0809.30
11:50:18
Economic Policy 101 cont’d
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Instead of posting a massive comment reply I thought I’d just make a new entry in response to Matt’s comment on Economic Policy 101:
In this case, there is all of this bogus debt from mortgages out there that banks have been hesitant to disclose, or whose presence is otherwise not transparent due to the complexity of these derivative transactions. Because of this, banks are very shy of lending to each other, because they’re afraid that the other bank might have a bunch of bad debts, become illiquid, and collapse; this is why the LIBOR rate is climbing. Since, though, these liquidity-strapped institutions find it harder and harder to access short term capital it makes them look even more unstable which continues the feedback loop. That instability causes investors to flee to treasury bonds as the government looks much more stable than the financial institutions backing the other investment instruments, and this heightened demand has depressed the t-bill yield to almost zero. Banks can neither ensure their continued profitability (and therefore existence) through long-term investments in private financial instruments like CDOs, as they could be backed by unpayable subprime mortgages and therefore be worth much less than their face value, nor can they through government-backed long-term investments as their is so little yield that banks would end up losing money as the interest payout would be lower than the inflation rate.
The United States government, however, as a sovereign entity, is not fettered by the profit motive. Even still, your trader friend is absolutely right: expropriating CDOs at 20 cents on the dollar is actually an asset purchase even if those CDOs are really only worth 30% of face value. The issue for banks is that its too big of a risk for them to sell to other banks at below face value (because certainly some of these are worth as much as or close to what they used to be traded for, so it would be unprofitable to sell these) and it is too big of a risk to buy (because even if you by at 50 cents on the dollar, what if you’re getting a bunch of loans that are on houses that were worth $250k ten years ago but because of the housing bubble were purchased at $600k? Loss!). Therefore no long-term liquidity, and as previously mentioned, there is no longer any long-term liquidity refuge in T-bills. But if the government can clear this blocked system of the obviously-bad debts, The banks and other investors are re-incentivized to invest in private instruments, restoring both liquidity in that field and raising the yield on treasury bills as long-term investment demand shifts away from solely t-bills (I almost typed Tblisi) to a broader focus.
Because the government is sovereign it can stand to take a loss if every instrument it buys is worth less than what it pays. It’s not just throwing money down a hole, like is when it pays for United’s broken payroll scheme; those instruments are still worth something because they are tied to a piece of improved real estate that by definition has a non-zero value. Further, because of the flight to treasury bills, the government is taking in money from those purchases! The receipts of this situation can be used, directly or indirectly, to finance the expropriation of the CDOs.
I am using expropriation instead of purchase for good reason: I think it is more useful to look at this as the government exercising its eminent domain powers than any of the other currently-offered perspectives. Instead of declaring that it is going to take a stretch of land to build a highway that benefits the public, it is declaring that it is going to take a subclass of asset from the financial system in order to restore liquidity that benefits the public. In both situations, the government pays a compensation, that in someway is based on “fair market value” but not always as closely as the previous asset-holder would have hoped for in the open market.
Severance packages piss me off to no end, too, Matt. Few high-level executives have ever done anything that should justify taking as much money as they do away from where it should go: to the shareholders as a dividend, or to the employees generally as compensation, or even better reinvested in the business. Perhaps there was a time when these huge executive bonuses and severances were justified when they were once coupled to executive performance; this is no longer the case in Anglo-American liberal capitalism (see pg 222, right column, of this article.).
An ordoliberalist viewpoint on this would say that in order to optimize market efficiency, there should be a constraint on the relation of executive pay to the median employee income. This would prevent wastage of funds on a few executives who are not doing anything sufficient to earn such money, and force it to be invested elsewhere, or returned to the shareholders. Ordoliberalism is not an ideology seeking a socialist or command economy. Far from it: it is as liberal (not in the American political sense) as 19th century lassiez-faire capitalism, or classical liberalism, and, I think, more liberal than what has become of the Anglo-American system, which has slid towards this bizarre combination of lip service to producerism and the hyperextension of corporate consumerism, neither of which is inherently liberal.
I can’t find my citations on this stuff, but basically if you look at the ratio of median salary to top executive pay in the US versus all of the other liberal economies, it’s pretty absurd. Don’t quote me on this, but I think it’s something like 10:1 or 12:1 in places like Germany and Japan and a bit higher in England, but something like 30:1 or 50:1 in the US. I’m pretty sure this information is in Capitalism vs Capitalism, because I can remember writing the name of that book down in my notes during a lecture last year which covered the subject.
Executive malremuneration, however, while a significant issue in the overall performance of the American economy, is not intrinsically linked to remedying the current situation and therefore needs to be treated separately, as the current situation is time-critical. The fact that someone as terrible an executive as Carly Fiorina can make about half as much in compensation for being fired as a good executive like Henry Paulson (whose merit I previously argued) made after leaving in good standing to run the Treasury is to me more absurd than the actual figures, as stupid and irresponsible as they are ($20 million for her, ~$50 million for him).
Carly Fiorina is actually relevant into my thoughts on the election, so look for that in the coming days.
