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Would it have been better if Timothy Geithner had had the power to guarantee all bank debt early on? As James Surowiecki reminds us, that was part of the Swedish solution. Justin Fox plausibly suggests that we might have avoided a lot of pain with a fast, full guarantee.
But that's not the point. The question isn't whether we could have avoided this crisis, if only we had cut a big check. We could have, and that was not lost to any of us debating these issues more than a year ago. (See e.g. me or Mark Thoma.) Had we done so, the near-to-medium term fiscal costs might have been less than they probably will be now. So, with 20/20 hindsight, would it have been a good idea?
How you answer that question depends upon how you view the crisis. Is it an aberration, a shock to a basically sound financial system, or is it a painful symptom of an even more dangerous condition? Under what circumstances would our political system be likely to impose reforms that would prevent large scale misallocations of capital and shifting of losses to taxpayers in the future?
If you think that our financial system just needs some tweaks, some consolidation of regulators' organizational charts and sterner supervision, then you should prefer that we had just cut a check, passed Sarbanes/Oxley Book II, and moved on. But that is not what I, or most proponents of nationalization temporary receivership for insolvent banks, believe.
If you believe, as I do, that we need a root-and-branch reorganization of the financial system, which must necessarily involve the dismemberment and intrusive restraint of deeply entrenched institutions, does that mean pain is the only way forward, "the worse the better" in the old revolutionary cliché? It need not mean that. But it does mean that palliative measures, like giving the banks money, would have to be attached to curative measures, like enacting capital requirements and imposing regulatory burdens that would force financial behemoths to break themselves up or become boring narrow banks. For almost two years, policymakers at the Fed and the Treasury, including Secretary Geithner, have offered bail-out after bail-out and asked for nothing serious in return.
Do I regret that Henry Paulson was not empowered to issue a blanket guarantee of bank assets early on, as the Swedes did? No, I don't regret that at all. Why not? Because I think that "Hank the Tank" was a crappy negotiator, not only for taxpayers in a fiscal sense, but also for the economy and the polity more deeply. He would have offered the financial system sugar without requiring it to make the medicine go down. He may believe, quite sincerely, that a cure would be worse than the disease. He may believe that, but he is wrong. If we "get past this crisis" by restarting a consumer-credit-based, indiscriminate-investor-financed, current-account-deficit-making, income-inequality-expanding economy, we will have increased, not diminished, the likelihood of a major collapse.
You may believe that we have learned our lesson, that if we can just get some stability and comfort for a while we are prepared to do what must be done. That's a respectable position. But I don't share it, and neither do the majority of Americans who are unwilling to allow their representatives to sign off on any more expensive aspirin. We want value for value, an ironclad commitment of root and branch reform in exchange for the unimaginable sums of money we are being asked to hand over.
Surowiecki has in the past suggested that those of us who favor nationalization would criticize any alternative simply because it is not precisely the policy we advocate. But it is not we who have refused to compromise. We've seen variations on the same basic proposal over and over again. Geithner's PPIP really does resemble Paulson's TARP, besides the part about actually asking taxpayers for the money. Each latest plan from our incestuous cadre of economic Mandarins demands only symbolic concessions from the dysfunctional organizations we are asked to support. The "moderate" political class goes on and on about how Geithner and Bernanke have to go all Enron, funding the banks via off-balance-sheet guarantees and special purpose vehicles, because "populist, childish" Congress won't put up the money. Setting aside how audaciously corrosive that sentiment is to Constitutional democracy, it is simply wrong. Congress would, because the public would, support large, explicit transfers, if they were attached to reforms sufficiently radical to prevent a recurrence, and suitably punitive towards the people who managed the system that brought us here. Value for value.
I am a true believer in American-style capitalism. So I would like to see people who earned profits lending to banks in good times bear the high costs of failing to monitor the organizations they funded. Investor fear is what is supposed to prevent the indiscriminate misuse of capital. To the degree that creditors have leaned upon "implicit" government guarantees, I think it would both be just and set a useful precedent if they were reminded that investors have to take responsibility for where they place the precious capital they steward.
That said, like Paul Krugman, I would be willing to hold my nose and tolerate a Swedish-style guarantee of bank creditors. I'd acquiesce to that even without formal nationalization. Nationalization is no one's idée fixée. It is a means to an end, and the desired end is a world in which too big to fail is too big to exist for any financial institution that originates or holds credit risk in any form. Secretary Geithner could send a bill to Congress today that would put all banks with a balance sheet of over $50B into run-off mode, while clearing away legal obstacles so that larger organizations could arrange their own breakups over time. I'd fax my Congressman and support a $2T on-budget buyout of bank creditors as part of that bill, as long as it had teeth. ("Teeth" would include making sure that off-balance-sheet and derivative exposures were included in the size cap, etc.)
