On Friday the WSJ ran a truly awful op ed that blames banking crises on Thomas Jefferson (I’m serious); I have done my best to organize a response. And yet Kudlow praises the article. Kudlow goes on to explain:
Paradoxical as it may be, strong government actions to stabilize banking are necessary to preserve the free-market-economy system. No free-market economy can survive without stable banking and credit. Without readily available credit, entrepreneurs can’t put their new ideas into commercial practice. And without that vital innovation, economic growth suffers.
Right, and that’s also why we need a strong government to stabilize schooling, food production, housing, and computer manufacturing. A free-market economy can’t survive without literate people who can eat, find shelter, and email each other.
Ah but here’s the funniest part:
The trick now is to use government levers in smart and efficient ways. Banks need to be recapitalized without punishing current and future shareholders. Henry Paulson is working on this.
Yep, I have no doubt that Paulson is working on ways to smartly and efficiently transfer a lot of that $700 billion into the hands of the shareholders of Goldman and others.
I’m not going to waste my time, but I would bet 2-to-1 that before the bailout passed, Kudlow wrote articles explaining that we had to be careful about “moral hazard,” and not to reward current stockholders. Free Advice readers, you can be famous! Find such a Kudlow quote and make it into the headlines here! For a hint, try looking up Kudlow’s discussions of the AIG bailout. I bet he explains why the government had to wipe out the common stockholders to avoid moral hazard.
Somebody sent this to me, and unfortunately I can’t remember who! (I can’t remember whom?) Anyway, it’s pretty good. If you’re on the fence in the beginning, just give it a chance.
It’s Sunday and I’ve already put up a bunch of posts dealing with mammon, so I thought I should at least post one on the Lord.
Most people know deep down that there is something “wrong with the world.” Sure, atheist evolutionary biologists (and I realize that is a subset of all evolutionary biologists) can try to explain it away, especially after studying some game theory. But deep down, most people know that it doesn’t make sense that the most intelligent creatures on the planet cause themselves so much unnecessary misery.
But this is no cosmic accident, in the Christian worldview. Behind every conspiracy theory and other explanation for it all, lies the fact that Satan is doing everything in his power to hurt us. I have not studied the topic sufficiently, but I believe his ultimate goal isn’t our suffering, but rather to get us to join him in his rebellion against God. However, since God gives us commands for our own welfare, it necessarily follows that to the extent he is successful in gaining our “independence” from God’s will, Satan causes us misery.
According to the Christian, the reason you need Jesus for salvation is that you don’t stand a chance against Satan yourself. You may be clever, but he is more clever, and he has a lot more power and a lot more experience. He has been tricking people into hurting themselves for thousands of years. In contrast, you’ve only been around for a century at most. You don’t stand a chance. As a poet once said, “You’re gonna have to serve somebody, yes indeed you’re gonna have to serve somebody. It may be the Devil, or it may be the Lord, but you’re gonna have to serve somebody.”
Now, when Jesus walked the earth, the Devil unleashed a masterful plot against Him. He actually tricked the masses of people–those whom Jesus had been literally healing daily–to demand that Jesus be tortured and murdered. They even insisted that a murderer be freed, in order to ensure the punishment for Jesus. In terms of convincing us that we are worthless scumbags, and that God couldn’t possibly love us like He says He does (so why believe His other promises?), the Devil should have won. It would be impossible for him to have engineered a better move; that should have been checkmate in the battle for our souls.
Ah, except for one thing. While He was bleeding to death, Jesus asked His Father to forgive us. This dovetails with the (Protestant) emphasis on salvation through grace, not works. Even in secular terms, if you commit an affront on somebody else, the power to fix the relationship doesn’t really rest with you. Rather, the other person has the power to forgive or hold a grudge. If you break somebody’s TV, you can pay him back to make up for it, I suppose. But if you torture and kill somebody who has spent His adult life literally healing you and your friends of bodily sickness, there’s really nothing you can do to rectify that. It should be unforgivable.
Except that it wasn’t; God did forgive those people, and by extension, all of us. With that voluntary action, He proved that His love was more powerful than our sins.
I am not sure of this last point, but I think it entirely possible that when Jesus asked for our forgiveness, the Devil was shocked. “What?!” I picture him as having moved his Knight into check, thinking the game was all over. And then the Lord did something that the Devil hadn’t even considered, since it was so alien to his worldview.
I have begun blogging at the Campaign for Liberty website, which is home to some serious Ron Paul fans. My inaugural post is on “Misunderstanding the Causes of the Great Depression.” An excerpt:
A relatively free market can handle huge disruptions. E.g. if an asteroid smashed into Chicago in 1929, that might have caused a sharp economic downturn too, but it wouldn’t have caused double digit unemployment 10 years later.
