What I Think About the Bailout
Sep. 27th, 2008 04:03 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
billroperI think that the current economic problems are the result of two regulatory failures and a subsequent market failure that have left us in the unhappy position that we're in. Let's talk about that for a moment and then see if there's a prescription that might make some sense.
The problem started back in the 1990s with the push to make it possible for more people to buy homes. After all, homes were a good investment, real estate only goes up (they're not making any more of it, right?), and encouraging people in lesser economic circumstances to build up home equity gives them a change to improve their economic situation. There's certainly something to be said for that argument, save for that little bit in the middle:
"Real estate only goes up."
That'll get us into trouble later, but not for a while. So what you do is encourage people to lend money to less-qualified borrowers. Of course, they may not have the traditional 20 percent down payment, nor may they be able to handle the payments on a 20-year (whoops, let's make that a 30-year mortgage), but we can accept lower down payments and set up adjustable rate mortgages, because the value of the underlying real estate is only going to rise, so our default risk is low. We can also force the borrowers to pay for private mortgage insurance which will add a bit to their payment, but which will guarantee that mortgage is going to be good when we resell it.
Of course, you have to be able to resell that loan. The biggest buyer and reseller of mortgages in the country are the government sponsored enterprises, Fannie Mae and Freddie Mac. They're able to borrow money at very favorable rates, because there's always been this implicit (not explicit) promise that the Federal government would step in should things really go sour and make everyone good. Heck, Fannie Mae and Freddie Mac debt is darn near as safe as a Treasury bill.
The FMs didn't used to buy junky-looking mortgages like these. This kept them from proliferating completely out of control. Once they were allowed to do so (regulatory failure #1, around 2002), we got a lot more of these mortgages into the marketplace. (See, for instance, the Home Possible program, which seems to have cranked up around 2005.) So now we've got a bunch of junky mortgages out there in bundles with better mortgages, all being bought and sold and guaranteed by the FMs and private insurers.
(You also should understand that the FMs were places where politically well-placed individuals were sent and made a lot of money. This included Obama advisor Jim Johnson and former Clinton administration official Franklin Raines. It turns out that Johnson and Raines got caught manipulating earnings to maximize bonuses. You can look it up. In the meantime, the FMs spent a lot of money lobbying Congress, which seems to have helped keep any improved regulation from landing on them.)
By 2007, the housing market was slowing down. The solution to this appears to have been to let the FMs buy more junk. (Note, by the way, the comments by Democrats Dodd and Schumer who wanted to let the FMs buy even more junk than that.)
Meanwhile, a lot of organizations had money invested in these sliced and diced securities that included some mix of traditional and subprime mortgages. It turns out that some of these loans had been so mixmastered that it wasn't even clear who was entitled to foreclose on a non-paying mortgage. There's nothing like accountability and this was nothing like accountability.
Ok, now, do you remember Enron? One of the long-term results of Enron was FAS 157 that requires companies to mark their securities to market value. In some sense, that's a good thing, because you want to know what a company is really worth and -- under normal circumstances -- mark to market works pretty well.
Unfortunately, the regulation devised to fight the last accounting war isn't working so well right now. (Regulatory failure #2.) Everyone who studies the problem understands that markets are imperfect. (Other systems are usually more imperfect, so markets generally look pretty good by comparison.)
All you have to do is to have enough capital, and you can wait out periods of market imperfection. (That's the market failure I'm talking about.) And here's where FAS 157 gets you in trouble.
There's not much doubt that these bundled mortgages are worth less than their face value. How much less turns out to be the question that no one has a good answer to. And under those circumstances, we've ended up with essentially no buyers prepared to make a market in the securities. When that happens, the mark to market rules call for marking the security down to zero. It's probably worth more than that, but it's a good conservative accounting rule.
It also means that companies with substantial amounts of these securities on their balance sheet discover that they have a lot less assets than they are supposed to have. And when you're a bank or an insurance company, being out of asset balance triggers all sorts of regulatory and contractual disasters. You have to have assets on your balance sheet to support your lending activities. So you can't lend money.
