Bankruptcy, not bailout, is the right answer
cnn.com
cnn.com
The problem here isn't "more government" -- it's that the government is showing a willingness to prop up an unsustainable system. If the proposed legislation was a package of hard-nosed reform and regulation, plus some money to bail out the most critical banks to our economy, it would make much more sense. However, in its current state, the bill oinks and waddles just like congressional pork.
We got where we are through a lack of government (regulation), and the solution to the problem almost certainly involves more of it; it just has to be the right type.
I hear this a lot, but what particular regulation do you think would have mitigated the crisis? I can't think of any, except restricting subprime lending - which would be directly contrary to the Government's other goal of more home ownership.
Meg Mcardle had a good discussion of possible regulation:
http://meganmcardle.theatlantic.com/archives/2008/09/hindsig...
Is there an economist on Hacker News somewhere that can explain these inconsistencies to us? The only thing I could come up with is that these people wanted to live beyond their means. My quandary is that I have either severely underestimated the number of middle class Americans who want to live beyond their means, or overestimated my capacity for financial analysis.
And yes . . . it could be both.
Most traditional mortgages are fixed-rate. Homeowners agree to pay the bank __% over the course of the mortgage in return for the bank providing payment up front. The house is collateral so the bank doesn't lose money if the homeowner fails to make payment. Variable rate mortgages are simply promises to pay the bank a certain percentage over its own cost of securing funding. This is usually tied to inter-bank lending rates.
Variable rate loans were popular with banks because they pushed risk onto homeowners. Banks no longer risked losing money if their cost of borrowing spiked (and interest rates were at historic lows....). The same loans were popular with speculators who could get cheap capital to purchase housing in a rising market.
This causes: (1) an explosion of variable rate mortgage products, and lots of people getting them to cover real estate purchases, (2) increased (speculative) demand which drives up housing prices and encourages speculation, (3) people going further into debt using the increased value of their existing property as collateral. In many cases homeowners took out second mortgages just to give themselves more free income. This is a lot like borrowing cash from the bank using your Pets.com stock as collateral back in 1999.
The game becomes untenable in two situations (1) when money stops flowing into the housing market and prices stop rising, or (2) when interest rates rise.
The Republicans have really screwed up here. The Fed is trying to lower the cost of borrowing between banks to help push down the interest rate and keep people from being forced out of their homes by rising payments - a situation that would only exacerbate the financial crisis from the perspective of lenders who have paid $$$$ and are now stuck with the collateral worth $$ and falling. Banks are failing and so banks don't want to lend money to other banks. This causes the inter-bank borrowing rate to shoot up, further exacerbating the problem.
Now that spreads are soaring again we can expect a lot more foreclosures which will push more glut onto housing markets and tank the price of property. Perhaps even the collapse of the banking system. That might have happened anyway though, since no-one has any clue about what sort of money is being lost in derivatives.
Act I: "Alan Greenspan: 'The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance.'...
What he’s technically saying is he’s going to keep the Fed Funds rate at the absurdly low level of one percent. It tells every investor in the world: you are not going to make any money at all on US treasury bonds for a very long time. Go somewhere else. We can’t help you."
Act II "And they sold so many mortgages that there came a point in 2003 where just about everybody who wanted a mortgage and was qualified to get one .... had gotten one.
But the pool of money had just gotten started. They wanted more mortgage backed securities.
So Wall Street had to find more people to take out mortgages. Which meant lending to people who never would’ve qualified before."
"At the height I was making between 75 and 100 grand a month" -Glen Pizzolorusso, who was an area sales manager at an outfit called WMC mortgage in upstate New York."
Act III: "The global pool of money is avoiding anything with even the slightest hint of risk and that affects everybody, no matter who you are. It's harder to borrow money to buy a house, or build a factory, or bring your country boldly into the 21st century. Take Iceland. A year ago it was easy for them to borrow billions. Now, they're seen as too risky. Their central bank has to pay more than 15 percent interest get anyone to loan them money. They could do better putting their national debt on a credit card."
With the economy tanking and the money tightening if they raised the interest rates, nobody would borrow and the situation would get even worse.
Also, the above fundamental philosophical differences are one reason why this stuff just shouldn't be here: people completely disagree and are just going to go on and on and on without really concluding anything.
Even worse than non-enforcement has been the active encouragement by the legislature of lots of this stuff. Tightening up the lobbying and revolving doors might help cool off some of that, but I don't really know.
Some of the regulation concepts being floated (not my ideas) are to ban off-balance-sheet vehicles, tighten definitions of what can be put in Level III/model-priced assets, and require that CDSs and other derivatives/wraps be traded on real exchanges so that a market-maker acts as central counterparty).
I'm not a financial expert, just trying to learn about this stuff. Maybe someone more knowledgeable will chime in.
