I'll try to respond a little more briefly than the treatise presented by Freyguy on "Capitalism Burning". He's only in his first year of the Phd program, and I doubt the physics department will accept "Capitalism" as thesis material, but it's certainly long enough and the viewpoint original enough to be counted as a thesis.
The grad student brings out one of his favorite whipping boys, Fox News, and accuses them of blaming Fannie and Freddie for the whole financial meltdown. Regardless of what Fox Newa says or doesn't say, I can state what I ascertain based on facts, and why I believe the significant contribution to the global financial meltdown of the Fannie and Freddie collapse is so important and instructive.
First, it is important to understand how big a role the overheated U.S. housing market and the irresponsible lending to it, played in the financial meltdown. Bools will be written about this, but I'll be as brief as possible, and let the readers do some of their own research. When the government seized Fannie and Freddie they had over $5 trillion of mortgages...more than half of the bloated biggest mortgage market in the world. At that time, the current Treasury Secretary Paulson said " Fannie Mae and Freddie Mac are so large and so interwoven in our financial system, that a failure of either of them would cause great turmoil in our financial markets here at home and around the world." (Sunday broadcast news) "They (Fannie and Fredie) guarantee or own roughly half of all the $12 trillion U.S. mortgage market and this figure has been steadily increasing as other lenders either failed or reduced their exposue to a falling market." "Almost all U.S. mortgage lenders, from huge financial institutions like Citigroup to small local banks, rely on Fannie Mae and Freddie Mac." BBC 7 Sept., 2008.
Further, large amounts of this massive mortgage debt portfolio was rolled up into packages named "Collateralized Debt Obligations (CDOs) and sold as securities by banks. These also collapsed with the housing market collapse. "The banking industry will be forced to take hundreds of billions of dollars of further writedowns on mortgage backed securities after Merrill Lynch sold $30.6 billion of CDOs for only 22% of face value." " Sean Egan of Egan Jones called this sale a watershed moment, with implications that would trigger huge additional writedowns on CDOs worldwide. This sends a loud and clear signal that the issue with CDOs is not liquidity in the market, but problems with the value of the underlying assets (mortgages)." (Times of London July 30, 2008). "A large proportion of synthetic CDOs reference Fannie Mae and Freddie Mac." (Forbes Sept. 2008).
Wow!...Trillions of dollars of mortgages held by two insolvent GSEs (Government Sponsored Enterprises)...Hundreds of Billions of dollars of mortgage related writedowns and additional hundreds of billions of dollars writeoffs on CDOs, of which a "large proportion reference Fannie Mae and Freddie Mac". Sounds like a pretty big part of the problem to me (and Congress seems to be fine with paying their executives $210 million in bonuses for this colossal failure).
I wish to make three points in response to Freyguy's post. (None of them have to do with the now standard liberal response to any criticism of current policy: "Oh yeah, but Bush started it, and the war in Iraq, and besides Europe didn't like Bush".)
1) The government is an incredibly poor manager of business, banking and the economy (no matter which party is in power) and should endeavor to do as little as possible in these areas. The government is poor in these areas for only two major reasons: the lack of skill (i.e. trainig and experience) and motivation(i.e. political vs. financial). However, I agree with the government having an important rol;e in regulating business, banking and the economy, as well as having the key role in monetary policy. The examples of this are too numerous to list, but Social security, Medicare, the aforementioned Fannie Mae, the postal service are good for starters (all bankrupt). And Fannie Mae is an excellent example of both business incompetence and political motivation superceding financial prudence. It is well documented and a matter of public record that Fannie Mae was directed by the government to increase the issuance of mortgages to people who were unlikely to be able to pay them, in the interests of increasing home ownership for constituent groups. (I'm not blaming the people who took these mortgages or saying it was a good or bad thing...simply that it was a financially imprudent and risky thing that was politically motivated).
2) The Grad student, liberals and some conservatives, really misunderstand government regulation of business and banking. It is done largely by...Congress...the legislative branch (remember?...the branch that makes laws)..not the president, or the executive branch. Guess who oversaw and held hearings to review regulations regarding Fannie and Freddie as long ago as 2003? That's right...the Congress. The heads of the relevant committtes were (as they are today) Senator Dodd and Barney Frank. Yes, Republicans were for deregulation of banks years ago, but the Congress had to pass the legislation on those changes. People...if you're angry...be angry at the lifetime job, family business, ruling elite in your CONGRESS!
3)I agree with the Grad student that there are serious problems created by the "coziness" of the financial industry and the government. But I struggle to understand how direct control of the financial institutions by the government somehow makes that relationship less "cozy" (seems to me it just went from "cozy" to "intimate".By the way...anybody want to guess who the top two alltime high presidential candidate recipients of wall street dollars were? (Hint: they're both in the present administration). My solutions? (A)Businesses and banks who fail, should...fail. (B)Government and Financial industry "coziness" would be significantly helped with term limits. (C)All campaign donations must be made anonymously.
The Old Man is dead on with his analysis, but I don’t think he goes far enough in assigning blame to the Fannie/Freddie/Government debacle. One of the most disastrous things about this sad fiasco is its contribution to moral hazard. Here’s why.
