had no weapons of mass destruction or Al Qaeda ties, so too there was no time to debate what might happen if the “too big to fail” failed...
While the national pastime of “follow the leader” is always the path of least resistance, it comes at a high cost … financial ruin and/or war and death. In either case, when disaster strikes, the followers typically absolve themselves of any direct moral responsibility for both the outcome and for the role they played in allowing it to happen.
Well, maybe. But Congressmen Brad Sherman and Paul Kanjorski and Senator James Inhofe all say that the government warned of martial law if Tarp wasn't passed:
Bait And Switch
Indeed, the Tarp Inspector General has said that Paulson misrepresented some fundamental aspects of Tarp.
And Paulson himself has said:
During the two weeks that Congress considered the [Tarp] legislation, market conditions worsened considerably. It was clear to me by the time the bill was signed on October 3rd that we needed to act quickly and forcefully, and that purchasing troubled assets—our initial focus—would take time to implement and would not be sufficient given the severity of the problem. In consultation with the Federal Reserve, I determined that the most timely, effective step to improve credit market conditions was to strengthen bank balance sheets quickly through direct purchases of equity in banks.So Paulson knew "by the time the bill was signed" that it wouldn't be used for its advertised purpose - disposing of toxic assets - and would instead be used to give money directly to the big banks? But he didn't tell Congress before they voted to approve the Tarp legislation? Does that mean that Paulson either actively misrepresented the purpose of the legislation or else committed a lie by omission - holding his tongue even though the fundamental idea behind his bill had changed?
It was a bait-and-switch, whether or not it was an intentional one.
The House Next Door
And while I have never heard of Obama and Bernanke's "house next door" speeches before, Celente does a good job of describing them and then pulling the rug out from under their rationale:
Asked why taxpayers should be forced to foot the bill to bail out banks, brokerages, insurance companies and other institutions that had made bad bets, Mr. Obama responded, “You know, if my neighbor’s house is on fire, even if they were smokingPreventing the Next Fire
in the bedroom or leaving the stove on, right now my main incentive is to put out that fire so that it doesn’t spread to my house.”
When asked the same question seven months later, Ben Bernanke resorted to the same illegitimate analogy: “If you have a neighbor, who smokes in bed. And he’s a risk to everybody. If suppose he sets fire to his house, and you might say to yourself, ‘I’m not gonna call the fire department. Let his house burn down. It’s fine with me.’ But what if your house is made of wood? And it’s right next door to his house? What if the whole town is made of wood? Well, I think we’d all agree that the right thing to do is put out that fire first, and then say, ‘What punishment
is appropriate? How should we change the fire code? What needs to be done to make sure this doesn’t happen in the future? How can we fire proof our houses?’ That’s where we are now. We have a fire going on.”
Comparing a neighbor’s house on fire to spending trillions to bail out failed financial institutions is a totally fraudulent, puerile and transparent analogy … one that happened to be accepted without question by the entire media and foisted upon the public as the logic of the wise.
“Smoking in bed” and “the house on fire” bore no relationship to the reality. More to the point, what if your neighbor is a compulsive gambler who lost his fortune in Vegas and is now losing his house? Should the “whole town” be taxed for generations to come so that your neighbor is able to retain possession of his McMansion? And for his gross failures, should he be further rewarded with millions in “executive compensation” so he can travel first class back to Vegas to continue his wasteful, profligate ways?
The bottom line is this. If the fire at the neighbor's house was threatening your house, wouldn't you want his matches taken away? Especially if he had lit fires that had burned down other houses in the past?
Unfortunately, as I have previously pointed out, Obama's proposed economic regulations are like a law which makes arson illegal, but exempts convicted arsonists.
The top independent economists warn that the economy will not stabilize - and hundreds of billions or trillions of additional dollars will need to be thrown at the giant banks and financial companies - unless the fundamental problems are actually addressed and fixed. They agree that - to date - Obama, Summers, Geithner, Bernanke and the rest of the boys have not done so.
Indeed, I would argue that the government is actually handing out matches by encouraging the financial giants to hide the extent of their toxic assets (through funny accounting and the continued use of SIVs), restart the shadow banking system, re-lever up, and engage in new types of financial schemes such as securitization of life insurance policies.
As I wrote a year ago, by trying to put out the raging fires of deleveraging, the government was ensuring that they would grow and wipe out the whole forest.