And credit dries up. And the people who have money aren't willing to lend it to you, because they don't know if you're going to arrive in technical bankruptcy and fail to pay them back which is why inter-bank lending rates went nuts. Mind you, the vast majority of the mortgages that you're holding in these mixmastered securities may still be performing assets, but their market value is zero this week.
Now, given all that, how do we fix the situation? Well, as they frequently say, the first rule of getting out of a hole is to stop digging and to some extent we're doing that, because mortgages are a lot tougher to get. Of course, that depresses the prices of the existing housing stock which doesn't help all those subprime mortgages out there, but there's a very reasonable argument that cheap mortgage money resulted in a classic inflationary bubble in housing prices (too much money chasing too few goods), so I don't really think there's a lot that we can or should do to try to support current housing prices. Keeping them pumped up is likely to make the situation worse rather than better.
The next step is to relax the mark-to-market rule in a very specific way. We're pretty sure that the mortgage-backed securities are worth less than par and more than zero. We're not able to figure out what the right price is, but we can take a guess.
And that's what we should do. Congress should pass legislation allowing the Secretary of the Treasury to declare an emergency and set a price that the mortgage-backed securities can be listed at on a company's balance sheet. This price is subject to change at any time based on our experience with the securities. Congress should also appropriate money, let's say up to the $700 billion total in a series of available installments, and allow the Secretary of the Treasury to buy tendered securities at 90% of the value that they're recorded at on the company's balance sheet.
In effect, the Treasury becomes the market of last resort for these securities. But the Treasury is allowed to adjust the price. If too many securities are being tendered, then the price is too high and needs to be reduced. If the price is too low and no securities are being tendered, then we may be putting companies into technical bankruptcy for no good reason. Since we're buying the securities at a discount to the balance sheet, companies have an incentive not to tender the securities unless they really need the cash in hand. We may also put some other incentives into the legislation to discourage excessive tenders -- it's certainly worth looking at limits on executive pay (although, as I observe elsewhere, this may have certain agency problems associated with it) or dividends to shareholders or corporate warrants that would allow the Federal government to claw back some gains from the tendering companies.
Eventually, the Treasury should be able to sell these securities in a functioning market once the uncertainties are better understood. If there are any profits from this venture (and I hope there would be), then they need to go to reduce the amount of the National Debt, not be redirected into any Congressman or Senator's pet program (as Senator Dodd is currently suggesting).
Finally, we need to pass legislation that encourages the banks and borrowers to renegotiate existing mortgages which are likely to be foreclosed. Part of this is setting rules so that we know who is empowered to negotiate on the part of the security holders, since that seems to be unclear now. Part of that is changing the tax law (if we haven't done so already; I may have missed the change) so that the amount that a mortgage is being written down doesn't become immediate taxable income to the person who owns the property while still allowing the folks who loaned the money to recognize the loss. Loathe as the IRS might be to recognize it, there are some transactions where my loss doesn't mean your gain. And given the costs involved in foreclosure, there is a range of negotiable values where the homeowner is better off than if he were foreclosed on and the bank is better off than if it foreclosed on the property. A win-win situation is possible, but we have to make sure that the tax code isn't preventing it.
So that's my thought on the situation. Probably imperfect, but I think it's better than some of the alternatives that are being kicked around Congress.
The problem started back in the 1990s with the push to make it possible for more people to buy homes. After all, homes were a good investment, real estate only goes up (they're not making any more of it, right?), and encouraging people in lesser economic circumstances to build up home equity gives them a change to improve their economic situation. There's certainly something to be said for that argument, save for that little bit in the middle:
"Real estate only goes up."
