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Now that the government has proposed bold solutions to the financial meltdown, and also rejected them, I am digging my underground bunker and hoarding canned goods. I call that "doing my part."

I wasn't truly scared until I saw on the Internet that Michael Moore has waded into the economic discussion. When citizens start getting their economic guidance from Michael Moore, well, that is a harbinger of doom. But the worst part is that I'm not entirely sure he's wrong. Stay with me on this.

There is a growing school of thought - let's call it the Michael Moore school - that the $700 billion dollar so-called bailout is intended primarily to enrich the already rich. To me, that sounds like a cartoon characterization of a complex situation that couldn't possibly be accurate. On the other hand, a year ago if you told me the entire economy depended on making loans to people who couldn't repay them, I would have dismissed that too. So I am reluctant to dismiss ideas just because they sound crazy.

Let's pause here to acknowledge that any governmental action to maintain the health of big banks, and the economy in general, will benefit rich people the most, simply because they have more money on the line. That's how capitalism is constructed. The relevant question is whether lower income people also gain by the $700 billion bailout.

Viewed in terms of suffering, it seems obvious that rescuing the economy helps low income people the most. A billionaire who becomes only a half-billionaire doesn't suffer as much as a factory worker who loses his job, or has to pay more taxes, or gets devoured by inflation. So if the price of helping the factory worker is that some rich people get richer, that's unavoidable under capitalism.

Lately I have been hearing that the $700 billion should go directly to help the people who need it, not to help the greedy corporations. In other words, the government should borrow $700 billion from the taxpayers and then give it back to them. I think that is the kind of thinking that caused the problem in the first place. Unless this is just another way of saying the government should transfer a huge amount of money from the rich to the poor in one fell swoop. If that's the plan, let's call it what it is, and debate it clearly.

What seems missing in all the discussions of the bailout is some sort of description of what is likely to happen if we do nothing. Personally, I am not persuaded by hand waving and vague pronouncements of doom. I'd like to see the risk illuminated a bit.

For example, is the risk primarily to a number of big financial institutions that wouldn't be missed by anyone but the stockholders and employees who signed on for the risk? Or is the failure of those companies just the start of a process that would inevitably cause a great depression? I have no idea.

Does anyone have a link that describes what probably happens if the free market sorts out things on its own?
 
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Oct 13, 2008
Paul Krugman wins nobel prize in ECONOMICS. I my reading it seems more republican economists are moving to the democrats. BUT NO, THATS NOT A ONE, REAL ECONOMIST HAS EVER BEEN A NEOCON. THE SO CALLED NEOCON ECONOMISTS ARE MOSTLY OLD HACKS. L.OOK THEM UP ON THE WEB.
 
 
Oct 13, 2008
you don't like moore. well he says his aim is to be as right as opinion pages. f you talk to the same people who belive the same as you. well there are people who really know things out there. Paul Krugman was at MIT for years. and i never thought of him as liberal. now he is. for about the last 6 or 7 years. he didn't like people who could or would not count running the country. he can tell you what happened, how long its been coming and thing about the bailout you may not want to hear. then there Robert Reich. hes always been a liberal. . and its his job to see whats really happening.

 
 
Oct 4, 2008
Hi Scott, I recommend you take a look at some of the articles on the Mises Institute website, such as http://mises.org/story/3131. I find these articles quite interesting to read.
 
 
Oct 1, 2008
not exactly credit crunch, but quite interesting.

http://tbm.thebigmoney.com/articles/explainer/2008/09/18/how-aig-fell-apart?page=0,1
 
 
Oct 1, 2008
Regardless of your feelings on whether the bailout is a good idea in general, the bill has some huge issues itself. A buddy of mine did a great (long) writeup on what is wrong with the bill as it's currently written, in response to Congressman Price's form letter he's been sending out to constituents on the matter:

http://loobin.wordpress.com/2008/10/01/dear-congressman-price/
 
 
Oct 1, 2008
Depends on what you mean by doing nothing. The Fed, Treasury, FDIC and others have all been doing something for a long time. So are you asking what would happen if they stopped? Or, do you mean what would happen if Congress doesn't act right now? If the latter, the Fed has emergency powers to do just about anything, so it would probably pick up the slack of Congressional inaction along with the Treasury. As McCain has pointed out, the Treasury has about $1 billion at its disposal for emergency action as well. The vote before the House gets the executive branch and the Fed off the hook for whatever happens next and lets the political caricatures grandstand and pander before the election. If it passes in its current form, the bill has the added benefit of paying off Wall Street constituents for their bad decisions. Despite my cynical view, I wrote the following to my Representative as though legislative action were absolutely necessary. I would rather have my version than the current version, but would prefer nothing. Hopefully, this will clear up some misunderstandings about the structure of the credit markets, banks, investment houses and regulators (e.g., that the FDIC is underfunded--which it is not).