And as former head BIS economist William White wrote recently, we have to resist the temptation to blow another bubble every time the economy gets in trouble:
Whoever started the fire in the first place, and whether or not there was really a crisis which required bailouts the first time around, the fact is that the government is ensuring more - and - bigger fires in the future.Forest fires are judged to be nasty, especially when one’s own house or life is threatened, or when grave harm is being done to tourist attractions. The popular conviction that fires are an unqualified evil reached its zenith after a third of Yellowstone Park in the US was destroyed by fire in 1988. Nevertheless, conventional wisdom among forest managers remains that it is best to let natural forest fires burn themselves out, unless particularly dangerous conditions apply. Burning appears to be part of a natural process of forest rejuvenation. Moreover, intermittent fires burn away the undergrowth that might accumulate and make any eventual fire uncontrollable.
Perhaps modern macroeconomists could learn from the forest managers. For decades, successive economic downturns and even threats of downturns (“pre-emptive easing”) have been met with massive monetary and often fiscal stimuli...
Just as good forest management implies cutting away underbrush and selective tree-felling, we need to resist the credit-driven expansions that fuel asset bubbles and unsustainable spending patterns. Recent reports from a number of jurisdictions with well-developed financial markets seem to agree that regulatory instruments play an important role in leaning against such phenomena. What is less clear is that central bankers recognise that they might have an even more important role to play. In light of the recent surge in asset prices worldwide, this issue needs urgent attention. Yet another boom-bust cycle could have negative implications, social and political, stretching beyond the sphere of economics.
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I always thought the more appropriate analogy would be the castle on the hill is on fire and the serfs in the valley below are saying "don't those bastards take three quarters of what I make, F em, let the castle burn!"
ReplyDeleteTwo cents:
ReplyDelete1. The financial system was about to freeze up, and something drastic had to be done immediately to prevent this. What would have happened? Well, with credit frozen, there would have been no working capital extended to meet payroll across the country.
Did the government do the right thing following Paulson? Probably, not. But there wasn't a lot of time to think about this, and it did occur on Bush's watch, when there wasn't a lot of thinking going on. Only the Democrats were willing to step up to the plate. The GOP Congress was apparently willing to let the system freeze up and take the "free market" consequences, which would have been instantaneous massive liquidation and a global depression. Thankfully, this was avoided by timely action in the US and abroad. But the initial action should have been followed up on quickly with a better plan, as the following points elaborate.
2. The Paulson Plan was designed to rescue and reward those that failed through their own doing. The plan should have been corrected as soon as practicable. While bank nationalization was an option, it was not a practical one, given the personnel and information needs that could not be met on such a scale that quickly.
Once the system was unfrozen initially, he proper course would have been something on order of a resolution trust such as was set up to deal with the S&L crisis. The people who engineered the debacle should have been replaced, including top executives and boards, as part of the resolution and restructuring. The TBTF institutions should have been broken up right away, when they were clearly insolvent.
3. A great deal of the crisis arose from specious means employed by the private sector on all levels, some of which were illegal and many, unethical or unprofessional. Accountability should have been swift through a Pecora-style commission, and reforms instituted immediately to shut the barn door. The door is still open and almost no one has been replaced, let alone prosecuted. The oligopolies that caused the crisis to be so deep and far-reaching are now larger and more powerful. The financial sector is in poorer shape and taking more risks than ever.
4. The first three points involve market failure (due in no small measure to white collar crime). Government failure was also involved. One aspect of government failure was regulatory capture, which prevented the system's brakes from being applied in time. The other aspect of government failure is the continuing attempt to rescue and reward those in the private sector who failed, using taxpayer funds to reflate toxic debt instead of restructuring it or writing it off if it can't be paid. This lack of accountability is creating a dangerous double standard that establishing privilege and an elite that is above the law. This is also creating a populist backlash against the administration. It is also leading to other asset bubbles that will end badly.
5. The biggest government failure lies in the misplaced focus on the financial sector instead of rising unemployment, which is causing great personal misery and a destruction of human resources that will hamper the economy in the years to come. The stim was way to little, for example. Much more needs to be injected at the bottom, where it will be used immediately, not only in order to stimulate aggregate demand but also to rescue the innocent people injured by imprudent risk-taking at the top.