That'll get us into trouble later, but not for a while. So what you do is encourage people to lend money to less-qualified borrowers. Of course, they may not have the traditional 20 percent down payment, nor may they be able to handle the payments on a 20-year (whoops, let's make that a 30-year mortgage), but we can accept lower down payments and set up adjustable rate mortgages, because the value of the underlying real estate is only going to rise, so our default risk is low. We can also force the borrowers to pay for private mortgage insurance which will add a bit to their payment, but which will guarantee that mortgage is going to be good when we resell it.
Of course, you have to be able to resell that loan. The biggest buyer and reseller of mortgages in the country are the government sponsored enterprises, Fannie Mae and Freddie Mac. They're able to borrow money at very favorable rates, because there's always been this implicit (not explicit) promise that the Federal government would step in should things really go sour and make everyone good. Heck, Fannie Mae and Freddie Mac debt is darn near as safe as a Treasury bill.
The FMs didn't used to buy junky-looking mortgages like these. This kept them from proliferating completely out of control. Once they were allowed to do so (regulatory failure #1, around 2002), we got a lot more of these mortgages into the marketplace. (See, for instance, the Home Possible program, which seems to have cranked up around 2005.) So now we've got a bunch of junky mortgages out there in bundles with better mortgages, all being bought and sold and guaranteed by the FMs and private insurers.
(You also should understand that the FMs were places where politically well-placed individuals were sent and made a lot of money. This included Obama advisor Jim Johnson and former Clinton administration official Franklin Raines. It turns out that Johnson and Raines got caught manipulating earnings to maximize bonuses. You can look it up. In the meantime, the FMs spent a lot of money lobbying Congress, which seems to have helped keep any improved regulation from landing on them.)
By 2007, the housing market was slowing down. The solution to this appears to have been to let the FMs buy more junk. (Note, by the way, the comments by Democrats Dodd and Schumer who wanted to let the FMs buy even more junk than that.)
Meanwhile, a lot of organizations had money invested in these sliced and diced securities that included some mix of traditional and subprime mortgages. It turns out that some of these loans had been so mixmastered that it wasn't even clear who was entitled to foreclose on a non-paying mortgage. There's nothing like accountability and this was nothing like accountability.
Ok, now, do you remember Enron? One of the long-term results of Enron was FAS 157 that requires companies to mark their securities to market value. In some sense, that's a good thing, because you want to know what a company is really worth and -- under normal circumstances -- mark to market works pretty well.
Unfortunately, the regulation devised to fight the last accounting war isn't working so well right now. (Regulatory failure #2.) Everyone who studies the problem understands that markets are imperfect. (Other systems are usually more imperfect, so markets generally look pretty good by comparison.)
All you have to do is to have enough capital, and you can wait out periods of market imperfection. (That's the market failure I'm talking about.) And here's where FAS 157 gets you in trouble.
There's not much doubt that these bundled mortgages are worth less than their face value. How much less turns out to be the question that no one has a good answer to. And under those circumstances, we've ended up with essentially no buyers prepared to make a market in the securities. When that happens, the mark to market rules call for marking the security down to zero. It's probably worth more than that, but it's a good conservative accounting rule.
It also means that companies with substantial amounts of these securities on their balance sheet discover that they have a lot less assets than they are supposed to have. And when you're a bank or an insurance company, being out of asset balance triggers all sorts of regulatory and contractual disasters. You have to have assets on your balance sheet to support your lending activities. So you can't lend money.
And credit dries up. And the people who have money aren't willing to lend it to you, because they don't know if you're going to arrive in technical bankruptcy and fail to pay them back which is why inter-bank lending rates went nuts. Mind you, the vast majority of the mortgages that you're holding in these mixmastered securities may still be performing assets, but their market value is zero this week.
Now, given all that, how do we fix the situation? Well, as they frequently say, the first rule of getting out of a hole is to stop digging and to some extent we're doing that, because mortgages are a lot tougher to get. Of course, that depresses the prices of the existing housing stock which doesn't help all those subprime mortgages out there, but there's a very reasonable argument that cheap mortgage money resulted in a classic inflationary bubble in housing prices (too much money chasing too few goods), so I don't really think there's a lot that we can or should do to try to support current housing prices. Keeping them pumped up is likely to make the situation worse rather than better.
