Monday, September 29, 2008
In Which I Admit to Being Really Confused
And a whole bunch of banks, quasi-banks, sorta-banks, and insurance companies are in trouble because, at the root of it all, too many people aren’t able to pay back what they’ve borrowed. (The “no credit, no problem” approach to lending only works when house values are climbing, since anyone who can’t make payments anymore can sell at a profit. With house prices falling, now folks who can’t make payments often owe more than the house is worth, so they can’t get out from under.) The banks used to sell the IOU’s from mortgages on the open market to get new money to lend, but now the buyers of those IOU’s aren’t buying anymore, since they’re afraid of getting stuck with unpaid loans. And the banks don’t want to hold the loans themselves, since they know just how shaky the stuff actually is.
Since the banks aren’t getting infusions of money to lend from selling the IOU’s anymore, and the loans they can’t sell are often going unpaid, they have a lot less to lend (and much worse jitters about lending it). This means that people who want to buy houses or cars often can’t, since they can’t get loans. When houses and cars go unsold, their value drops, and the people who make and/or sell houses and/or cars get laid off. Then the people who are laid off have trouble making their mortgage payments, and it gets uglier.
(On the bright side, the relatively few people who make stuff for export are actually doing better, since the declining dollar makes our stuff more competitive.)
Left to its own devices, the market would jack up interest rates to compensate for perceived increased risk. But the Fed doesn’t want that to happen, for fear of accelerating the downward spiral and turning a popped-bubble recession into a devil-take-the-hindmost depression. So the Fed is pouring money into the financial markets to make sure that banks can still lend. And now the government is considering borrowing another 700 billion or so to buy up the stinky IOU’s, to free the banks (and the people the banks sell the IOU’s to) from the consequences of their mistakes, so they can make more.
Here’s where I get confused.
Obviously, there's the 'moral hazard' problem. If the lenders are freed from the consequences of their actions, won’t they revert to form and keep doing what they were doing before? If they get to keep windfall profits in good times, but get bailed out in bad times, why not bet the house (literally) every time?
But more basically than that, where the hell are we getting 700 billion or so to buy up the stinky IOU’s? Aren’t we already running a huge national debt? The only way I can figure it is that either we snooker the Chinese real good and convince them that we’re much better risks than we actually are – which seems unlikely to work – or we just print more money. But the ‘print more money’ approach doesn’t do much to build trust with our lenders, who find that the substantial IOU’s they hold from us are suddenly worth less, since dollars are suddenly worth less. Won’t they compensate by either jacking up interest rates or just refusing to lend?
And if they do that, aren’t we just re-creating the same problem, but on a much larger scale? If the government bails out the banks, who bails out the government?
This has a ‘banana republic’ feel to it. If the cost of borrowing from foreigners becomes prohibitive, the way around that is to either stop borrowing and get our stuff together – probably a wrenching process in the best of times – or to just roll the presses even faster. That’s what a lot of third world countries do. It seems to work for a little while, but usually leads to hyperinflation and economic collapse. You can’t keep flooding the market with money and not expect prices to go up, since the supply of money would increase so much faster than the supply of stuff.
Wouldn’t it make a lot more sense to stop borrowing money for, say, wars of choice, and instead direct infusions of cash to, say, the people who can’t make their mortgage payments? If they can make their payments, then the IOU’s suddenly become non-stinky, and the financial institutions will have the money to start lending again. If people can actually get loans, they’ll buy stuff – we Americans are good at that – which leads to jobs making stuff, so then those folks buy more stuff, and so on. If you direct a bailout to the IOU holders directly, you aren’t addressing the root of the problem – just because old IOU’s got paid off doesn’t make new ones any more solvent. The root of the problem is that people can’t make their payments. Address that through, say, rediscovering the principle of progressive taxation, and taking a serious look at the distribution of income. A prosperous middle class will consume more than enough to keep everything humming along nicely. We’re good at consuming. It’s what we do. We just need the money to do it.
