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Thread: Financial and Economic Crisis

  1. #76

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    I am all for letting bad business fail. More failure and disincentive is what is needed. Shareholders and boards of directors will demand less risk in the future.
    FAILURE and BANKRUPTCY are part of free market capitalism. They are the corrective mechanism.
    Quote Originally Posted by lofter1 View Post
    How many times do we to go through similar scenarios to learn the lesson?
    That managed market capitalism is a failure?
    And no doubt the neo-system now under construction with the guidance of Paulson et al will be just as fallible.
    Right you are. When any person, entity, or regulation thinks it can alter or ignore the economic rules of reality with impunity there are serious consequences to be paid -- that is to say, the government itself is not immune.

    *****

    Sunday, September 21, 2008
    Editorial: Learning from this financial fiasco
    Fannie and Freddie's perverse incentives, pressure to make bad loans, inattentive credit-rating agencies all played a role
    An Orange County Register editorial

    The financial industry this past week has been exposed as much more vulnerable to what might have seemed like ephemeral economic developments than almost anybody – including most in the industry – imagined. The supposedly wise people of Washington were huddling this weekend to come up with a plan to "stabilize" the markets, which eventually will undoubtedly cost taxpayers hundreds and hundreds of billions of dollars – although there's a chance that taxpayer exposure won't be quite as bad as some fear.

    We would have preferred it if the government had allowed businesses that got caught taking undue risks to feel the full consequences of their mistakes, even if that meant bankruptcy or being purchased at a deep discount. That's how mistakes in a reasonably free marketplace are handled. When the government or some other entity steps in to shield people from the consequences of their mistakes, there is little incentive to learn from mistakes or to avoid undue risk in the future.

    The key to a smoothly functioning economy is to get the incentives right. In a properly functioning free-market economy, one profits by fulfilling the needs and desires of customers, so there are strong incentives to be attentive to the needs of others and not to cheat them.

    As we work through this crisis, then it will be important to figure out what mistakes led to this debacle and put in place proper incentives to minimize the chances of such large-scale problems developing again – though, given the fact that we are imperfect human beings, you can be sure that the future will have its own problems.

    Put events in perspective: It is also important to put the financial problems in perspective. The financial markets are connected to what might be called the "real economy," and developments of the past few weeks no doubt will impact the general economy, especially insofar as the pendulum swings, and even creditworthy individuals and small businesses have trouble getting access to credit.

    As William Niskanen, chairman of the Cato Institute and formerly a member of the Council of Economic Advisers, reminded us, however, GDP growth in the third quarter of this year came in at about 3.3 percent, and personal savings – the real basis for future capital – actually increased. Finance, housing, airlines and the domestic auto industry have problems, but many sectors of the economy are doing better than the headlines would lead you to believe.

    How did problems develop? Still, the financial markets were revealed to have huge problems. How did they develop?

    The government made three key mistakes. The first was not to reform the obviously failed business model of Fannie Mae and Freddie Mac, government-sponsored enterprises run like private companies when they were profitable but able implicitly – and eventually explicitly – to shift their losses to the taxpayers when things didn't go well. The incentives were all wrong, encouraging management to take ever-greater risks and to double down on bad investments rather than getting out of them, hoping they would turn around but figuring Uncle Sam would come in if they didn't. Those entities cannot be allowed to return with that model.

    A second mistake was to create the market for subprime mortgages, which the government did about 20 years ago with the Community Reinvestment Act. The intentions – making homeownership more affordable for low-income people – were good, but you know which road is paved with good intentions. The act's provisions prodded lenders to make loans to people who had little chance of repaying them, and some lenders learned to game that system. The mistake was compounded in 2005 when Fannie and Freddie were allowed to securitize – to package into new investment instruments – risky subprime mortgages.

    The third huge mistake was made by the Federal Reserve, which kept interest rates artificially low from 2002-05, after the brief 2001 recession. This created a general bubble in the economy that inflated, then popped with particular intensity (see above) in the housing market.

    Credit rating bureaus failed

    Private actors made big mistakes, too. The credit rating bureaus, which are supposed to assess risk for savers and investors, failed utterly to evaluate the exotic investment instruments that Fannie, Freddie and others were devising. Investment bankers and others thought the housing bubble would never burst, so they overestimated their capacity to assume risk and underestimated their need for working capital.

    Wall Street operators will learn from their mistakes – at least for a while – and most will survive. But government actions and regulations create many of the incentives within which the market functions. Whatever structures come from this debacle must avoid undue encouragement of dangerous risk-taking and too-easy money.

    *****

    Sheldon Richman writes:
    To hear the media pundits and presidential candidates tell it, you’d think Adam Smith has been president for the last eight years and, with a Congress full of free-market advocates, had enacted an agenda of full-blown laissez-faire.

    Had that been the case, we would not be in the mess we are in economically. Alas, it has not been the case.

    Politicians have an obvious interest in portraying the financial meltdown as the result of a government hands-off policy. They can’t very well advocate government controls if government controls are responsible for the debacle we’re now living through. The pundits just don’t understand economics.

    But believe it or not, the problems in the financial and housing industries are not a market failure. They are a government failure.