ReplyDeleteFirst the government directs Fannie and Freddie, the multi trillion pound gorillas under the tent, to make sure that people who can’t afford a home can none-the-less qualify for a mortgage. And since being in charge of Fannie or Freddie is worth million and since having an implicit government guarantee (now explicit) allows F&F to play poker while being dealt from a pinochle deck, they will make damn sure that it to follow their marching orders, especially since Congress is keeping the regulators at bay. Besides, F&F are committed to social good. So they tell the mortgage makers to ‘make it so’.
And so if I am a mortgage broker and a charming couple wants a house that they can’t afford a question immediately presents itself: what documentation should I examine to verify that they really can’t afford the house they want to buy? No, really, I give up, what should I look at. And once the slide downs this steep slipper slope begins, why bother with any financial niceties? How much of a leap (slip) is it to say, well, what the heck, let’s give you a mortgage for more than the house is worth and maybe we can even arrange for you to get ‘instant cash back’? (They aren’t doing that deal anymore, but prices have fallen enough in some markets that you can get something approximating ‘buy one, get one free’.) You can’t trash the rules and then be surprised at the mob mentality that results.
Now admittedly securitizing those loans made it easier to do more of them; but look at the bright side – at least that allowed US investors not to get stuck with the entire mess. This is not to say there aren’t other problems. Too much leverage and a risk reward system that compensated executives for short term performance also contributed mightily. If nothing else, this proves (if any was needed) that people respond to incentives, good and bad.
Which brings me to a sour note for Freyguy: while I enjoy and respect your point of view I was disappointed by the line, “The suggestion that poor, lazy masses of people--especially minorities--had some hand in it is not far off.” That cruel over-the-top straw man stuff should be left to politicians.
But I do agree with Freyguy on the military. I too am tired of picking up the tab for most of the entire free world I am appalled at the fact that we are keeping a huge nuclear missile arsenal and a large standing army. I suggest we keep the missiles (what the heck; they’re paid for already), but just to protect the US.
Let’s not get involved so much overseas. Let’s cut our conventional forces by pulling troops out of Korea, Japan, Europe, the Middle East and Antarctica. We should encourage those countries (and regions) to get by without us. They should be responsible for arming themselves to the teeth and developing their own nuclear weapons. And they should learn how to deal with their own crises. The next time the Balkans explodes They should bother Uncle Sam because it’s their problem. Other democracies need practice learning how to get along with rogue states and terrorist, err, sorry, ‘people who make man-made disasters’ on their own nickel. Nothing focuses the mind quite as much as imminent extinction. Besides this strategy was good enough for Americans in the first half of the 20th century so it should be good enough for Americans today. Back to the Future or something like that. And anyway we always win the World Wars in the end, right.
Finally, I slaved through the overly long (11 page) article you recommended from Simon Johnson, professor of MIT, the head of IMF and economic savior of lesser countries. So I feel justified to continue my own overly long post with some observations.
The way you get Crony Capitalism is big intrusive government. Most businessmen find Crony Capitalism offensive, but when government is all pervasive businessman (and women) often feel they have no choice but to become heavily involved. Either they want to buy favors or they want to buy protection (from rules or regulation or indulgences granted to competitors). Yes that’s also pretty much the way the Mafia operates so at least we can have confidence that this kind of system works. And while politicians say they want to reform the process, I just can’t believe they will ever devote themselves solely to the olive oil business. You can’t kill Crony Capitalism, but the bigger and more intrusive the government, the more you get.
I also found entertaining Mr. Johnson’s identification of large banks as Oligarchs? It conjures up visions of a corrupt Russian-type business arrangement (again, the Mafia). This kind of labeling is a great way to gain attention to your premise and stoke populist outrage, but ultimately it gives off more heat than light. All banks do not have the same agendas and government responses to the financial crisis have not been universally applauded by them. And while the financial firms right now are the cause du jour, the arguments Simon Johnson uses about oligarchs could and are also used against big oil and the likes of Microsoft (though Microsoft is mostly the bogeyman in Europe). But it leads me to wonder how others feel about financial oligarchs being credited for controlling the government. I’ll bet the executive in the ExxonMobil boardroom are hopping mad about being excluded.
It is interesting that Mr. Johnson concludes his article by saying that the IMF can’t save the US. Apparently we are too big to succeed. According to the professor the US has only two alternatives: one is certain to result in failure and the other is initially more painful and likely to result in failure anyway. Economists, particularly liberal economists have been betting against the US economy at least since I began following financial news in the 70’s. One day they may be right, possibly even for the reasons they think.
Old Man,
ReplyDeleteYou make some really excellent points. We agree on fundamentals:
1) I agree with you that this entanglement between the public and private sectors is dangerous and that the government's primary role should be regulation.
2) This entanglement includes Congress, and not just Republicans or Democrats.
3) Businesses and banks who fail should fail; I would add there should be measures which restrict bank/investment size so they cannot become "too big to fail". I also think your ideas about term limits and campaign finance are sound. These are ideas which I have heard coming from people on the right (like Newt Gingrich) as well as people on the left. Unfortunately, as you suggest, Obama received an enormous amount of campaign money from Wall Street.