The next step is to relax the mark-to-market rule in a very specific way. We're pretty sure that the mortgage-backed securities are worth less than par and more than zero. We're not able to figure out what the right price is, but we can take a guess.
And that's what we should do. Congress should pass legislation allowing the Secretary of the Treasury to declare an emergency and set a price that the mortgage-backed securities can be listed at on a company's balance sheet. This price is subject to change at any time based on our experience with the securities. Congress should also appropriate money, let's say up to the $700 billion total in a series of available installments, and allow the Secretary of the Treasury to buy tendered securities at 90% of the value that they're recorded at on the company's balance sheet.
In effect, the Treasury becomes the market of last resort for these securities. But the Treasury is allowed to adjust the price. If too many securities are being tendered, then the price is too high and needs to be reduced. If the price is too low and no securities are being tendered, then we may be putting companies into technical bankruptcy for no good reason. Since we're buying the securities at a discount to the balance sheet, companies have an incentive not to tender the securities unless they really need the cash in hand. We may also put some other incentives into the legislation to discourage excessive tenders -- it's certainly worth looking at limits on executive pay (although, as I observe elsewhere, this may have certain agency problems associated with it) or dividends to shareholders or corporate warrants that would allow the Federal government to claw back some gains from the tendering companies.
Eventually, the Treasury should be able to sell these securities in a functioning market once the uncertainties are better understood. If there are any profits from this venture (and I hope there would be), then they need to go to reduce the amount of the National Debt, not be redirected into any Congressman or Senator's pet program (as Senator Dodd is currently suggesting).
Finally, we need to pass legislation that encourages the banks and borrowers to renegotiate existing mortgages which are likely to be foreclosed. Part of this is setting rules so that we know who is empowered to negotiate on the part of the security holders, since that seems to be unclear now. Part of that is changing the tax law (if we haven't done so already; I may have missed the change) so that the amount that a mortgage is being written down doesn't become immediate taxable income to the person who owns the property while still allowing the folks who loaned the money to recognize the loss. Loathe as the IRS might be to recognize it, there are some transactions where my loss doesn't mean your gain. And given the costs involved in foreclosure, there is a range of negotiable values where the homeowner is better off than if he were foreclosed on and the bank is better off than if it foreclosed on the property. A win-win situation is possible, but we have to make sure that the tax code isn't preventing it.
So that's my thought on the situation. Probably imperfect, but I think it's better than some of the alternatives that are being kicked around Congress.
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no subject
Date: 2008-09-27 10:51 pm (UTC)no subject
Date: 2008-09-27 11:04 pm (UTC)Your proposal is not far from what the Libertarians are proposing. If I weren't trying to sell a house, I'd be less concerned, but throwing money at the problem won't solve the problem.
no subject
Date: 2008-09-27 11:46 pm (UTC)no subject
Date: 2008-09-28 01:13 am (UTC)no subject
Date: 2008-09-28 01:58 am (UTC)I don't have the knowledge to evaluate George Soros's long-swing theory (i.e., that the Bretten Woods agreement in 1944 set up the dollar as a de facto reserve currency, giving the U.S. economy an advantage in securing long-term credit, and that we've been destined for a fall for a long time). But you don't have to agree with that to understand that market fundamentalism helped put us in this situation by allowing the radical and unregulated development of mechanisms to leverage debt far beyond the capacity of large institutions to absorb losses from a catastrophic collapse of a major speculative boom... i.e., the current disaster.
