Can Capitalism Survive Its Latest Entanglement With Socialism? 14 comments
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Since whatever I would say about the latest trillion dollar bailout by the United States government would be unprintable, I am going to devote this column to describing what should have be done instead.
This financial meltdown is happening due to a lack of liquidity. The brokerage firms were buying long term assets with short term financing, a recipe for eventual disaster. In an ironic twist, Wall Street, the banker for the entire world, was unable to secure its own financing.
Lehman Brothers (LEH) was rolling over $100 billion each month to finance the real estate on its books. All of the financial firms currently have billions of dollars of illiquid, toxic mortgage securities on their books, which can not be sold.
Secretary of the Treasury Paulson proposed last week that the Federal Government buy these securities in an entity similar in structure to the Resolution Trust Corporation [RTC], which was created by Congress to bail out the savings and loans in the eighties. The RTC ended up costing the American taxpayer $150 billion dollars.
This newest rescue will be much bigger, the biggest bailout in the world. The amount of money requested by Bernanke and Paulson is 40% more than the Pentagon's entire budget for a year. It is $2,000 per every American citizen.
The last two weeks have seen the largest government interference in the markets since the Great Depression. This hardly seems warranted when the Dow Industrials is at the lofty level of 11,000.
What bothers me most is that the firms being saved by this bailout will not pay with a reduction in shareholder's equity. This bailout should have been structured similarly to the AIG (AIG) rescue that gave the government 80% of the equity of the company.
A substantial reduction in the trader's equity would have taught them not to gamble. Instead the US has socialized risk. It is as if we have switched from playing rugby to crochet at half time.
The government, instead of the marketplace, is now the referee deciding who the winners and losers are. Winning no longer means managing your company well, but being the most astute beggar of the US government.
After a week that saw the bankruptcy of the fourth largest brokerage firm, the fire sale of the number one securities firm, and the nationalization of the nation's biggest insurance company, the Dow Industrials ended up for the week. There is something wrong with that.
In order for the markets to work properly in the future, they must feel pain and moral hazard. I am not sure why the brokerage firms should be bailed out while Main Street was blithely ignored.
I would rather have seen this money go to keep people in their homes or to buy foreclosed homes to reduce the glut overhanging the real estate market. The collapse of the real estate market is still the central cause of this market downfall, but yet this bailout does not address that.
This plan does nothing to thaw bank credit. Without the free flow of bank credit, the economy will continue to stagnate. If they were going to do a bailout, I do not understand why they waited until after Lehman Brothers, with $600 billion in assets and 25,000 employees, declared bankruptcy, Merrill Lynch (MER) sold itself to Bank of America (BAC), and AIG with $1 trillion in assets was nationalized.
Bear Stearns (BSC) was rescued 6 months ago. They should have had ample time to review the situation before now.
No one has answered the question of who determines what price levels these securities will be purchased at. Can the brokerage firms survive after the resulting write downs?
If I were Secretary of the Treasury, the first thing that I would do is close the markets while we are negotiating this bailout. The market needs time to absorb this information. Although the Treasury only had a half formed idea, Paulson had to appear before the cameras early in the day on Friday to reassure the markets.
The recent volatility in the market has made it just a casino, albeit one with worse odds than Vegas. I would remove the head of the Securities and Exchange Commission [SEC], Christopher Cox. Fed Chairman Bernanke and Paulson have been running the show. During this financial crisis, he has been largely absent. In order to restore faith in the markets, you need to bring in someone strong, preferably a market player, to helm the SEC.
It was a mistake last week for the SEC to suspend short selling in certain financial stocks. Blaming the short sellers for this market crisis is as nonsensical as blaming matches for a fire. The stocks of financial firms deserve to be lower due to their own mismanagement.
The markets need short selling. Sometimes, short selling is a legitimate hedge strategy. Short sellers have been the most prescient market players in recent years. They are the ones that were the first to warn on Enron and this crisis.
Markets needs both buy and sell information. While short selling was suspended on 799 financial stocks, what happens to the trading in the stocks that were not protected? It does not seem appropriate to discriminate.
To stem the down movement of stocks, I would reinstitute the uptick short selling rule that the SEC foolishly eliminated right before the crisis started. Not just the SEC, all regulators have been AWOL. The alphabet soup of regulators needs to be overhauled and combined into one regulator.
Credit swaps are at the heart of this crisis, but yet this multi-trillion dollar market is not regulated at all. The insurance company AIG was nationalized by the Federal Government although the Federal Government does not even regulate insurance.
The Federal Reserve is lending the brokerage firms money while they are regulated by the SEC. Four years ago, the SEC pushed through a rule that allowed brokerage firms to increase their leverage from 12 to 1 to 27 to 1. From 2004-2007, Lehman Brothers added $300 billion in securities while only increasing shareholder's equity by $6 billion.