Played right it 1) can make you more money, although that's tough to quantify right now with everything going to hell 2) make you more flexible, since you're not on the hook for a major life change if you want to change your investment vehicle and 3) diversifies you and provides more security -- your investment is not coupled to where you sleep at night.
Same deal here. Bought in 2005 with the intent to live in the house for a few years and move to a different part of the country. Dreamed about a home run, hoped to break even, didn't expect the worst financial crisis since the great depression. Fine time to be holding the bag. :)
Some people just like to tinker, and when you don't own something, that's not really a possibility. After renting at my current residence for over a year, there are some things here that annoy me: we have no porch to speak of, we have a huge kitchen that is laid out horribly (not even a dishwasher), there is a nice basement that is just begging to be finished, and all the walls everywhere are white. It sure would be nice to have a place of my own where I could fix these "problems", both adding to the value and increasing my happiness, all without having to move.
And there is just something satisfying about owning something, about working towards a common goal with someone you love, in building something together. When the area you live in is pliable to your wants and needs, happiness is just a little bit of hard work away.
Staying on a gold standard would have prevented the crisis. The gold standard was eliminated by Nixon in the 70's. In general, there were many checks and balances in place that had to be removed for us to get to where we are now. All in the name of political expediency.
I hear this a lot, too, but it's hard for me to see how the Glass-Steagall Act repeal had anything to do with the current crisis. In fact, deregulation seems to have mitigated the damage. The reorganization of Bear, Merrill, Morgan, and Goldman would have been impossible were the Glass-Steagall Act still in full force. They would have all gone bankrupt or had to be rescued by the government. Many of the entities that are in good financial shape are the large financial conglomerates that would have been illegal were G-S still in place. Customer bank deposits provide a stable source of funding when lenders are skitish. Reducing the supply of capital in an embattled industry would be the height of stupidity.
Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems. As logic tells us, the current crisis seems to be orthogonal to the presence or absence of Glass-Steagall.
Mcardle also had a wonderful post FACTUALLY summarizing the provisions of Glass-Steagall and its relation to the current crisis:
http://meganmcardle.theatlantic.com/archives/2008/09/clear_a...
I also addressed this issue on my libertarian blog a while back:
http://distributedrepublic.net/archives/2008/09/22/the-end-e...
A large problem during the Great Depression was that the United States had laws that artificially limited the size of banks (see "Unitary Branching Laws"). The result was that institutions in the United States had smaller financial cushions in crisis time and were more likely to go under. The United States suffered a FAR higher rate of bank failure than other countries, and states with unitary branching laws had higher failures than those without.
So I know blaming the Glass-Stegall repeal for our current problems is popular(populist) wisdom, but it seems to me that popular wisdom is, as usual, wrong.
But isn't the point to separate the investment banks away from the savings banks? There's a fundamental type difference between a dollar earned and saved, and a promissory-based dollar conjured up by a debt instrument.
When an investment bank fails (as it should when it's made a bad mortal investment), the funny money dries up, leaving the holder high and dry. If this holder employed bad accounting (by counting promised dollars as dollars-in-hand), then they may fail as well (and so on). However, this should not continue into the institutions that hold the savings of the people who didn't want to play economic make-believe.
> Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems
How many other countries have currencies that are used as reserve by the rest of the world? (which greatly lengthens the time for consequence of inflationary policy to be felt)
If this holder employed bad accounting (by counting promised dollars as dollars-in-hand), then they may fail as well (and so on).
How are these savings going to provide any interest if they are not redistributed as loans? The whole point of a bank is to allow your money to work for you while also providing loan capital to those who have a good use for it. It's impossible to have a non-negative (due to administrative costs) savings account without loaning the money to someone.
Or am I completely missing your point?
> "Many foreign countries never had any law like Glass-Steagall in place and they don't seem to be suffering the same problems. As logic tells us, the current crisis seems to be orthogonal to the presence or absence of Glass-Steagall."
I don't buy into that logic. Just because every financial system in the world hasn't failed due to too much deregulation, doesn't mean deregulation is bad or not the cause of our current crisis. There are a multitude of things contributing to the current problem, but excessive regulation and checks and balances aren't one of them.
We don't necessarily need to reinstate Glass-Steagall, but we need a modern-day equivalent. We need to ensure financial institutions can fail without jeopardizing the entire economic system. I'm personally in favor of something along the lines of the DoJ anti-trust mechanism, with an independent body that analyzes financial mergers and assets from the perspective of whether they are dangerous to the economy and citizens. On the other hand, I don't feel that our current DoJ is working very well so maybe that's not the best idea. I'm open to suggestions.
I agree with you; government regulation is good, meddling is bad.
> It only costs $8 million per quarter (see AT&T) to hire a team of lobbyists and Senators to unfairly block your competition out of the game and take over an entire industry (see network neutrality).
to
> I agree with you; government regulation is good, meddling is bad.