In other words, wouldn’t it make a lot more sense to avoid the ‘borrow and print’ strategy, and instead to tax the uber-wealthy to help the middle class make good on its mortgages? Yes, they’d bitch, but they always bitch. That’s what they do. And as annoying as, say, the income tax can be, depressions are much more so. Instead of borrowing money from abroad and hastening a catastrophic collapse, we could tap the huge private reserves of money already here and actually right the ship. Among other benefits, this would demonstrate to our creditors that we’re a good risk, which would keep the overall system nice and stable. It would also have a nice moral cast to it, since many of those private reserves of wealth are essentially ill-gotten. Make the folks who profited from irresponsibility pay for it. Fair is fair.
Instead, some very experienced, very smart people are saying that we have no choice but to borrow hundreds of billions right now, not bother connecting the dots, and trust that the same very smart people who caused the mess will fix it if we just leave them alone with all that money. They’re good for it, right?
We're supposed to believe all that. And that's why I'm confused.
... and although depressions are terrible for almost everyone, the truly wealthy still remain wealthy in a depression.
That said, I think it's pretty obvious that the parameters of this mess are not yet known. The second-and third-order effects are also going to be spectacular. I think I know just enough to realize that I have no flippin' idea what's going on.
For those interested, I've written an "Open Letter to My Friends on the Left" on the whole current mess, focusing more on the causes than the cures.
Imagine what would happen at your CC and mine if the credit market for student loans dried up. Was the cutback in student loans we saw this summer a result of this credit crisis? Now that we see major banks failing, I think it was. Now imagine the world with no new student loans, and you see the problem.
As for who pays for it, that will be decided by the next President and Congress, not the current ones, who will also be free to pass a revised bill. We should just be glad that Bush is no longer acting like Calvin Coolidge.
Finally, once you nationalize these mortgages, the more criminally exploitive ones can be re-written without the balloon payments that made foreclosure part of the business plan. Those might then might get paid off and increase in value for the taxpayers.
On the other hand, the Japanese government faced a similar situation in 1991 and decided not to bail out financial institutions--and the country ended up in a 15-year depression. We aren't in Japan's situation, but their experience does suggest that maybe we need to grit our teeth and go ahead with it.
The only way I can get a grasp on the bailout is half-understanding that banks, etc. make loans based on a balance sheet of what people owe them, well above and beyond deposits. If I owe a bank $100K, they count that as an asset. Then, that increases the amount they can loan to you. So, in a perversion that sounds like a conspiracy theory, debt creates wealth.
The U.S. government's newly even-more-astronomical debt helps maintain that spiral.
A moment of reckoning came at which there was just too much debt to be paid, lenders just couldn't extend any more debt based on other debts that probably wouldn't see a return, and what seems to me to be smoke and mirrors began to be revealed. An assurance that some funds will be available regardless of current borrowers' ability to repay debt creates a safety net upon which banks can create more debt. And debt equals wealth (for somebody, just not for me).
I think pumping money straight into banks is an acknowledgment that it's too late to change the system. (Or, an unwillingness to suffer the pain of doing so.) It seems to me to be a decision to perpetuate the smoke and mirrors.
That said, it would make a lot more sense to me to pump a bunch of the newly invented money into the ailing bottom & middle economic rungs. When that money "trickles up" as it is sure to do, bad loans and things will fail, good businesses will regain liquidity, and some "correction" will occur. The issue is that because we placed an undue burden on the housing market to drive our economy since the last recession, a lot of that correction would be in home values, and everyone is afraid of sinking that ship. As it is, I feel like someone just turned off the "trickle down" tap and took his droplets back. Being squarely at the bottom (I said I was in art...), and that a correction in housing prices is probably the only shot I'll ever have at home ownership, I'm a little upset.
P.S. If anyone in economics can correct my understanding of things, please do so...
However, despite the fact that nobody's willing to buy them, the mortgage-backed securities in fact are worth quite a bit (since most mortgages will be repaid). We just don't know how much. Of course the government is taking on risk by buying them, and the taypayers may lose money. However, there's no way we can lose 100% of the money invested (surely not all of these mortgages are bad), and we may even make a profit off of it.
So this is very different from subsidizing people's mortgages. That would amount to simply giving money to people outright, whereas the current plan involves the government making a risky investment. Because of the risk, we are probably giving something away, but not as much as it might appear.
Obviously, there's the 'moral hazard' problem. If the lenders are freed from the consequences of their actions, won’t they revert to form and keep doing what they were doing before?
We need more regulation to fix the problem permanently, but that's a long-term problem that can be solved over the coming months or even years.