The amount of leverage brokerage firms are permitted should be drastically cut. The structure of salaries on Wall Street must be overhauled. Right now, traders are incentivized to take risk. They keep the winnings and walk away from the losses. Salaries on Wall Street must reflect the good years and the bad years over at least a five year horizon.
One of the reasons that this crisis has been so severe is that America is fighting it with one hand behind its back. In the last several decades, financial assets have moved away from being controlled by individuals to funds, but the legislation has not kept up with the times. The Glass-Steagall Act forbids funds from having majority ownership of financial firms. Private equity funds, which have $2 trillion in assets, were not allowed to step in and bail out the Wall Street firms.
I have to think that one of them would have considered buying Lehman Brothers at a price of $3.50 a share if they could have. The Glass Steagall Act must be amended so funds can ride to the rescue in the future.
Whether I like it or not, this bailout will most likely pass Congress. The bigger question is, can capitalism survive its latest entanglement with socialism?
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This article has 14 comments:
en.wikipedia.org/wiki/...
If you are truly interested in why the United States and the rest of the world are possibly heading to a disaster greater than the "Depression" read all about in Wikipedia.
What you will read will make your blood boil and tell you the truth without political distortion.
There are many other web sites that discuss and analyze the financial failure of Fannie and Freddie. Just take a look with Google. You don't have to take my word for it.
Just search for Community_Reinvestment...
Ehm... Who do you think owns the government?
One cannot resolve a problem unless one understands the problem.
PROBLEM: Financial institutions have reduced their lending.
The problem results from the impaired equity portion of the balance sheets of these institutions, with the impairment caused by write-downs of their assets (loans).
Due to the losses they have taken, these institutions, by law, have had their maximum potential lending amounts reduced.
The amount they are able to lend is contingent upon the amount of their equity capital (EC), e.g., if an institution has an equity capital of one billion dollars and is able to lend up to 20 times its equity capital, it could lend up to 20 billion dollars.
After taking loan write-downs (losses) of two hundred million dollars, its EC would now be 800 million dollars, thus it would have its maximum lending authority limited to 16 billion dollars, i.e., a constriction of its legal authorization to lend.
This is the crux of the problem.
The institutions have funds, i.e., liquidity. But, without the legal authority to increase lending, they are sitting in stagnant water.
Those who say that one going to one’s ATM for a withdrawal may find a closed sign are, absolutely, lying or ignorant.
If one is a Representative or Senator and is lying, he or she should be Impeached and removed from Office.
Likewise, if that Representative or Senator is ignorant, he or she, apparently, is not, adequately, accepting his or her fiduciary responsibility of understanding a subject prior to advocating or voting for it, thus he or she should also be Impeached and removed from Office.
PAULSON PLAN: Purchase impaired mortgages from financial institutions with taxpayer funds.
Indeed, this would positively affect an institution’s EC, because the impairment (loss) would have been transferred to the taxpayers. This reversal of loss would be achieved by paying face price rather than market price, since if the market price were paid, there would be no effect upon EC.
This contemplated action is anti-capitalistic, immoral, and a method of stealing from taxpayers.
The taxpayers did not cause the capital impairment (this IS the problem, i.e., “It’s the balance sheet, stupid”).
Anyone involved with designing this scheme and voting for it should be incarcerated as co-conspirators to steal from the citizenry.
The scheme’s authors and those who advocate for it would be precipitating an admission that capitalism doesn't work, which is a lie.
Capitalism is the best economic tool ever devised, but as with any tool, it can be and has been abused.
Congress should accept most of the responsibility for creating the economic atmospheric conditions that enabled the abuse.
Further, any resolution of this financial phenomenon will not abate the underlying problems of the economy.
It is not the lack of lending that has damaged the economy. It is the economy, affected by greed, that has damaged the lending, but, of course, if appropriate corrective actions are not taken in regards to this financial phenomenon, our weak economics will be adversely affected.
If the Paulson plan were adopted, it would be the most massive SPE by multiples, the dollar would weaken, interest rates would go up, thus the decline in home prices would be exacerbated, and the EC would require further resuscitations.
BEST PLAN:
1) Allow some institutions to go the route of Countrywide, Bear Stearns, IndyMac, and Washington Mutual. I, also, like the AIG model.
2) Most rational institutions will do what UBS, Merrill Lynch, Goldman Sachs (just recently with Warren Buffett) have done, i.e., they have raised additional EC, usually by selling preferred stocks.
Months ago, when Merrill sold 6 billion (as I recall the amount) dollars of preferreds paying 9%, I knew they were desperate, and that this was just an early domino.
Goldman Sachs, from what I have heard, is paying Buffett 10% for the preferreds. Keep in mind; this is after-tax money. The only reason for Goldman Sachs to take a desperate (GS also gave Mr. Buffett 43,000,000 warrants to purchases GS common @ $115 per share) action was because it knew it was experiencing an EC impairment and needed to raise additional EC.