Dear Representative ___________,

Those in Congress who voted “nay” yesterday on the Emergency Economic Stabilization Act of 2008 (H.R. 3997) may well have extended their political careers. Despite the brevity and opacity of the debate, and the complexity of the issues, the American people yelled “Stop!” and got the issue right. There is hope for capitalism in this country; however, congratulations are not in order yet.

The crisis is severe. I witness it myself everyday as I work in the financial markets. However, we must not hastily enact foolish half measures and giveaways that will only serve to worsen the problems we face. Nor should we overact with stifling legislation that only solves the last debacle.

As you know, the Act is being revised as I write this and there will be great pressure to pass it soon. Legislators say it is being “tweaked.” Rather, it must be completely reworked to address its fundamentally flawed approach. I have read the statement on your website dated September 30, 2008 and appreciate your principled decision to vote no. I did, however, find the statement a bit vague and feel obligated to make the following clarifying points and to offer what I feel to be a workable solution.

Why the Act will fail in its current form and, in fact, make things worse.

1. The Act approaches the current crisis from a liquidity standpoint. Though liquidity is an issue, it is not a root cause. The problem is one of capital and solvency, or the lack thereof. Though the Act will temporarily help the balance sheets of banks and investment houses, it will not encourage them to lend. They will have no incentive to cease their hoarding of cash until the issue of trust can be resolved. Not until the insolvent institutions are placed in receivership and sold off will that trust be regained.

2. Not only must the financial institutions trust each other, but the other business sectors of our economy must trust the banking system. There is a silent bank run that is decimating our financial institutions and will continue until that trust is restored. The Act does nothing to restore that trust. It is correctly perceived by businesses and individuals as a stop-gap that temporarily shores up all players in a system where many players deserve and need to fail—and quickly at that.

3. Many have compared this crisis to the Great Depression or the protracted Japanese Recession of the 1990’s. While the direness may be comparable, there is a key difference. The U.S. in the 1930’s and Japan in the 1990’s had current account surpluses, as opposed to the trade deficit that we now run. Because we rely on a constant stream of investment from abroad to finance this deficit, what should be domestic economic issues have now become matters of international policy. The nationalization and government guarantee of Fannie Mae and Freddie Mac are the prime example. We were forced to save these failing institutions to protect the foreign bondholders that we had implicitly guaranteed in the late 1990’s, most of whom are foreign governments (as private foreign investment in the U.S. has long ago dried up—an ominous and prescient indicator of the current crisis). A $700 billion plus giveaway will tank the U.S. dollar, will dilute existing foreign investment, and threatens the future foreign capital investment that we still need desperately. South Korea has publicly stated this in their objection to the Act, and others are saying it privately.

4. In the late 1920’s, Germany was recovering with the aid of capital investments by the U.S. and Great Britain. Upon the Depression, those investments dried up and Germany succumbed to hyperinflation. The resulting political unrest gave way to the Third Reich. I would not disparage my fellow Americans by suggesting we would act similarly, but I can assure you that you do not want to be running for re-election in a climate of hyperinflation. Capital flight in Russia in the late 1990’s and in Argentina early in this decade provide additional examples and insight. Simply because we are currently the world’s reserve currency does not insulate us from these problems and, until we run a current account surplus once again, we need to protect our foreign investors (though not be entirely beholden to them). The Act as currently written does the opposite.

5. In an ironic twist, because FASB 157 now requires banks to account for their illiquid assets at fair value or marked-to-market, sales of a distressed asset to the government by one bank will cause other banks holding similar assets to write down such assets to the sale price. This in itself could worsen bank’s balance sheets.

6. The only role in which the Fed or Treasury has proven adept is in the facilitation of transfer of assets, not the purchase and management of complex assets. The suggestion that the taxpayers may actually make money off the $700 billion purchase is a fraud akin to the pitch of a stockbroker that has just tanked your 401K and is promising to make it all back if you’ll only send more money. The reason the market for these assets is illiquid is not because price discovery has failed, it is because the prices are still too high. The fallacy of a “reverse auction” will not cure that. Only lower prices will. If that means that institutions must write them down and become insolvent, so be it. Many of these opaque instruments are likely garbage and will remain that way, and the government is the least efficient entity to sort through them. The only way these assets will rise in price, if at all, is through inflation. Is that what Paulson has in mind?