If they get to keep windfall profits in good times, but get bailed out in bad times, why not bet the house (literally) every time?
The moral hazard isn't as high as you would think. Even assuming the bailout goes through, most people in the industry are pretty miserable and have lost a lot of money (as well as sometimes their jobs). Nobody thinks the benefits from previous years outweight the current suffering.
The real danger isn't moral hazard but an unwillingness to learn from history. Someday, a new generation may make the same mistakes, and we need to have better regulation in place before then.
And if they do that, aren’t we just re-creating the same problem, but on a much larger scale? If the government bails out the banks, who bails out the government?
No, because the government is so much bigger. For the banks, these securities represent a large enough fraction of the banks' holdings that the banks are forced to take action based on market conditions, to make sure they can cover their deposits. By contrast, the US government is so much larger that it can comfortably hold the securities for years to find out their true value over time (as the mortgage situation becomes clearer). That gives us a tremendous freedom the banks don't have.
The banks used to sell the IOU’s from mortgages on the open market to get new money to lend, but now the buyers of those IOU’s aren’t buying anymore, since they’re afraid of getting stuck with unpaid loans. And the banks don’t want to hold the loans themselves, since they know just how shaky the stuff actually is.
This part is the underlying error. The banks in question didn't sell the securities to get money to lend. Rather, they bought the securities and held them as part of their capital requirements. They need to have a certain amount of relatively liquid investment available at any given time. When the mortgage-backed securities become harder to sell, the banks start wanting to shift to other forms of investment, but of course they can't all shift at once since somebody needs to be buying the mortgage-backed securities. That's where the US government comes in, as the one entity big enough to buy them and hold them long enough to wait things out.
No we haven't forgotten other cultures and systems. My point was that greed is a constant, however large or small it might be. And perhaps "self-interest" is a better word than "greed" (but it's not the free market types using "greed", it's their critics).
Civilization, western and otherwise, is chock full of people pursuing their self-interest (broadly defined). You can't explain the current crisis as a sudden outbreak of hyper-greed without confronting that fact and explaining what's different now.
What IS different now is the way in which the institutional framework has changed the rewards to self-interest in such a way that we get disasters like the present.
And sorry you stopped reading. You might have learned something if you kept going. It happens to me all the time.
2. Please, let's all try to avoid the knee jerk response of applying leeches to anemia. E.g. central to the cause of this mess in the first place was too much credit chasing unqualified borrowers- infusing "cash" into a situation where "too much cash" was the core problem is, well, kinda stupid. Likewise, taking measures to prop up artificially inflated mortgage values with additionally inflated money is bogus as well.
2. "Self Interst" (e.g. "Greed") is a natural human motivation. It is a powerful engine of human behavior. Frankly, it drives human choice and decision making in a wide variety of contexts. This is why communism, socialism, etc. will never work. Capitalism *requires* self interest in order to work. Socialism/communism requires that self-interest be suppressed (with force?) or not exist in order to work. Frankly, given a choice between two competing theories of socio-economic political systems, the one that relies on (instead of refutes) reality is the one that I will bet on.
You can "wish" that people are perfectable all you want- I will bet on the people we actually have rather than the people we hope to create in some totalitarian utopia [sic].
Through your lenses and filters, your perspective is "valid."
If you aren't even aware of your lenses and filters, well, therein lies the rub . . .
Perspective: the doctor who murders a human being in support of a womans "choice" vs. the investor who chooses "what the vast majority of people actually want" vs. "what environmentalists want" comparison.
I have actually met people who say the abortionist is "moral" and the capitalist is "immoral."
Go figure . . .
[back to deandads almost-epiphany: the conundrum of greatest good for greatest number (socialist credo, and capitalist reality) has long been agonized over. Fact is- by the time it is *you* shoving a gun barrel in someone else's face "for the greatest good" it is generally too late to claim any moral high ground.]
A counterpoint to Steve Horwitz's open letter worth reading was sent to me by a friend. A different free market advocate wrote here about why a program is necessary and about why it shouldn't be called a bailout. The essence was that good assets are being sold cheaply because banks have to sell something in order to meet regulatory requirements for the ratio of loans to capital.
How does the gov't fit in? They are the one entity with enough money and patience to buy depressed assets and hold them for a long time, essentially unfreezing the credit markets so Main St businesses can conduct business as usual.