I think some version of your proposal would be part of a workable solution. Another part would be a set of mechanisms to slow the turnover in housing from foreclosed properties. (That would be the reason why I wouldn't mind my and your tax dollars to help people who had been duped and duped themselves into mortgages they couldn't afford: too many foreclosed properties on the market at any time will prevent a recovery of the housing market.) And a third part would be a check on the development of derivatives that are inherently highly leveraged. "Oh, trust the mortgage wizards." Yeah, right. Derivatives are useful hedges, but there ain't no such thing as a free lunch. Or at least in my Keynesian perspective, you should have some free lunches but only once every year or so.
no subject
Date: 2008-09-28 03:52 am (UTC)no subject
Date: 2008-09-28 01:17 pm (UTC)no subject
Date: 2008-09-28 02:57 am (UTC)no subject
Date: 2008-09-28 03:50 am (UTC)no subject
Date: 2008-09-28 04:49 am (UTC)I saw the push for home ownership in the eighties and nineties (we had it over here as well) as an attempt to get more people into debt (and yes, we fell for it, if only because we needed to get out of London, and we've been struggling ever since). People in debt are easier to control, as Lord Vetinari would tell you, and a mortgage is a whacking great debt on which you end up paying at least twice the principal (we've seen cases of five or six times). Our (Conservative) government at the time knew that people who had a mortgage hanging over them would be running scared of any increase in their tax bill and pathetically grateful for any reduction in same, so they could go right ahead and sell off essential public services and utilities to profiteering private companies and use the money to cut taxes. We're still paying for that in a hundred different ways.
Real estate only goes up, but I've never been exactly sure why it goes up: my trousers are not worth three or four times what they were worth ten years ago, my car isn't even worth a tenth of what it would have cost new, so why should my house (which has gone through the same process of gradual dilapidation over the years) be automatically worth more than it was when it was first built? That's never made sense to me. As it is, we paid five figures for a house that was certainly built for no more than four, and the market is currently trying to tell us it's worth six. If I were a moron, I could probably (before this all blew up) have gone out and got a mortgage on the six-figure sum, and some huge company would have sat back and rubbed its hands and waited for me to work myself into the grave paying back seven figures. It's ludicrous, or at least it seems so to me.
Something has to be done, obviously. We can't just stand on the sidelines waving and yelling "burn, you parasites! Burn! Ahahahahahahahaaa!" Your plan seems on the face of it to make sense within the system, and I can't see any reason to object to it. Which could mean no more than that I haven't found the kicker yet, of course. :) And the National Debt does need reducing. How did it get so high? Oh, right.
no subject
Date: 2008-09-28 06:09 am (UTC)no subject
Date: 2008-09-28 12:20 pm (UTC)And I _really_ don't want to see the CEOs getting bonuses for saving their companies after a bailout with my money. It's bad enough seeing them get bonuses for talking unions into pay cuts to save the companies. Yeah, I know, different industry, but still...
no subject
Date: 2008-09-29 05:39 am (UTC)Explain to me EXACTLY how letting these banks and insurers fail will "bring down the country", when there are other, more responsibly run companies in the wings waiting to buy the assets and carry on?
There IS no size that is "too big to fail" see also: Roman Empire
no subject
Date: 2008-09-28 03:36 pm (UTC)The one minor correction is that you don't buy a home just because you think the value is going up, you buy it so that you have an end point to renting. My house payment is a third more than I paid in rent, but a) The house payment hasn't went up in the intervening decade, whereas the rent certainly would have, and b) in 8 more years the payment goes to zero.
To my mind those reasons are sufficient to make me encourage the less well off to buy a house they can afford.
no subject
Date: 2008-09-28 09:07 pm (UTC)We are not in an "economic crisis". We are in a severe market correction. You want to find the best way to value those mortgage assets? Let the companies holding them go tits-up, as well as the idiots that insured them, and then see what smaller banks will pay for them when the carving knife comes out during bankruptcy. The defenition of "market value" is what the market will pay for something. Sometimes the only way to find that out is to PUT IT ON THE MARKET. CREATING a new market with taxpayer funds does NOT fix the problem - it delays the day of reckoning until the inevitable reality that these instruments are currently overpriced forces SOMEONE to take the damn loss, go out of business and sell them at their true value. The feds propose that now the taxpayers should be that someone. Except that the government cannot go out of business, because it has the ability to print money. So when the day of reckoning comes, instead of a clean market death, we get a debt-zombie, which will shamble around for years, haunting future generations of taxpayers. This is not acceptable.