Is "unfairly block" and "takes over" good?
Surely you're not suggesting that we can have good govt regulation if only we believed in Tinkerbelle.
There's a very good read on the the regulation that got us here: http://myslu.stlawu.edu/~shorwitz/open_letter.htm
The problem is government -- period. This whole situation is the result of government manipulation of credit and a long running policy to deliberately inflate the housing market.
How could anyone be so naive as to think the current problem is lack of government involvement? The housing inflation was deliberate policy. Also, it's a deliberate policy that has blown up before!
http://www.scoop.co.nz/stories/HL0709/S00238.htm
Read that link and tell me it's remotely possibly to expect the federal government to affect better outcomes in markets. It's about how exactly the same shit that's going down now in the lower end of the housing markets ran in the 80s, because of criminal government enterprises.
http://www.marginalrevolution.com/marginalrevolution/2008/10...
Sounds like these guys just know a whole lot of nothing...
Just to expand on this topic a little bit: http://jtame05.wordpress.com/2008/09/30/we-dont-need-a-bailo...
The bottom end is a secondary problem, people defaulting on mortgages. Which the system would be able to tolerate in a market place where mortgages are properly secured. That is, a marketplace where people on the top end do their jobs right. This problem is caused only in part by CRA, AND in a manner different than Ron Paul argues. CRA encouraged a large number of middle class people to move back into the city cores around the country. Poor people moved out, hip, young, creative class moved in. All funded by CRA allowances. Gentrification and all that. Basically, Fannie and Freddie were moving 'good' people in, while Ginnie moved 'bad' people out. Problem was, according to the auditors, these "gentrifiers" are defaulting in droves. To the point where Fannie and Freddie collapsed. And, to add insult to injury, Ginnie is fine. The problems it does have it acquired in government attempts to rescue Fannie and Freddie.
I, frankly, find this state of affairs difficult to believe. If we were redeveloping the city cores, and then letting the same people who lived there before buy the redeveloped housing, then I could see a high level of defaults. But the people in those neighborhoods now are actually pretty solid. That is one of the most perplexing facets of this entire mess to me. I understand the bad risk assessment at the top end, I think ANYONE generally assigns a higher risk to people in poverty, and a lower one to people in higher socio-economic classes. I would have gotten that risk assessment wrong as well if I was judging that market. So how can so many solid home buyers be hitting the skids at the same time? I would like to think there is something more going on here. I am simply unable to find it.
As for how it could happen - my cubemate bought a house in the South End of Boston in 2006, right next to downtown. He's a well-established professional, solid skills, solid resume, and I believe makes over 6 figures. But he bought the house with a $500k interest only mortgage. His banker told him that nearly everything they wrote these days is interest-only, and he should buy the biggest home he could afford. So if housing prices fall, he has every incentive to walk away. It hasn't happened yet (he got promoted to CTO, and prices are still rising in the South End), but I could imagine there're many people who took out similar terms but don't have the same wherewithal to pay them.
Note: I am not alone and I am not stupid.
I don't know enough about the details to know what Miron was talking about, though. He didn't say in the article.
Take a midsize bank market cap of $5B and multiply it by 25-50 for the number of banks that might fail. That is a total loss of around $125B-$250B for which shareholders and employees of these companies bear the losses. Also should these banks fail, the government will have to step in via FDIC. The problem with this is that assuming an average balance of $10000 per depositor $700B covers 70 Million accounts. While this is probably sufficient for average individual depositors, what is to happen to the small businesses that have greater than $100k in assets? Also, what happens to the availability of credit with so many banks in default?
Bankruptcy actually seems more risky, as the people who would lose are small businesses and those with over $100k in the bank, people who would never have recourse to get their money back. Rather than socialized losses (through inflation), its losses for an unlucky few. The bailout plan, however, which involves taking warrants in the companies we are giving money to seems to have a good chance of repaying at least a significant portion of what it costs overall.
Thoughts?
We do need some kind of government intervention, but the current form stinks.
If we have $700b to give, why use it to buy up toxic debt? I understand wanting to keep the markets moving, so why not address the problem there?
There are many better if anyone cares to look; the mortgages defaulting lend themselves to a house of cards analogy. Banks were so heavily leveraged that they may not even be able to handle even a small number of defaulting loans on property that decreased in value.
However, this doesn't account for the root financial problem of our country that has plagued us since 1913; the federal reserve. These crooks sway the entire economy and have exponentially inflated our currency. The dollar is worthless today. It is worth $0.02 to the dollar of the beginning of the 20th century.
We went off the gold standard, we decided fractional reserve banking was a good thing, and we put in charge idiots and crooks to create a lesse faire market that only benefits them.