A connection I see between Steve's open letter and DD's original post (which I must attribute to an NPR ATC/This American Life story last Thurs or Friday) is that the customers for securities based on these risky loans were overseas owners of dollars who were looking for an investment. That large customer base created the demand for the sub-prime products that have caused this crisis.
So what do we do? Like DD, I don't know.
I love that faith-based reasoning. Those other worldviews and other cultures are irrelevant to the reality of overoptimistic borrowing and lending, augmented by political pressure to lend money to people who ordinarily would not be creditworthy, but as long as the house prices kept rising, the risk was acceptable.
What amuses is the coalition of libertarians and ghetto politicians that blocked Monday's version of the restructuring, if ultimately for different reasons.
"for fear of revealing this popped-bubble recession's true form, a devil-take-the-hindmost depression".
2) The Fed has decided to do what Dean Dad suspected, run the presses flat out: http://www.bloomberg.com/apps/news?pid=20601087&sid=a9MTZEgukPLY.
Stephen - you've broken new ground by calling my response "religious" as I'm what Americans would call a godless Liberal. What I was actually referring to, and I'll let confused professor in on this too, is that there are other ways of looking at the world. Not every culture has a concept of "greed" or a similar concept of "self-interest" as we Western thinkers do, and we should pay attention to that. Not every economic system in the world is a capitalist one, although one of the main goals of capitalism of the late, neo-liberal kind is to re-make the whole world in it's own image. And hell yes those other world views and cultures are relevant, are they not being dragged down with the rest of us?
Oh, and you might want to watch the "ghetto-politician" references. From where I'm sitting that sounds like racism, especially when coupled with an "other world views don't matter" argument.
Giving out an abundance of loans to people when one is keenly aware they will never be paid back is bad for business on the simplest of terms. I wonder if these bankers or brokers actually question the fact that these loans were the cause of bankruptcy. It is easy to blame the borrower for lack of knowledge or ignorance (that seems to be on both the business side and individual, what a great way to avoid implication.
On a personal note, I was consistently called by mortgage companies 3-5x a day for months trying to convince me to switch from a great stable mortgage rate to a risky fluctuating interest rate. Their calls were to the point of harrassment. I self-educated myself through reading endless articles from the point of view of people who were in trouble with their loans and company explanations for losses. Many borrowers were not someone who took extra home equity loans out to pay for college or flipped a house. These were peole who had legitimate issues and the companies did everything in their power to not help these people. Corporate memos were leaked. Basically, even if the mortgage company made the error it was still the borrowers fault and cost. The conclusion I found was that these brokers were actually making more money when a house foreclosed, since they were still entitled to all their fees, etc. The banks were losing money, which is how we end up here.
Any system that is based on self-interest is not reality. There has to be a balance of community, otherwise how to we differentiate from anarchy. We have never had a system of "true communism" to know whether or not it would work. The only thing I find amusing is that it is stated that out of capitalism will arise communism and this will happen when society is saturated with useless goods. The problem with this philosophy is that it was written so long ago and failed to foresee a variety of things we are dealing with today such as overpopulation, environemental destruction, etc. I don't think this theory will come to fruition in my lifetime, but we can see some things moving towards it like a balancing of economic standards of living. It seems the U.S. will lower while China will rise up. I am speculating here which is not accurate in any means.
The problem is that if you want people to act outside of their own self interest, you have to *make* them act that way.
Like all socialist economic systems; they can't exist without totalitarian political systems (see Europe for an example).
The other argument I have with your assumptions is that you are a "zero summer" ie the only way for the SoL in developed and developing economies to improve is by reducing the SoL in developed economies. Umm, no- the "natural" state of transfer is for the SoL in developing nations to rise faster than the (still rising) SoL in the developed economies- eventually catching up.
(see Adam Smith/David Ricardo relative and absolute advantage theories; "Invisible hand" and all that)
And China/India are *perfect* examples of this dynamic. While SoLs are continuing to increase in the developed world (G7), the rate of increase in SL for CHina and India have been ncreasing even more rapidly.
Of course, China and India are more capitalistic than Europe today so it should be no surprise that their growht rates outpace Europe . . . =8^)
"Not every economic system in the world is a capitalist one, although one of the main goals of capitalism of the late, neo-liberal kind is to re-make the whole world in it's own image."