So what did cause the severity and length of the Great Depression? The New Deal.…
The New Deal represented the most comprehensive “war on depression” ever waged by the US government. And, just like the War on Drugs and the War on Terror(ism), the war on depression waged by FDR gave us the worst depression in US history.
All of the “unprecedented” measures that have been taken in the last 14 months are making things worse. Suppose Bernanke and Paulson had announced in September 2007, “Yep, a bunch of banks made goofy loans to unqualified applicants, and a bunch of whiz kids on Wall Street bundled them together with fancy models that, in retrospect, were totally wrong in their estimates of massive defaults. We feel your pain, fellas, but this is America where we have a profit and loss system. If you had been right, you would have kept your profits, and since you were wrong, you go belly up. Better luck next time.”
That tough love would have been painful. Plenty of investment banks would have folded. The stock market would have tanked. The dollar would have gotten hammered in the foreign exchanges. But, on the bright side, major firms would have written off their multibillion dollar losses, capital would have been rearranged in light of the new information, and then economic growth would have resumed. There would have been a recession, but there have been lots of recessions over the years. Life would have gone on.
Instead of that, though, Bernanke and Paulson decided they were going to somehow magically erase all of the mistakes that bankers and investors made from 2001 to 2007. They were going to prevent a recession.
Guess what? All of the negative consequences (folding investment banks, tanking stock market, falling dollar) happened anyway. Recession, though postponed, is still coming.
Also, I have an article on oil in this month’s Freeman. Notwithstanding my usual self-centered focus, I have linked to the table of contents of the issue, because it’s a really good one. But here is an excerpt from my contribution (with a certain part put in bold to satisfy my frequent critic, TokyoTom):
Here we run into yet another nonsensical aspect of the official story from Big Oil’s critics. Let’s suppose for the sake of argument that the accusations are correct and that opening up ANWR and other federal lands wouldn’t lead to more drilling. Then what in the world is stopping the politicians from accepting the oil companies’ money? In these hard times, why not take billions from ExxonMobil and all the rest? If they don’t end up drilling—as the harshest critics allege—then people in Alaska, Florida, and California don’t need to worry about their coastlines being soaked in crude spills, now do they?
Things get worse. It’s not merely that the conspiracy-charging politicians deny companies access to federal lands that have the potential of major oil and gas discoveries. They want to swing the pendulum in the other direction with so-called “Use It or Lose It” legislation, which would penalize energy companies that lease federal land if they don’t begin producing within a specified time.
Putting aside the arrogance of politicians telling oil-industry experts how to run their businesses, such legislation would merely present an additional risk to domestic exploration efforts. As it is, an oil company runs the risk of paying to lease a certain area and finding nothing. The proposed legislation would increase the hazards, causing companies to become more conservative in where they explore.
This sorry episode underscores the flaws with government ownership of land. There are legitimate concerns over environmental quality, just as there are obvious concerns over high gasoline prices. But the political process is a terrible way to settle disputes. If the federal government auctioned off its massive landholdings to the private sector, oil companies and conservation groups alike could make bids and channel resources into appropriate ends, guided by the price system.
As it is, we have the worst of both worlds, where valuable oil and natural-gas deposits are arbitrarily placed off-limits and where oil companies are given rights to develop in certain areas without local owners exercising oversight to ensure that the mineral extraction occurs with the appropriate level of attention to long-run resource and environmental value. The “use it or lose it” mentality already prevails when politicians sell access rights to the vast lands they temporarily control—though economists know that this mentality is conducive to economically inefficient exploitation, rather than the wise husbandry that would develop under truly private ownership.
According to news reports, on Friday night the Financial Accounting Standards Board (FASB) caved to pressure from the SEC and will suspend the “mark-to-market” rules:
Pressure is mounting on the International Accounting Standards Board to abandon its “mark-to-market” accounting principles, which many believe has been one of the key factors in causing the credit crisis.
The rules insist that assets be held on a bank’s book at the most recently traded market price. As the markets took fright from exotic credit derivatives, the prices fell well below what is considered to be their true economic value — leading to bigger than expected paper losses being taken by the banks. As the markets have crashed, the problem has become ever more acute.
On Friday night, America’s chief accounting body, the Financial Accounting Standards Board, revealed that it would suspend the mark-to-market rules to take account of extreme market conditions. Institutions will be able to use their own estimates of an asset’s worth instead. The move follows pressure from the US Securities and Exchange Commission.
In a “position” statement, the board said: “In determining fair value for a financial asset, the use of a reporting entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.”