6. The crisis will continue until the excessive overhang of private debt is properly addressed through restructuring, and bankruptcy if necessary. The personal bankruptcy law needs to be revised.
A large part of the debt problem is in derivatives. Shadow banking needs to be regulated.
7. None of this is going to happen without getting the money out of politics through public funding of campaigns and ending legalized bribery aka lobbying. The system has been corrupted by money buying influence, and real change is virtually impossible under such a regime.
Article proves a point; there are no Austrian economists in the US government and there are not likely to be any for the forseeable future.
ReplyDeleteAs for 'the people' ... almost every person who contacted their congressional representative argued against the bailouts. The first congressional vote was against Paulson's plan.
Had the banks been allowed to fold, the country would have found itself in an unrecognizable landscape of non- functioning and non- existant intitutions, all trapped by massive paper losses. There were no alternative structures to be put into action, no cadre of managers to jumpstart basic services and no sense of what to do next. The existing structures were supported because alternatives had never been seriously considered. No person or agancy had taken the time or made the effort to imagine successors and draft a 'reboot' plan.
All this despite the failure of LTCM a few years earlier.
A reboot mechanism exists within the IMF, but certainly that group would have advocated bailing the big boys rather than jumpstarting into an austerity regime as was done with Argentina or some other 3d world country. I don't know about the rest of the country, but the Treasury and Wall Street big shots would never have withstood such a blow to their collective esteem.
As for the future, the Treasury should start working on a 'Plan B' that will allow the country to function alongside a finance failure. History proves finance's instability, time to insulate it from the rest of the economy, particularly since no efforts have been made to fix it.
Just out of curiosity, who was drawing down the billions of dollars of money market funds?
ReplyDeleteTo do it on such a large scale, there must be some big players or some connectivity. Where did the money go?
The entire financial system did not freeze up. That's a lie and many smart people believe it because they've heard it so many times.
ReplyDeleteThe "freeze" was in commercial paper -- but not all commercial paper. Main banks and financial institutions. Whirlpool, Campbells Soup? They could make payroll just fine, thank you very much. Don't continue to believe Hank Paulson's lies about payroll. That's 100% bullshit.
Don't think so? Check out the data from the Minn Fed. You can see it was only financials that were deemed suspicious, not ordinary mfg companies. Plus, ordinary bank lending was up back in September in response to the CP problems.
But the elephant in the room is the question of the bank bondholders. If the banks have crappy balance sheets, then they need to have an "adult conversation" (ht Chris Whalen) with the bondholders, swap some debt for equity and off you go. Why are we not going down this obvious path? I don't know except lack of courage and lack of financial sense.
Don't believe Paulson's lies. Any of them. Remember, LIBOR was only spiking, it wasn't infinite. It's not the case that banks literally wouldn't lend. They just wouldn't do it in a way that would save Lehman's ass for another month. Good for them.
Every single bail out dollar went directly or indirectly to Fidelity Management and Research, Boston Mass.
ReplyDeleteThey are also holding privatized Social Security accounts. I found mine.
Governor Mark Sanford, SC, who skipped the country without telling anyone this past summer, wrote a cryptic book entitled " The Trust Committed to Me" back in 2000. He worked at Goldman Sachs in 1987. His wife at Lazard.
He went to Argentina, home of Fidelity's " retirement" center last summer.
He is up to his eyes deep in the financial problems.
Bernanke is from Dillion South Carolina.
Congressman Spratt runs the Congressional Budget office, also from York SC.
BIG BIG BIG Coverup.
None of my complaints about the privatized SSA account ever got acknowledged.
BUT I HAVE PROOF!!
So do Alan Grayson and Ron Paul, for what that is worth.
Side comment: Remember Minot Air Force base incident in 2007? Disgraced General asked to resign.
That General Michael Moseley recently went to Langely ( home of CIA) Air Base for a change of command ceremony.
Yes there was a ceremony. What does a disgraced General do at a change of command ceremony?
http://www.scaeronautics.com/FlightDept/logs/2009-09-01%20to%202009-09-15%20Manifests.PDF
Scroll to third manifest.
Other passengers don't have military connections necessarily. They " live close' to an Air Base.
I have reason to suspect on Halloween, 10/31, we may all get tricked again.
Please help me get this word out.
I wrote the bailout of the financial system. You can read everything I wrote at www.tfriordan.com.
ReplyDelete