It's not that us pitchfork-totin' populists are unwilling to pay the bill. It's that we want to know that in exchange for writing a very, very large check, the people that we are paying will actually deliver the goods. Given the behavior of bankers before the crisis and of shifty policymakers during, we have every reason to watch warily and to insist upon every precaution while we hand over suitcase after suitcase of freshly printed Federal Reserve notes.
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Who would have thought of a viable solution at those times when George Bush was on the way out and an ignoramus Obama campaigning his hearts out, not because he would want to solve the unfolding economic crisis, but in order to change the 7 years of Bush policies? Neither Obama nor McCain knew what was happening to the economy when they staged their face-the-nation debates - while ordinary people were so evidently hurting badly at that time. The government was dysfunctional while the credit crisis was unfolding at unprecedented speed.
Is this not the first time in capitalism's history that the government acted pro-actively against an impending economic collapse? They have no prior experience on how to do the job!
Value for Value - when you have been given enought time to think about it. Enought time to hear everybody's side of the story. Hindsight is a blessing, is'nt it? Does it solve anything at the time when a solution was needed?
Would you ask your son first that he would not go swimming again far away from the seashore and that he will have to mow the lawn every Sunday for 2 months as penalty -- WHILE HE WAS DROWNING?
Value for Value from now on and into the future. No exception?
Are we out of the woods yet?
newsmax.com/calltoarms
In many jurisdictions this would be classified as "theft by deception", i.e. fraud.
It is high time these games became illegal.
On Apr 28 02:10 PM Mad Hedge Fund Trader wrote:
> This is a sector best avoided. IBM has made public an excellent report
> on the long term future of the financial industry, one of its largest
> customers. The survey of 2,750 firms concludes that the age of extreme
> risk taking and huge bonuses is over. The high returns of the past,
> which thrived on the opacity of financial products, are history.
> Their guess is that profit margins will drop from an average 26%
> to 14%. Lower margins will be more sustainable. Long term compensation
> will be linked to long term gains, not short term profits. The government
> is going to mandate capital and liquidity cushions. Product sophistication
> outstripped investors’ ability to manage, or even understand inherent
> risks. Up to 88% of past profits came from off exchange, over the
> counter trades that never saw the light of day. The easy money will
> be commoditized as the business is moved on to listed exchanges.
> Large hedge funds with easily replicated strategies will be under
> extreme pressure. It’s an insightful report with more than a ring
> of truth which you should get your hands on.
There is precious little that changes in regards to human nature. And the forces of fear and greed will undoubtedly create bubbles and recessions far into the future. It seems futile to try to legislate or regulate our way out of what is truly hardwired into society.
At the same time, I do think DISCLOSURE is the most important issue for regulators to tackle. This would allow investors to understand better what they are buying. It would ensure that consumers and businesses who buy insurance products actually have a picture into the insurer's ability to make good on his commitments.
It can be argued that balance sheets have become so complex that disclosure does little to help business partners make rational decisions, but if this is true, then I prefer to place my investment capital with firms who have a simple model. And I can buy my life insurance from a smaller firm who can show me their balance sheet in terms I can understand.
My view is that we let AIG, Lehman, Bear Stearns and others conduct the business that they will, but simply enforce the fact that they MUST disclose their capital base and balance sheet details. From that point, it is up to me as the consumer, or the pension fund, or the hedge fund, to decide if this is the company I want to do business with.
Going forward (at least for the next decade while our memory is still fresh) I think this would benefit simpler firms, and act as an incentive to cause companies with deep esoteric financial contracts to simplify their business in order to attract the wiser clients.
I appreciate your article and the chance to think through the big picture...
Zach
zachstocks.com
Guess what - they were, my more than a few trillion dollars.
What I can't work out is why everyone is acting so surprised.
I am trying to put an article together that looks at the last 10 years while asking the question: What was motivating the major players as these years unfolded. What were politicians, regulators, financial exceutives and people on Main Street thinking in 1998, 2000, 2003, 2006 and each year in between?
I'm trying to get at your statement: "What I can't work out is why everyone is acting so surprised."
At the bottom line through these years is a complex web of conflict of interest. A little rationalization here and there eventually added up to catastrophe.