For weeks now, I have been planning on doing a “mark-to-market” post, but I never got around to doing it justice. Well, looks like I better do the good-enough-for-Free-Advice-work version:
Investment banks and other troubled institutions are sitting on mortgage-backed securities (MBS). For example, there might be a pool of 10,000 mortgages from all over the country. Every month, most of the homeowners make their mortgage payment, and this cash flows into the pool. Then the owners of the MBS get their respective cuts of this cash flow. If some of the homeowners miss payment, the rules of the MBS specify which owners take the hit first. (These are the people who bought into the riskier “tranches” of the MBS originally, which had the promise of a higher rate of return but also the greater risk of an interruption in cash outflow.)
So, for regulatory and also just business reasons, a big bank needs to be able to tell outsiders what its solvency position is. I.e. it needs to be able to say, “We have total liabilities of $x trillion, and total assets of $y trillion, leaving us with a net worth [equity] of $(y-x) trillion.” If x>y, then the firm is insolvent and has to declare bankruptcy. (Or at least, that’s how it used to work; nowadays, if x>y, the government stampedes in, issues a few dozen billion of taxpayer money, and then hands the firm’s assets over to JP Morgan in a sweetheart deal.)
Now what does all this have to do with MBS and mark-to-market? Well, if the bank is holding a bunch of these MBS, it needs to assign them a value on its “assets” side of the ledger. The mark-to-market rule says the bank has to plug in the price from the most recent market exchange involving a comparable asset. (I am being fuzzy here because I don’t know the precise details. E.g., maybe the bank has to use the average price during the preceding 30 days or something, or maybe there needs to be a minimum level of volume. Otherwise it seems there could be all kinds of gaming.)
OK, we’re almost there. People have been blaming the financial seizure, at least in part, on mark-to-market. The reasoning is as follows: A bunch of financial firms get into trouble because they paid way more for MBS than those securities are worth. Specifically, the models used to price these MBS didn’t assign a very high probability to the scenario in which real estate markets across the country all suffer massive, simultaneous declines–and yet that is what’s been happening.
In this environment, troubled firms have to sell off their assets, and bankrupt firms get completely liquidated. But everybody is spooked about the MBS, and so they can only move at “fire-sale” prices.
Yet, the critics allege, mark-to-market sets up a vicious cycle. During the first round of fire-selling, the prices of various types of MBS get pushed way down. But then all of the other firms, even relatively healthy ones, now find that their net worth just plummeted, because the MBS on their asset side of the ledger just shed 40% of their official market value (or whatever). All of a sudden a new batch of firms are in trouble, they have to sell off assets, this pushes down the price of MBS even further, and so on.
I have not decided whether mark-to-market is really driving this process. As I have said repeatedly, I think the paralysis in (portions of) the credit markets is ultimately due to the hope of a government bailout, and now more recently, due to the erratic seizures (literally) of the feds. On the other hand, I have talked with some sharp people who know financial markets more than I do, and they think mark-to-market is definitely causing some unintended consequences.
In any event, the suspension of the rule, and its replacement with mark-to-myth, where the owner of the MBS is allowed to value the asset based on the owner’s own conjectures about future default rates in the underlying mortgages, is crazy. Michael Rozeff over at the LRC blog explains why:
This idiotic move will drive the prices of financial stocks down and carry the whole market down. The credit markets cannot function without transparency. Lenders have to know the real values of the assets of borrowers. If the borrowers can fabricate figures, they lack all credibility. Thus, FASB has undermined even the creditworthy borrowers with this move. Lenders will now be even more reluctant to extend credit, and interbank borrowing will lock up even more. The exchange economy is almost entirely a credit economy. Without credit, it will grind to a halt. We are looking at an imminent DEEP depression.
If you want to hear the same from a “serious” analyst, John Cochrane from the University of Chicago said the same thing (when it was still just a possibility, not a fait accompli):
There is other talk (reflected in the Senate bill) of abandoning mark-to-market accounting, i.e. to pretend assets are worth more than they really are. This will not fool lenders who are worried about the true value of the assets. If anything, they will be less likely to lend. Conversely, if prices are truly artificially low, then potential lenders to banks know this and would lend anyway. We might as well just ban all accounting if we don’t like [the] news accountants bring. No, we need more transparency, not less.
I’ve said it before, and I’ll say it again: If the feds were purposely trying to destroy the US financial sector, we would have to salute them on a masterful job. They are hitting it from at least 8 different angles. It’s like when the FBI shows up at a bank robbery and cordons off the area. Same thing here. Paulson et al. are engaging in a massive bank robbery, and they want to seal the area of from outside investors. Nobody in his right mind would buy stock in, or lend money to, the US financial sector after all the government’s meddling in the last few months.