Let me clarify some points:
I wasn't suggesting permanent government takeover of banks. What I am saying is that IF taxpayers are going to pay for a bank, then taxpayers should get a stake in that bank and have some say in how its strategic decisions (i.e. lending to help the economy vs. taking advantage of the situation by buying up competitors). This logic seems elementary to me. The public can then sell the bank back to the private sector when conditions improve.
Yes, Fannie and Freddie are Government-Sponsored Enterprises. Though it's unofficial, that would be a valid description of many major U.S. banks these days. Of course I agree Fannie and Freddie played a big role in catalyzing this particular meltdown. What I said was that these bailouts "are just the most recent manifestation of a recurring trend...that privatizes profits and socializes risk".
The historical examples I had in mind were: the bailout of the Savings & Loan industry in the '80s; and the bailouts of Mexico, Thailand, South Korea, and Indonesia in the '90s. The last four were in fact bailouts for foreign and U.S. investors who (once again) had made large, risky moves for enormous profits, knowing that taxpayers would probably come to their rescue in the event of failure, and that they would get their giant severance packages in any case. Common causes have been identified in all of these cases: socially risky but privately profitable investment--encouraged by investors' awareness of the "too big to fail" problem, their influence on public policy through campaign finance contributions in Congress, and their friends and colleagues in the Treasury Department, and above all deregulation (e.g. repeal of the Glass-Steagall Act).
In ALL of these cases, each stage--risky investments, unemployment and downturn for average people, and then bailouts--was enormously profitable for a certain group of people, people who have enormous influence on public policy through non-democratic means. The gentlemen in the Treasury Dept. whom you have criticized tend to be the giants of the investment world. Their public service appointment is just a stint (perhaps a favor for campaign contributions?) after which they return to the private sector to make additional fortunes in consulting. The problem here is not "government incompetence", it's corruption.
In 1998 when Treasury Secretary Robert E. Rubin argued for billions in bailouts for "Asian countries" (U.S. investors), he cited large declines in profits at banks like J.P. Morgan, Chase Manhattan and Citicorp. Rubin, previously co-chairman at Goldman Sachs, successfully conjured hundreds of billions of dollars. The bailout probably had no effect on most people living in the U.S. or Asia, but it did alleviate the heart-wrenching suffering of large investment firms. Former Treasury Secretary Paulson was chairman at Goldman Sachs before being called to public service in 2006, and shortly thereafter getting $800 billion to dish out, with no strings attached, to his favorite people. The Secretary during the S&L bailout was yet another chairmen of a large investment firm. History is repeating itself.
The Old Man has told me that there should have been strings attached: banks could only accept bailout money if they used it for lending. This would help the economy, and therefore the average taxpayer, which seems fair since it was the average taxpayer coughing up the dough. But that's not what the benevolent Paulson advocated. Why? The NYT quoted an anonymous high-ranking banker as saying, “It doesn’t matter how much Hank Paulson gives us, no one is going to lend a nickel until the economy turns.” JP Morgan sent a letter to its shareholders assuring them no bailout money would be used for lending; only buying up competitors. Is it possible Paulson, who played the cutthroat investment game for decades, did not know exactly what he was doing?
I'll take my chances this time with a longtime public servant, Obama's pick for Treasury Secretary Tim Geithner, thanks.
-Freyguy
Fred,
ReplyDeleteGreat to hear from you, as always!
Cavuto of Fox Business channel said: "I don't remember a clarion call that said: Fannie and Freddie are a disaster. Loaning to minorities and risky folks is a disaster." I stand by my remark that the blame on poor people and minorities is not far off in some circles. It's a notion worth throwing away, and I'm glad neither you nor the Old Man would dream of suggesting it.
I note that the Old Man did not comment on our splendid little $3 trillion war in Iraq or the $500 billion/year Defense Department. I'm glad you brought it up. Wouldn't you say now is a good time to review our expenditures and tighten our belts a little?
I've met some physicists who worked in private high-tech companies subsidized by the government, on expensive, fancy-sounding Laser Weapons for planes. Presumably the goal is to replace our ineffective stealth bombers, nuclear submarines, and unmanned predator drones, in order to keep pace with the colossal military might of our third-world enemies.
I'm not saying we should not spend any money on defense. But the genocides in Rwanda, Darfur, Turkey, East Timor, and the violent conflicts in Israel, Iran, Iraq, El Salvador, Sri Lanka, Afghanistan, and so on were not a result of insufficient U.S. military spending. In some cases, a mere diplomatic gesture to an ally (like Turkey or Indonesia) would have greatly mitigated if not ended the killing.
I concede to you that if we did not arm our friends and enemies to the teeth, they would probably arm themselves to the teeth. The difference is that we wouldn't be the ones paying for it, while they enjoy higher standards of public education and health.
I agree crony capitalism is a serious threat. However, I think one part of any solution should be to break up large institutions, such AIG, into smaller, less politically powerful businesses.
ReplyDelete