Don't believe me?
http://en.wikipedia.org/wiki/Image:USACPI1800.svg
Usury, fraction reserve banking, and crooks.
Taxes are not the only way to tax people.
* Yes, the government has been playing this game for around a century. But does that make it right to tack on another trillion in the theft?
"Many of these companies are like the one in which my next-door neighbor is employed: they are middlemen who arrange mortgage loans for borrowers including "subprime" borrowers with banks, including CRA-regulated banks"
Compromise is the right answer.
The assets remain intact, the investors who poorly judged the risk lose their investment and those who buy up the assets (to clean things up and bring about a recovery) rightfully reap the rewards of taking on a very high risk.
Enron, to take an example, went bankrupt, but energy kept being generated and traded under new management. Former employees went on to find work at the acquiring company(ies) or took their labour elsewhere. Would things have been better if Enron were still scamming around after a bailout today?
How about the dot.com collapse? What if Pets.com and WebVan were given billions of dollars to continue on?
Bankruptcy is good. It's the market's way of flushing out bad ideas and starting fresh.
This discourages companies, particularly banks, from trusting each other.
The problem we're having now, which is also the problem that brought the Great Depression, is lack of trust. Banks won't lend to each other, or to other businesses, because they don't trust that they'll get their money back.
Saying that we should let the banks go bankrupt at their leisure is just letting this problem of trust fester for the next few years and resolve itself one bank at a time, slowly. While the problem is correcting itself, the market doesn't allocate money where it's needed because of the lack of trust, and everyone suffers. The total cost of that is much larger than a trillion dollars.
At the other extreme, you could just nationalise the whole banking system. That's a better option, but still not ideal, because governments suck at running businesses, and this would also be less efficient in allocating capital where it's needed (the primary function of banks),
So, somewhere in the middle lies the compromise. How can we get the banks to start trusting each other again and yet not nationalise them? Well, one way is to offer them a kind of "knife armistice". Bring out your knives to the police station, hand them in, and we'll let you go free. We'll even give you a water pistol as a compensation prize.
Don't be fooled into thinking that just because the bailout bill doesn't put the CEOs of banks in prison, that it will not be followed by further regulation. For better of for worse, tighter regulation will be on its way. But that's a separate debate that's not tied to the bailout. The purpose of the bailout bill is to resolve a crisis right now, not to make long term fixes to the system.
Banks are special types of companies because of their effect on the economy. You might let Enron go bust, because after all that's unlikely to cause widespread damage to the entire world economy. Let the banks go bust slowly and painfully, though, and every business pays for it. Calling for "Bankruptcy not bailout" is terribly short-sighted.
I think you should research the process of bankruptcy (and the Great Depression) before proposing solutions. Bankruptcy is not evil and does not destroy wealth -- it shoves bad companies aside and makes room for those who stand the best chance of making use of the assets that remain.
It sounds like you're proposing what Japan has been doing for the past decade. Look up "Zombie Corporations Japan" to find out what ultimately happens when you back bad companies with taxpayer dollars to keep them from going bust in order to retain some daft idea of social harmony.
A capitalist system isn't born or sustained by government-managed compromise kicking in when your favourite team loses.
Of course they have been. That's the core of the problem. Did you even read my post before replying?
We can live without these incompetent fly-by-night money men. Bailing them out sustains and rewards their incompetence.
* There were honest banks like BB&T that /chose/ not to get involved in these shady deals
Remember in this case we're not looking at one isolated element - this is just one big global neighbourhood. If it turns into a ghetto, we're all still living there.
You know these folks. They've been saving for a house and watching the market run away from them. Now that prices have dropped, they can afford to buy IF we don't insist on taking their money and giving it to the folks who couldn't handle their existing mortgage keep the house.
Making low-rate-variable-interest credit less attainable is not a problem, it's a solution to our current problem that has everyone living beyond their means, with an unfathomable percentage of their earnings going to creditors.
I am not enough of an economist or politician to be able to tell you in detail what the ideal compromise is in this situation, nor do I care to claim that I am.
What I do know, however, is things are not black and white. Baying for the banks' blood and shouting "liquidate!" is exactly what they did in 1929 and that kind of behaviour is even more reprehensible than the banks'.
Similarly, handing the banks a giant wad of cash with no strings attached is not right either.
The solution lies in the middle, as always.
Moderation is often a far superior strategy then extremism, but a little of both is not a superior answer to the question: Is this circuit on or off?
The "middle is always right" attitude reminds me of the US media, which will often juxtapose facts and spin, then idly stand by, pointing out that both "extreme" positions are equally valid.
Every entrepreneur knows that those who choose to ignore history are doomed to repeat it.
Tech guys create jobs, and save money for old companies with ease. I mean, what's the utility of some of these idiots? Seems like the next phase of obsoletes are just raping the system before they're noticed as completely useless.