We (the people) should stay out of it. Let those who often profit from taking calculated risks go through the damage of a wrong bet, and lose their shirts. This is what is supposed to happen. It's not going to wreck the economy - it will change it. Hopefully for the better, because then future business decision makers will be more careful when they make a bet. If you bail these guys today, nobody learns a lesson.
If we MUST have some kind of package to appease the masses, offer to buy the assets for 25% of their original value, on the condition that every C-level employee of the firm being helped refund their entire salary to the company, and not take one until the company shows a profit again.
no subject
Date: 2008-09-29 03:21 am (UTC)We're certainly seeing some signs that liquidity could completely dry up, despite any other efforts by the Fed, if we don't do something about the current situation. While it's almost certainly true that the situation would correct itself in the long run, the short run could be very painful for everyone in the U.S.
no subject
Date: 2008-09-29 05:09 am (UTC)It can hurt a lot for a short period up front, or hurt a little for a longer time, and then eventually hurt a lot anyway when we get to the end.
The pain WILL occur. Pushing it to the future is expensive, and only relocates the pain. It WILL NOT reduce or eliminate it.
no subject
Date: 2008-09-29 05:34 am (UTC)While the root causes of the financial situation were similar (unchecked idiotic business practices, rampant consumer spending and debt creation, sudden devaluation of market values, causing people to owe more than their leveraged assets were worth, etc) there are several differences.
1. we are not on the gold standard. The fed can "create" as much money as it wants, thus avoiding the constriction of funds to banks that contributed to the GD
2. Not ALL banks are facing the same problem, as was the case in the GD. In this current scenario, there are SOME financial instituions that chose not to join the mortgage orgy, and are still financially solvent.
3. The world is not following us into collapse this time - the US was more isolationist back then, and tried to shore up the economy with tariffs (didn't work). Europe really depended on us as a market, and when we stopped buying, they started collapsing also. In today's global market, we aren't the economic powerhouse we used to be, and our woes are unlikely to hurt all of Europe, let alone trigger Germany into a mad grab for world domination.
Similar causes, different outcomes. Letting these idiots fail will hurt, but will not cripple us anything like the GD.
no subject
Date: 2008-09-28 09:35 pm (UTC)I think the "25% of face value" rule ought to be a good starting point for the notional value.
no subject
Date: 2008-09-29 03:27 am (UTC)I haven't found examples of Republicans proposing anything worse in the area. :) (This doesn't prove that they don't exist. But it doesn't appear that the bill that allowed commercial banks more flexibility in what they do was a critical factor in all this, although I see people pointing to it. What I don't see is an explanation of why that was a contributing factor...)
no subject
Date: 2008-09-29 01:48 pm (UTC)The two enterprises serve different purposes and different populations. Commercial banks by definition are more conservative than investment banks. Commercial banks' customers, by definition, are choosing less risk, while investment bank customers are, by definition, open to higher risk for higher gain. In general (there are always exceptions, and sometimes these things are subject to the pendulum swing) investors are more affluent than non-investors; that's why they have the money to invest in the first place. They can afford higher risk. The regulations on reserves and risk have always been looser on investment banks than commercial banks. (And both have been looser than regulations on insurance companies.)
When you put those two groups together, the institution has a conflict between handling its assets to the benefit of the commercial customers and handling its assets to the benefit of the investors. And, when the investing side starts losing money (as happens with the stock market) the temptation to take the "commercial bank" reserves to tide over is just too great.
And we won't even start on what happens when you add insurance to the mess, as well!