This is nice. A NYT blogger tackles the idea that Paulson might be helping Goldman Sachs–and for a good summary of the conspiracy theory, check out this post–and offers no argument whatsoever, only a smirk and a reference to Kool-Aid. Incidentally, someone recently informed a Listserv on which I participate that the Jonestown sheep didn’t actually drink Kool-Aid, rather they drank Flavor Aid. Do you think the Kool-Aid execs are mad, or do they think it’s kinda cool?
Here at Free Advice, we have been rather skeptical of the Paulson Plan, to say the least. In addition to its naked theft of $700 billion (at least) from taxpayers, the plan makes no sense economically. I.e. we are paying hundreds of billions for the government to kick the economy while it’s down.
To add fuel to the fire, in a recent WSJ op ed Nobel laureate Vernon Smith explained that the Treasury’s plan to buy up “toxic” debt is silly. Smith is quite literally one of the top 5 world experts on auctions and public policy.
The Senate spelled it out more clearly: “troubled assets are not limited to mortgage related assets but could include auto loans, credit card debt, student loans or any other paper related to commercial loans.”
“Any other paper?” Heaven help us! …
Auction designers should immediately note that we are talking about a market with one buyer and many sellers of a hodge-podge of items. The mechanism that will be used is a “reverse auction” — with sellers competitively submitting asking prices to sell Treasury a heterogeneous mix of good, some sour, apples and oranges whose content is better known to sellers than the Treasury.
Treasury expertise is in auctioning Treasury securities of a given maturity to multiple competing buyers: say $10 billion worth of six-month bills, or two-year notes. In either case every bill (or note) is identical to every other one. The only uncertainty is the final clearing price and Treasury is assured that it will get the best price.
Treasury has no expertise in this ridiculous new venture.
I note with some irony that although Smith is nobody’s fool when it comes to auctions, apparently he’s not good at market timing. When googling to find the above article, I came across a WSJ piece from May 23, 2007 that began like this: Vernon Smith, a Nobel laureate economist, is so bullish on stocks that he’s put money in small drug companies — investments he “wouldn’t have touched in the late 1990s,” he says.
Pepe alerted me to Casey Mulligan’s blog. Some awesome stuff here, especially on the bogus crisis (outside of financial sector). If you’re a bailout junkie, I encourage you to just go to his blog and start scrolling. But for now, let’s focus on a recent post where he explains how incredibly stupid the new plan to purchase bank equity is:
Treasury capitalization would recapitalize the banking industry MUCH LESS than each dollar expended by the Treasury. I was hoping Professor Barro would voice this opinion, because I learned it from him (not in 2008, but back in 1989 when I enrolled in his courses). Quite simply, Treasury capitalization will crowd out private capitalization.
To see this, assume for the moment that future taxes are lump sum (with a known incidence) and the economy is closed — i.e., that all potential bank stockholders are also U.S. taxpayers. Professor Barro has explained that taxpayers will recognize that the Treasury has invested more in bank stocks, and has implicitly done so on their behalf because the taxpayers will reap the gains and pay the losses of those investments. As a result, taxpayers will attempt to reduce their holdings of bank stocks by the same amount that the Treasury increased them.
You might say that taxpayers cannot reduce their investments in bank equity, because those investments are already zero. If you say this, you err both in fact and in logic. In fact, Bank of America announced this week that it would issue $10 billion worth of stock. Even if we ignore that fact and accept the premise that taxpayers have no intention to invest in the equity of existing banks, I cannot believe that investors would not invest in new banks, or would not invest in alternative institutions that could compete with banks. Thus, at best, the Treasury plan reallocates capital FROM new entrants to the banking industry and TOWARD the existing (and struggling) banks. What a plan for strengthing an industry — to take from the young and strong and give to the weak and old! As I have written many times, public policy needs to ENCOURAGE entry, not discourage it.
We cannot assume that taxes are lump sum, or have a known incidence. But recognizing taxation deadweight costs and uncertain incidence only increases taxpayer exposure to bank stock risk, which might cause them to reduce their bank industry investments MORE than the Treasury increases them! What a plan for strengthing the banking industry — to decapitalize it!
I can’t remember if it was Thomas Sowell or Walter Williams (they all write the same to me…) who said something like, “If the Grand Wizard of the KKK aimed to destroy the black community, he could have done no better than the Great Society.”
By the same token, if a Marxist set out to destroy the American financial sector, he could not have outdone Paulson and Bernanke’s actions of the last 14 months. It’s not merely that their actions aren’t helping. On the contrary, they are CAUSING the very instability they claim to be trying to quell. We just had the worst week in the stock market’s history, after the bailout plan was passed, which (you’ll recall) was supposed to avoid unprecedented bleeding in the stock market.