  2. #77

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    Ninja, read that interview with Bill Moyers that contradicts your view that it's the fault of the American people. Here is an excerpt:

    KEVIN PHILLIPS: Oh, it's created great wealth for a small slice of America. But if you go back and we remember the manufacturing heyday, the auto workers in Michigan had fishing cabins up on the lake. And the middle class had been fattened by the rise of the blue-collar middle class. Well, there's no rising blue-collar middle class now. The middle class is shrinking.


    The pie in a financial economy goes to the one or two percent — or even less- that have capital skills and education. We have never had so much polarization and wealth disparity and just groaning wealth right at the top of ladder as we have now under finance.

  3. #78
    Chief Antagonist Ninjahedge's Avatar
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    Ed, I never really said it was the fault of the people.

    But if the only thing we have to regulate buisness is government, and government is selected and is supposed to be a representation of the people.....

    How do you get the people to realize what is going on and vote for the ones that would make the changes needed? I don't think that anyone will vote for what we need, or push for it, until they start hurting.

    What I was asking was how do we make the people uncomfortable enough to get off their butts and start DOING something?



    As for more money being made in the handling of money than in any useful trade, I am 100% on this. It annoys me that a so-so broker can make more money than a professor in Physics, or (ahem) an Engineer designing skyscrapers. That we have gotten so skewed that even real estate agents make more money than almost all the other professions involved in the properties construction (thanks to the antiquated % commission and the housing bubble).

    So I don't disagree with what you are saying Ed, I just think that maybe I did not convey the proper meaning to you? (what I meant to convey...)

  4. #79

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    ^^

    I agree with that to a point. Sometimes people need to be hit in the head with a shovel to get it... and afterwards, they still don't. It boggles the mind.

    @ Jasonik, just typed in a long response to the message directed to me... and lost it. I will get back to it later, but suffice to say, there are aspects to your position I agree with and others that I do not.

    The great scandal to me is not as much in how the Fed and Treasury handled the crisis after it occurred but what they did and did not do over the past 7-10 years to prevent a crisis from occurring in the first place. Greenspan is a political pig who implemented policies that curried favor with the administration at the expense of well-thought out monetary policies. He sold his soul to the devil and high-tailed out of here just before the perverbial sh&t hit the fan.

    Still once the crisis hit, I think Paulson and Bernake acted in the only way they could. The ramifications of failing to act would have been too severe and globa and would have affected all economic classes.

  5. #80
    Chief Antagonist Ninjahedge's Avatar
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    EH...

    Are you saying that it is hard to argue against putting the fire out at the mansion when the orphanage is right next door?

  6. #81

  7. #82
    Chief Antagonist Ninjahedge's Avatar
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    Ah, the memories....


    BTW, try this:


  8. #83

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    September 22, 2008
    Op-Ed Columnist
    Cash for Trash
    By PAUL KRUGMAN

    Some skeptics are calling Henry Paulson’s $700 billion rescue plan for the U.S. financial system “cash for trash.” Others are calling the proposed legislation the Authorization for Use of Financial Force, after the Authorization for Use of Military Force, the infamous bill that gave the Bush administration the green light to invade Iraq.

    There’s justice in the gibes. Everyone agrees that something major must be done. But Mr. Paulson is demanding extraordinary power for himself — and for his successor — to deploy taxpayers’ money on behalf of a plan that, as far as I can see, doesn’t make sense.

    Some are saying that we should simply trust Mr. Paulson, because he’s a smart guy who knows what he’s doing. But that’s only half true: he is a smart guy, but what, exactly, in the experience of the past year and a half — a period during which Mr. Paulson repeatedly declared the financial crisis “contained,” and then offered a series of unsuccessful fixes — justifies the belief that he knows what he’s doing? He’s making it up as he goes along, just like the rest of us.

    So let’s try to think this through for ourselves. I have a four-step view of the financial crisis:

    1. The bursting of the housing bubble has led to a surge in defaults and foreclosures, which in turn has led to a plunge in the prices of mortgage-backed securities — assets whose value ultimately comes from mortgage payments.

    2. These financial losses have left many financial institutions with too little capital — too few assets compared with their debt. This problem is especially severe because everyone took on so much debt during the bubble years.

    3. Because financial institutions have too little capital relative to their debt, they haven’t been able or willing to provide the credit the economy needs.

    4. Financial institutions have been trying to pay down their debt by selling assets, including those mortgage-backed securities, but this drives asset prices down and makes their financial position even worse. This vicious circle is what some call the “paradox of deleveraging.”

    The Paulson plan calls for the federal government to buy up $700 billion worth of troubled assets, mainly mortgage-backed securities. How does this resolve the crisis?

    Well, it might — might — break the vicious circle of deleveraging, step 4 in my capsule description. Even that isn’t clear: the prices of many assets, not just those the Treasury proposes to buy, are under pressure. And even if the vicious circle is limited, the financial system will still be crippled by inadequate capital.

    Or rather, it will be crippled by inadequate capital unless the federal government hugely overpays for the assets it buys, giving financial firms — and their stockholders and executives — a giant windfall at taxpayer expense. Did I mention that I’m not happy with this plan?