I don't completely disagree with your suggested solution; there are parts I like and parts I don't.
But I think you are fingering the wrong regulatory failures -- and that difference of opinion underlies most of my dislikes of your plan.
no subject
Date: 2008-09-29 01:51 pm (UTC)no subject
Date: 2008-09-29 05:12 am (UTC)It's the thing you count on when you play that game called Capitalism.
no subject
Date: 2008-09-29 02:31 pm (UTC)A. Home ownership as an American Value (and therefore worthy of governmental support and encouragement) is not a phenomenon of the 1980s or 1990s. Rather, it's been an American Value since post-WWII. And there are sound financial and social reasons for the encouragement.
Ownership spreads responsibility. When you own something, you take care of it more than if you don't. Home ownership gives owners a real stake in the health of their neighborhoods. Home ownership, like marriage and children, give optimum motivation for individuals to take care of one another. That latter is the glue of social structure.
While that may sound "liberal" (TM) -- you know, the bad word as opposed to the normal word -- it really isn't. At a basic level, the only reason we join in societies is because we can do more together than any of us can do alone. Mutual enlightened self-interest. Without it, each person is an individual nation-state.
I will agree, however, that the push for home ownership changed in the 1980s and 1990s. All that Reaganesque optimism was part of it. But mostly, it was the generational remove from the GD. The financiers coming into the full flush of their careers then simply didn't believe that risk was as high as it really was. When you exist at the end of the pendulum swing, it's hard to see that it will swing back -- the end is the norm.
But the encouragement of home ownership was very good for the US economy for much longer than it's been bad.
B. I don't accept your premise that the Freddies are at the root of the bad mortgage market. Comparatively speaking, the Freddies were much more lightly involved in the sub-prime machinations than the private institutions. The level of involvement seems to me to be inversely directed to the level of regulation. The Freddies were on their way to full privatization, but not there, yet. For which, at least right now, we should be very thankful. This latest economic upheaval is a great argument against privatization of Social Security.
So, what do I think are the two greatest regulatory failures? See next comment (I ran over the LJ limit on comments. Am I talking too much?)
My picks for top 2 regulatory failures
Date: 2008-09-29 02:33 pm (UTC)What do I see as the two most significant regulatory failures leading to the current mess?
1. The blending of commercial banks, investment banks and insurance business in single, massive entities. I explained my views on this in a previous comment. The summary is this: each of them serves different purposes and different levels of risk. Blending them makes for inherent conflicts of interest among those levels. And the loosening of regulations made it easier for the banks to resolve the conflicts in favor of risking more rather than less.
2. The lack of regulation on derivatives. The new investment vehicles created by breaking up mortgage assets were inherently unstable. When the mortgagee holds the mortgage, it takes on the entire risk and is more careful of the mortgages it accepts. When the mortgagee breaks up the mortgage and pieces of other mortgages and sells them, the mortgagee has NO risk at all; it has money in hand to do it again. It's a Ponzi scheme, with the ones at the start getting all the benefits. This was the motive behind the extreme availability of sub-prime mortgages. For the folks at the head of the line, this was a sure thing.
I understand the attraction of a free market. It's great for those who win.
But I tend to distrust extremes. I believe in unchecked capitalism as much as I believe in unchecked communism -- neither works well for the majority of the society. Finding the right balance is, of course, the crux of the problem.
Starting with Reaganomics, we went to far to the side of no regulation. It's time to move back to the center, again.
Where I most agree with you is the start of your solution. The credit freeze is caused by lack of confidence, and lack of confidence happens when no one can figure out the worth of money instruments. And I'm not talking about credit freeze at the level of my credit card. I'm talking about the credit freeze at the level of commercial paper. That is more than a market correction. It's a fundamental blow to the entire economic system of this country. (And, increasingly, the world.)
So I'm glad we're all talking about fixing it.