The solution.

The solution should provide temporary help to financial institutions that are still solvent and not reward financial institutions and the investors (shareholders and bondholders) thereof that have made the bad decisions that put them in dire straits.

1. Insolvent financial institutions (both banks and investment banks) must be placed into receivership and sold off as quickly as possible, and the solvent ones must to be made viable by being injected with capital in exchange for preferred shares to the government. This will restore much needed trust among financial institutions.

Insolvent financial institutions must be identified quickly. The FDIC has proven adept at this as it facilitated the closings, receiverships and sales of Indy Mac, Washington Mutual and Wachovia at very little relative taxpayer expense. The FDIC should be granted temporary expanded regulatory authority (similar to the authoritative scope of the Reconstruction Finance Corporation of the 1930’s) over banks as well as investment banks to aid in this process.

It is important to note that, were it not for their debt to bondholders, most banks that are currently insolvent would be solvent. By placing them in receivership, wiping out the shareholders, and doing a debt to equity conversion on their outstanding debt as is commonly done in bankruptcy (or wiping out the bondholders entirely), these banks would be easily salable with little taxpayer cost. There is plenty of private investment capital looking for these deals. The buying party would take on the depositor and counterparty obligations of the bank with no disruption to the customers.

Of course, there are banks in terrible shape, the depositors of which will need to be fully reimbursed by the FDIC. This is unavoidable under any scenario (the $700 billion giveaway will only prolong it) and needs to be done sooner rather than later to restore confidence in the system.

For financial institutions that are solvent, the government should provide them with temporary capital funding in exchange for preferred equity or debt senior to everything but customer deposits and counterparty obligations. These capital infusions could incur an interest rate after a period of time to encourage repayment.

2. After the insolvent banks are identified (again, as quickly as possible), the Congress must remove the $100,000 ceiling on FDIC insured deposits and make it unlimited so that individuals and businesses will feel safe to move their assets out of Treasuries and once again into the banks. The silent bank run identified above is draining banks’ deposits and capital base. Once this is reversed, financial institutions will have more to lend against.

There is a legitimate fear that an unlimited ceiling would quickly deplete the approximately $45 billion current surplus in the FDIC’s funding. However, making this measure effective after closing the insolvent banks mitigates this risk. In addition, because the FDIC is already self-funded through depository insurance premiums that it sets and collects and because it may run a deficit with the Treasury, it is unlikely to reach the statutory deficit limit and would eventual repay any deficit in its entirety by collecting future premiums from its member banks.

3. This solution is still costly and I would expect a minimum of $400 billion would need to be allocated to infuse capital in solvent institutions. However, it is not an exchange of cash for garbage and, therefore, not as likely to hurt the U.S. Dollar, nor would it reward corrupt idiocy. It has the greatest chance of being repaid to the taxpayers because the capital loans will be made only to fundamentally solvent institutions. If the voters demand direct help to the individuals in home foreclosure to pass this legislation, then there are sane models, such as one proposed by the Professional Risk Managers International Association. See here: http://www.institutionalriskanalytics.com/research/proposal_092808.html.

Future regulation and reform.

This crisis is not a result of free markets gone awry. No bubble, including the housing bubble, can take place without the blessing and assistance of the government. To trace the specific path that leads to where we are is beyond the scope of this letter. What I will stress now is that the worst possible course of action would be to react as Congress did to the Enron debacle, and to pass Sarbanes-Oxley type legislation that increases the cost of business, stifles free enterprise, and does very little to prevent future malfeasance.

The Commodity Futures and Modernization Act of 2000 created the “Enron loophole,” which was purposefully inserted into that sweeping legislation to accommodate Enron. A loophole does not equal deregulation or free markets, and the latter two should not be impugned by or confused with the first. Similarly, the current crisis is a result of government intervention that engineered loopholes into the regulatory structure to fuel a speculative boom in housing prices and allowed financial engineering to hide the risk associated with that boom off bank balance sheets and to shift it abroad.

Our current financial system is flawed and will not be rectified until we can end our reliance on foreign investment and bubble-fueled hallucinated wealth. Until then, crippling legislative reform must be avoided. Many required changes have already occurred. As mentioned previously, Financial Accounting Standards Board 157, passed in late 2007, requires that banks account for their illiquid assets at fair value. Though this popped the housing asset bubble, it was necessary. We would have been better served had it come sooner, and are fortunate it did not come later.