    The logic of the crisis seems to call for an intervention, not at step 4, but at step 2: the financial system needs more capital. And if the government is going to provide capital to financial firms, it should get what people who provide capital are entitled to — a share in ownership, so that all the gains if the rescue plan works don’t go to the people who made the mess in the first place.

    That’s what happened in the savings and loan crisis: the feds took over ownership of the bad banks, not just their bad assets. It’s also what happened with Fannie and Freddie. (And by the way, that rescue has done what it was supposed to. Mortgage interest rates have come down sharply since the federal takeover.)

    But Mr. Paulson insists that he wants a “clean” plan. “Clean,” in this context, means a taxpayer-financed bailout with no strings attached — no quid pro quo on the part of those being bailed out. Why is that a good thing? Add to this the fact that Mr. Paulson is also demanding dictatorial authority, plus immunity from review “by any court of law or any administrative agency,” and this adds up to an unacceptable proposal.

    I’m aware that Congress is under enormous pressure to agree to the Paulson plan in the next few days, with at most a few modifications that make it slightly less bad. Basically, after having spent a year and a half telling everyone that things were under control, the Bush administration says that the sky is falling, and that to save the world we have to do exactly what it says now now now.

    But I’d urge Congress to pause for a minute, take a deep breath, and try to seriously rework the structure of the plan, making it a plan that addresses the real problem. Don’t let yourself be railroaded — if this plan goes through in anything like its current form, we’ll all be very sorry in the not-too-distant future.

    Copyright 2008 The New York Times Company

  9. #84

    Default Tom DiLorenzo notes:

    "The Italian Charter of Labour says that private enterprise is responsible to the state . . . [but] it is the state, i.e., the taxpayer, who has become responsible to private enterprise . . . . Profit is private and individual. Loss is public and social."

    --Gaetano Salvemini, Under the Axe of Fascism(1936), p. 380. (Salvemini was a brave critic of Italian fascism under Mussolini).

  10. #85

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    Quote Originally Posted by Ninjahedge View Post
    EH...

    Are you saying that it is hard to argue against putting the fire out at the mansion when the orphanage is right next door?
    I believe that is the case, yes. Don't misunderstand me, I HATE the fact that the people responsible for this are getting a free ride, but I just don't see the alternative.

    @Kris

    i read the Kruman article too, and I suppose you can make the case that stopping short on "2" is a more reasoned and less radical response. Interestingly, Kruman written word seems to at least to an extent, contradict the position he took on Maher last week, where he seemed to at least partially support Paulson's position.

  11. #86
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    Well, well... It's now seven days since we were told the financial system would collapse without immediate passage of this bail out - and look - we're still here.

    This is a manufactured crisis.

    Warren Buffett rode in and saved GS and, in return for his investment, he gets a piece of the company. Apparently, we tax-payers have some nerve demanding the same on any investment we make.

    I'd prefer if the Warren Buffetts of the world stepped up and bailed these firms privately. You know that GS is not going to screw Buffett in the end as surely as you know the other firms WILL screw the tax-payers.

  12. #87

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    Goldman Sachs is a good bet for Buffet since Paulson, just three short years ago was their CEO. This move has encouraged Sumitomo Mitsui, Japan's 3rd largest bank, to take a $1 billion stake in GS (rumored).

    AP yesterday:
    JPMorgan Chase & Co. analyst Kenneth Worthington maintained an "Overweight" rating on Goldman Sachs, writing in a research note, "we see the perception of Goldman Sachs as a perpetually independent company as improved."

    Moving to a bank holding company will allow Goldman Sachs to have permanent access to the Federal Reserve's lending window and allow it to create a large depository institution, which could provide a stable source of funding.

    Worthington also said Goldman could move some of its businesses from its broker unit to the holding company level to take advantage of the deposit funding.

    However, the move also will lead to an increase in regulation.

  13. #88

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    Quote Originally Posted by BrooklynRider View Post
    This is a manufactured crisis.
    Do you understand the mechanisms at play here, or do you think this is just about rescuing companies that made bad decisions?

    The credit market loosened last week just on word that some action was contemplated. What happened today...

    Amid uncertainty about the plan’s prospects, US money market funds controlling thousands of billions of dollars in assets led a stampede to safety, buying short-term government debt, selling commercial paper and withdrawing funds from the interbank market. As a result, the rates that banks charge each other soared, while yields on Treasury bills plunged.
    http://www.ft.com/cms/s/0/a68e789e-8...nclick_check=1

  14. #89

    Default Playing Chicken

    It seems about as close to extortion as can be.

    Kind of like the bratty kid that knows there are cookies in the cookie jar and will throw a tantrum to get one. The parent is likely to give in rather than make a scene - especially when company comes over (think election year).

    Whether the market could survive without clearing the "toxic" derivatives at this point is moot since "King Henry" Paulson has so spooked everyone by painting it as in dire straits. They've got a self fulfilling scenario on their (our) hands. Perfect for making election year political hay.

  15. #90

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    The US mortgage pool from which mortgage backed securities are derived is worth over $12 trillion.

    The securities are leveraged to an average of about three cents on the dollar.

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