The refutation, dear dbm/gaa is in the inversion of cause and effect. It's not capitalists attempting to remake the rest of the world, it is much of the rest of the world figuring out how to improve its standard of living. The period from the end of the Cold War to the recent run-up in oil prices showed the single largest increase in prosperity in the Third World (not limited to coastal Chinese and Indians either) in recorded history. (And I do not begrudge these people their gains. They gain by trading with me, which benefits me.) Now, if some of them are holding mortgage-backed securities they can't unwind, too bad.
"And hell yes those other world views and cultures are relevant, are they not being dragged down with the rest of us?"
Less prosperity in the developed world means fewer trading opportunities in the developing world, yes. On the other hand, when you're getting by on US $2 a day purchasing power equivalent, you're probably not exposed to capital appreciation during the housing bubble or loss of capital when the mortgages the banks were mau-maued into issuing to people who had no prospect of paying collapse. Your life sucks either way.
A statement of faith? Well then I guess all of the social science theory (an upstart discipline called anthropology, for instance) that I base my argument on is faith-based, and has nothing whatsoever to do with research. Oh wait, isn't economics a social science? Damn I guess all you economists are spouting faith-based rhetoric too!
My refutation is only a reversal of cause and effect according to your world view, not mine. There are many other ways to improve one's standard of living that don't involve capitalism, or even "self interest" as you've described it.
I would like to add one important qualifier to the challenge: systems that must use force by the state to compel the peasantry to yield their labor against their wills are not valid. Plantation life may have benefited many, allowing them to increase their SoL but I don't think that's what we are looking for?
While I agree that the view from the Dacha may be lovely this time of year; the view from the potato bogs under the watchful eyes of der polizei are not so pleasant . . .
1. Grow something edible and share it. In order to avoid the taint of capitalism you can use seeds that you collect from an existing plant, or from a neighbour. You can plant it in the ground or collect soil, containers are easy to come by without the exchange of capital. Gardening on public land is also acceptable.
2. Volunteer your time and labour.
3. Use public services, and work to enhance them (see #2).
Please explain how each individual activity results in a lifting of SoL for *anyone?*
And how individual acts of altruism can substitute for an economic system as well . . .
(yeah I feel great about donating blood but that doesn't quite fit the bill now does it? p.s. I am a pragmatic hippie, organic local food producer and survivor of the co-op wars of the 1970s so I am familiar with the obvious failures of "free store" economies so we can skip the nonsense.)
But now we have no solutions to Dean Dad's question, as none of those choices admit of a financial sector. Well, maybe choice 3 does, but then there's the little problem that the public-service-ization of the financial sector is an opportunity for boodling.
Today, Dean Dad posted on his college's troubles hiring people who are liquidity constrained (that's economist-speak for not being able to sell a house at the old location and buy one near his college.) And you in all earnestness suggest I grow some vegetables and swap them with my neighbour.
Perhaps I could find somebody who would be willing to trade me some vinegar for a few of my habanero peppers, in order that I could put up habaneor peppers for the winter.
But perhaps I'm liquidity-constrained in that my neighbour doesn't want any habanero peppers, or he doesn't have any vinegar.
And that's why I'd really like the opportunity to buy vinegar from a grocer, or to buy fresh habaneros all year around.
And I really find it a kick to be able to communicate with a man I've never met, in Russia, who will accept a few numbers on a secure server, on the strength of which he is paid in rubles to build me a model of a streetcar which I am billed for in dollars.
So when you said "there are other economic systems in the world" I was hoping you could tell me that I could have my fresh vegetables and my Russian-built streetcar models and all manner of other conveniences, AND a lowered exposure to occasional rational expectations hyperinflations (econ-speak for what you might know as the tulipmania or the Victorian railway mania or the interurbans or the dot.coms or the financial sector, and I would have been delighted to be told that that exists.
You told me to dig a garden on somebody's commons.
That's so fifteenth century.
Those pesky "private property" (including one's own body and labor) rights are so darned inconvenient.
That's why we need to tax the productive more- so that they won't enjoy the "ill gotten gains" of being smarter and harder working.
The current bailout v2.0 mess brings to mind the Solzhenitsyn quote about the line between good and evil running through each human heart . . .