Please keep in mind that pain is not all bad. It is a signal that something is wrong and indicates that the source of the pain (problem) must be determined, analyzed, understood, and finally the best alternative action must be taken.
We are experiencing pain regarding this financial phenomenon.
3) As a last resort, it would be appropriate for the government to establish a fund (call it the RTC 2.0 AKA Peoples' Financial Fund) and use those funds to purchase (just as have Mr. Buffett and others) preferred stock from institutions. The fund should follow Mr. Buffett’s lead and demand additional potential remuneration in the form of long-term warrants.
The stock would receive dividends and would have a convertible feature to convert to common stock, at the option of the fund.
Further, until certain parameters were met, the preferred ownership would assume voting control, thus the matter of executive compensation would be moot.
We either believe in capitalism or we don’t.
We will have displayed a pragmatic solution well within the parameters of capitalism.
The U.S. dollar will strengthen.
The next step would be to address the underlying economics with the basic problem being unbridled greed.
We should not have a "shot" stimulant as we did earlier.
We need to eliminate the largess given to the very wealthy, in error, by the Bush tax cuts, and to reduce taxes on the middle-class on a permanent basis.
This will have an immediate positive effect upon our economics and we will be on the path to a rational economy.
I will appreciate all comments regarding the foregoing.
Michael Z
Sherman Oaks, Ca.
1) Capitalism can survive the U.S. Post Office much easier than it can survive Microsoft. (Compare the fate of Ubuntu and UPS.)
2) The Socialist Party in America represents less than 1% of the electorate. One of two Socialist in Congress died in a plane crash and Bernie Sanders of little, rustic Vermont is going to throw his seat away with a certain loss when he runs for the Senate.
Socialism?
We either believe in capitalism or we don’t.
We will have displayed a pragmatic solution well within the parameters of capitalism.
While I agree with your conclusions about a proper rescue plan, maybe it's time we take a sober look at the fundamentals of the U.S. credit market. Everyone seems to admit that short-term lending to fund long-term investment has left us with a frozen credit market -- with lenders unwilling and sometimes unable to extend credit to other lenders.
There is another alternative, though I am sure that it will be frigthening to red-blooded capitalists.
Rather than beating around the bush by slowly nationalizing companies through the AIG model, take that $700 Billion and create the Bank of the United States of America. At a modest leveraged ratio of 10:1 the following would happen:
Begin lending to all of the credit worthy borrowers in the US that can't get credit from all of these crippled, dying banks -- with an equity stake of course, so the US taxpayer can get well after this crisis is over. Or let there be a reverse auction to find the 200 or 1000 strongest banks in the country, with the cleanest, strongest balance sheets, in each region, and inject equity capital into them. Congress ought to like that, since the most effective way to short circuit the recession would be to identify the BEST banks in each district, and inject $700 billion dollars worth of equity capital into them.
The banking system hasn't fallen apart: Let the healthy banks and brokerage houses who played by the old rules of capitalism pick up the pieces, and let the miscreants, cheaters and incompetents fail.
Hank Paulsen was the CEO of Goldman Sachs. He is trying (and knows very well HOW to) save his buddies in the industry. They don't need saving any more than commissars should be saved from prison after being caught siphoning money from a nationalized bank.
"O Ye of little faith."
It's mathematical models don't reflect an underlying reality the way molecular biology reflects real objects in living organisms, for example. It simply provides models for producing and distributing goods and services.
When the models become dysfunctional, we see the same power struggles that have produced wars and revolutions in the past.
Hyperinflation, economic depression, rationing and other economic illnesses are symptoms of financial, political, moral and other failures and reflect these failures but don't cause them.
And there are no simple fixes, unfortunately.
A Gloabl Market like we have is forcing the issue with regards to strengths and weeknesses of all producing Countries... If you can't build it, grow it efficiently then move on to something you can.... I still think the Americas need to work together and build our own economies to protect ourselves from the rest of the World..... We are looking at a serious Global problem manifested in much much more than bad loans and credit issues we have Gloab instability and balance of financial power that is killing us all.... China is a HUGE vacume sucking up resources at an allarming rate.
Hang on tight we are all going for a ride to financial restabalization...
For all you Milton Friedman addicts, der Fuhrer has been stripped of his clothing.
It makes the most cogent argument possible of how the influence of Friedman and the Chicago School led us down this yellow brick road of fairy tales that pumping money into the hands of the wealthy, getting rid of all regulation and letting the market work would trickle down to all the peons.
Friedman even had a recipe for how to institute this radical, dangerous idea. He called it Shock Economics, using times of war and natural disaster to institute his policies while the country was literally in shock and looking for leaders to guide the country.
The Shock Doctrine details that path much better than any summary argument I could make. It is a cautionary tale far beyond the pseudo-economic opinions of me or anyone else that pretends to be an expert.