Footnote: About the crazy credit spree of the American public. Yes, it was bad, and some of us said so all along. Smart people, prudent people, do not buy what they cannot afford. However, in their defense, I will point out that for the past 8 years, their government has told them and shown by example that we can decrease revenues while increasing spending and this is a Good Thing.
The moment I was most angry at President Bush? When his call to the American People to help with the war on terror and Iraq -- his call for them to do their part in supporting our troops -- was to go shopping.
No, I am not blaming Bush alone for the mess. But his bully pulpit certainly did nothing to stop it.
The angriest I've been with the Democrats? When they joined the Republicans to loosen the regulation on banks. (Well, actually, it was the passing of the Patriot Act, but that's not in the context of this discussion.)
no subject
Date: 2008-09-29 07:07 pm (UTC)So what happens when the hard market correction wipes out the retirement savings of a lot of people, including my parents (ages 79 and 81)? I predict a huge load on the underfunded part of the health care system followed by a bonanza in the funeral home industry. I can't predict the size of that impulse, though.
It's all well and good when you are young and in demand and (think you) can support yourself through the wilderness by your wits and abilities. However, there are lots of people whose version of "hurts a lot" includes dying fairly promptly, and lots of those people (and the larger network of people close enough to them to factor their fates into their actions) can vote. Naturally, the profiteers waiting in the wings (that are surely there) are selling fear, uncertainty and doubt in large "economy-size" doses.
What we need is a somewhat softer correction. The question is, how soft?
This is one such proposal. There is a lot to like in this analysis, but I think 90% is too high, since the uncertainty in the recorded value will surely surely be bigger than 10%. 25% of face value might be a starting point for the recorded value, but I suspect it's too low to restore liquidity. What I'd like to see is credible simulations. However, there is neither time nor adequate credibility for that.
This sure is going to be one for the history books.
no subject
Date: 2008-09-29 07:52 pm (UTC)The Secretary of the Treasury will establish a percentage of the par value of these instruments which they may be booked at on an institution's financials. He will then announce that the Treasury stands ready to purchase, say, up to 50 billion dollars of these securities at 90% of the amount that they're allowed to be booked at. However, the Treasury reserves the right to adjust the price in the case that the offer is either over or undersubscribed -- that last bit meaning that they'll reset the value that the securities are on the companies' books at based on the value previously announced by Treasury.
So let's say that Treasury says "Book them at 75% of par. We'll pay 90% of that value for up to $50 billion if you need liquidity." Because Treasury is buying the securities at a discount to their value on the balance sheet, there's a disincentive for the companies to offer them. If the value is close to correct, only those companies that really need the liquidity will move them to Treasury. If too many companies want to unload the securities, then Treasury reduces the price which should cause more companies to be willing to hold them.
no subject
Date: 2008-09-29 08:14 pm (UTC)Also, that price is only going to work to make these securities sellable-to-other-companies (which I gather is what you have in mind--the Treasury is only the market of last resort if there are other resorts) if the other companies believe the value that the government puts on them.
And even then, if the only guaranteed value is the price the Treasury will buy them at, I'm guessing nobody else will be willing to pay more for them.
Of course, having a guaranteed value, even if it is a fiat value, may make it possible to borrow money against that value and free up the credit markets I suppose. But the fiat value can be changed depending on how many companies are actually selling their securities to the Treasury--but there must be ways to deal with that because companies can use stocks as assets, and stock values change.
I like the idea of establishing the ability to renegotiate mortgage payments, though.
I know the FMs have contributed to Democrats, because I know perfectly well that they have contributed to practically everybody in Congress, Democrat and Republican alike--that's one of the ways they got the rules changed to favor their profits more. But when you single out only Democrats to complain about it makes you look biased, and that kind of undermines the ethos of the rest of your argument, which is really pretty good.
no subject
Date: 2008-09-30 03:31 pm (UTC)New Friend
Date: 2008-09-30 12:33 am (UTC)You've got some good ideas about the economic upheavals. I've been following this stuff on my blog too.