Also, Goldman Sachs and Morgan Stanley, both investment banks, recently applied for and were granted expedited Federal bank charters for their bank subsidiaries and they are in the process of moving hundreds of billions of dollars into such subsidiaries. Institutions are wary of doing business with publicly traded investment banks whose investors and counterparties can be wiped out, but feel secure doing business with highly regulated bank subsidiaries that protect depositors and counterparties. Accordingly, the transparency that Graham-Leach-Bliley failed to bring a decade ago now has begun to come about on its own.

Conclusion

Swift action is required; however, not at the expense of prudence. Consider the above when reviewing the revised Act and reject any proposal that does not get rid of insolvent financial institutions or that places complex assets in the hands of Washington. We are standing athwart history. Your votes are being recorded and we will remember them.

Very truly yours,

[Me]

[Thanks to Barry Ritholtz, Eric Janszen, Chris Whalen, Michael Hudson and others for their ideas and information, from which I borrowed heavily]
 
 
Oct 1, 2008
Hello Scott,
I am from India and a regular reader of your blog. The questions posted by you in the last post are precisely the ones that have been bothering/puzzling me and, I guess, many other people in the US and around the globe too. Coz so much in other economies is dependent on the US economy. But I (we) just dont have the necessary resources to get the answer to these questions which in ur words only are : "is the risk primarily to a number of big financial institutions that wouldn't be missed by anyone but the stockholders and employees who signed on for the risk? Or is the failure of those companies just the start of a process that would inevitably cause a great depression?"

So please get those answers, read about them, analyze them thoroughly, get a poll of economists if you may :) , or do whatever, but please post the answers to these questions. Believe me when it comes to the list of "logical thinkers", you are right on top. I am waiting for your answer in the next post(s).
Bye and thanks,
Kunal.
 
 
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Oct 1, 2008
Here's a link:
http://www.nytimes.com/2008/10/01/business/economy/01leonhardt.html

I won't bother trying to add any grandiose comments, suggestions, what have you. I mean Michael Moore has spoken, and that in itself is impressive because of uncommon largeness.
 
 
Sep 30, 2008
“They claim to be be free-market advocates when it’s really an anything-goes mentality: no regulation, no supervision, no discipline. And if you fail you will have a golden parachute and the taxpayer will bail you out. ”

Nancy Pelosi on the crisis. Truer words were never said.

 
 
Sep 30, 2008
The reason for the crisis were the wrong economic policies and faulty and inadequate regulation of the system.

Just to give an example, I have read that Richard Fuld,CEO of the now bankrupt financial giant Lehman Brothers, was also on the board of governors at the Federal Reserve Bank of New York . Talk about conflict of interest!

Whichever way the crisis is now addressed, thru bailout or otherwise, I see little being said about how to get to the cause and improve the system to avoid a recurrence of such a event again.

A bail-out is the fastest way to sweep the incompetencies and moral laxaties of the elected government under the carpet. The sooner everybody forgets about the crisis, the sooner they can get back to taking money from lobbyists for their parties.


 
 
Sep 30, 2008
I liked where one member of Congress, who acknowledged that gathering information about this economic situation which is beyond any understanding of economic policy he'd every known, said it was like 'trying to drink out of a fire hose'. I'm sure we all feel like that.
Because Phil Gramm weedled Congress into going along with deregulation in late '99, which took away the Glass-Steagall 1934 protections, we allowed the Federal Reserve to loan out $3 for every $1 we have. So it only took 4-5% of the bad morgage debt to crater the whole shebang.
There is no bailout or rescue possible. The choices are: the economy can die of a sudden heart attack, or of lung cancer. Either way, it's over. The bailout will prolong the process and make any type of rebuilding that much harder.
Those crazy ass conspiracy theorists have been talking about this for a long time. You know, the 'buy gold now' crowd. The US has been living off a credit card for a while. The credit could stop, real quick. Can the gov't. even make the $511 billion interest-only payment October 1st? I haven't heard any mention of that in this whole discussion.
The trouble comes when those people who depend on welfare checks and food stamps to feed their 3 year old and their baby cannot travel to an open grocery store after the gov't. quits sending out those payments. People who can't feed their kids get desperate, fast. That's where martial law comes in. But, thank god, this administration has thought of that, too! Phew! For the first time, military will be stationed in the US and trained to quell civil unrest. See, they have planned ahead. That starts October 1st. October could be a helluva month.
'May you live in interesting times'.
I personally have a bad feeling about Oct. 7. Don't know why. And I've been saying for two years that the elections and transfer to a newly elected president are not going to happen.
Now, if I'd only bought gold I'd be feeling pretty vindicated.
 
 
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Sep 30, 2008
"Does anyone have a link that describes what probably happens if the free market sorts out things on its own?"
This one is brilliant and you even get to watch a movie:
http://optionarmageddon.ml-implode.com/2008/09/28/a-picture-of-the-apocalypse/#more-267
 
 
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Sep 30, 2008
What's sad is that no one is considering the most logical alternative to this situation. The easiest way to solve a problem is to eliminate the cause.

We are having financial troubles. What this means is that there is not enough money. Well, if no one needed money, there would not be any financial trouble, would there? If we stopped using money, an I.O.U., to pay people, and went back to REAL trading, we would not have any problems. If you wanted to buy a bed, you'd find out what the other person wants of yours in exchange. If you are not willing to give up that item, then you really don't need a bed, do you?

If people would stop being afraid of not having money and started looking at what that money really is we'd be rid of this barely green paper and everyone would be better off.
 
 
Sep 30, 2008
Yeah, well instead of paying a $700 Billion bail out package which may have had some positive effects, they rejected it, and there was a $1 trillion loss within the first day in the U.S alone, not to mention other global financial markets. Wouldn't it have been worthwhile to go with the bail out package to at least keep some confidence within the markets and avoid the obvious loss that would occur by abandoning the proposal? Probably.
but Politics is > Economics at times.
 
 
Sep 30, 2008
Here's an article that sums the bail-out up. The jist of it: it's a bad idea to throw good money after bad. We would better off changing lending policies and getting rid of Fannie and Freddie, then letting market forces fall where they may, there will be some bankruptcies.

http://www.cnn.com/2008/POLITICS/09/29/miron.bailout/index.html


The author is a Haaavaad economist.
 
 
Sep 30, 2008
If the comments from Michael Moore seem like a harbiger of doom, how about the quote from Rush Limbaugh on the republican leadership, "C'mon guys, can ya grow up?"? When good old Rush criticizes the republican leadership and Michael Moore is regarded as an economist, truly the End of Days must be near. I think that's in Revelations somewhere.

My personal options seem limited to either the bunker and canned goods route or the purchase of a horse and a nice sword so I can go riding with the 4 horsemen of the apocalypse. I'm favoring the latter right now because it doesn't involve buying gas.

 
 
Sep 30, 2008
what does 'fallmoose' mean?
 
 
Sep 30, 2008
This wall street debacle is nothing more than corporate america and the bush administration giving themselves some more handouts on their way out the door.

You can pretend that you know something about what is going on, you can have an opinion based solely on the fact that the people you like on television say the things you already agree with- you can even have some graphs and articles that reinforce your beliefs. I don't care if you are a republican, democrat, independent, 99.99% of us out here are not qualified to make a statement about the state we are in, at best we can run around screaming with complete confidence that we are screwed.

If this bailout fails, we are screwed.

If this bailout succeeds, we are screwed.

If McCain is elected, we are screwed.

If Obama is elected, we are screwed.

This is the nature of our position, that is to say, NOT IN POWER. Our political system is merely an ongoing sporting event for the masses to be entertained by.

How do I know this? Turn your tv off. Ignore the election. A few years go by and guess what? Country's still here. Still a democracy. Still making a crappy wage. Still no decent health care. Educational system still the first thing that funds are torn from when budgets get tight. Still screwed. Tell me I'm wrong. Or, don't - I don't read the other comments on here because, largely, the world is populated with idiots. I am certain that I am one, too.

(I was going to cut down this tree in my yard, but I thought I'd do you the favor of seeing if you didn't want to hang yourself from it first. You know, kind of a public service.)
 
 
Sep 30, 2008
Seriously fallmoose?

85 Billion divided by 200 million adults is $425 per person, not $425,000.....to give 425,000 to 200 million adults would require 85 trillion dollars, or 6.5 times our 2007 GDP.

Check the math and keep junk out of my inbox.
 
 
Sep 30, 2008
Why not give the american tax payer the 700 billion?! that would immediately get a return of 25-60% back in income tax. People would be able to pay off their bad loans, and the good ones too. That would save the banks because people would deposit a a ton of cash each. The banks would then have plenty to loan out, thus resolving the credit freeze. People would also buy things, lots of things, and so the markets (all of them) would benifit.
Give me one relevant and accurate reason that wouldnt work?
 
 
 
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