MATT EDT 09:07:45 0809.30 (Tue)Yeah, the question of where the money will come from is a valid one, and your friend’s argument, while something I didn’t get into, is another reason why this is in no way a bailout. Past bailouts, of say, an airline, were essentially triggered because the company had gotten upside-down, you know, the airline was committed to spending more money than it could possibly take in. The reason why it had those commitments — pensions and union contracts and the like — was because the government formerly guaranteed airlines a place in the business through route regulation, and therefore airlines made financial commitments that they wouldn’t have if they were under the full pressure of market forces. As soon as the government removed these protections, it set itself up to throw money at the bloodbath that it, the government, had made of the airline industry, through the sudden release of “domesticated” corporations into the wilderness of the open market, if you follow my analogy.
I’m conflicted on this one.
What I didn’t ever hear is where the $700bn is supposed to come from. Do you have any idea? Seriously, no amount of Googling uncovers this information, and the fact that both Presidential candidates were asked in the recent debate how they would tweak the budget to fit the $700bn in makes me think that there really is no plan.
–Just print the money? I think that might cause some inflation.
–Cut $700bn worth of other federal programs? Good luck with that.
Still, it might not be such a bad investment either, according to a friend of mine who used to be a trader at CME. As he argued, this is “not a bailout, but a purchasing of assets at 20 cents on the dollar.†As he pointed out, those mortgage-securities aren’t worth zero because the houses are not worth zero.
What seems most damning about the “bailout†was the lack of oversight and the sweeping powers it gave to Hank Paulson. Not to mention the fact that not enough heads at the remaining banks have rolled  we’re extending ridiculous credit to the same “geniuses†who got us into this mess in the first place (not to mention that, for example, the 3-week CEO of WaMu got an $18m severance package!!) . Maybe if there’s a bit more new blood at the top on Wall Street, this plan would be more agreeable to the average Joe.
In this case, there is all of this bogus debt from mortgages out there that banks have been hesitant to disclose, or whose presence is otherwise not transparent due to the complexity of these derivative transactions. Because of this, banks are very shy of lending to each other, because they’re afraid that the other bank might have a bunch of bad debts, become illiquid, and collapse; this is why the LIBOR rate is climbing. Since, though, these liquidity-strapped institutions find it harder and harder to access short term capital it makes them look even more unstable which continues the feedback loop. That instability causes investors to flee to treasury bonds as the government looks much more stable than the financial institutions backing the other investment instruments, and this heightened demand has depressed the t-bill yield to almost zero. Banks can neither ensure their continued profitability (and therefore existence) through long-term investments in private financial instruments like CDOs, as they could be backed by unpayable subprime mortgages and therefore be worth much less than their face value, nor can they through government-backed long-term investments as their is so little yield that banks would end up losing money as the interest payout would be lower than the inflation rate.
The United States government, however, as a sovereign entity, is not fettered by the profit motive. Even still, your trader friend is absolutely right: expropriating CDOs at 20 cents on the dollar is actually an asset purchase even if those CDOs are really only worth 30% of face value. The issue for banks is that its too big of a risk for them to sell to other banks at below face value (because certainly some of these are worth as much as or close to what they used to be traded for, so it would be unprofitable to sell these) and it is too big of a risk to buy (because even if you by at 50 cents on the dollar, what if you’re getting a bunch of loans that are on houses that were worth $250k ten years ago but because of the housing bubble were purchased at $600k? Loss!). Therefore no long-term liquidity, and as previously mentioned, there is no longer any long-term liquidity refuge in T-bills. But if the government can clear this blocked system of the obviously-bad debts, The banks and other investors are re-incentivized to invest in private instruments, restoring both liquidity in that field and raising the yield on treasury bills as long-term investment demand shifts away from solely t-bills (I almost typed Tblisi) to a broader focus.
Because the government is sovereign it can stand to take a loss if every instrument it buys is worth less than what it pays. It’s not just throwing money down a hole, like is when it pays for United’s broken payroll scheme; those instruments are still worth something because they are tied to a piece of improved real estate that by definition has a non-zero value. Further, because of the flight to treasury bills, the government is taking in money from those purchases! The receipts of this situation can be used, directly or indirectly, to finance the expropriation of the CDOs.
I am using expropriation instead of purchase for good reason: I think it is more useful to look at this as the government exercising its eminent domain powers than any of the other currently-offered perspectives. Instead of declaring that it is going to take a stretch of land to build a highway that benefits the public, it is declaring that it is going to take a subclass of asset from the financial system in order to restore liquidity that benefits the public. In both situations, the government pays a compensation, that in someway is based on “fair market value” but not always as closely as the previous asset-holder would have hoped for in the open market.
Severance packages piss me off to no end, too, Matt. Few high-level executives have ever done anything that should justify taking as much money as they do away from where it should go: to the shareholders as a dividend, or to the employees generally as compensation, or even better reinvested in the business. Perhaps there was a time when these huge executive bonuses and severances were justified when they were once coupled to executive performance; this is no longer the case in Anglo-American liberal capitalism (see pg 222, right column, of this article.).
An ordoliberalist viewpoint on this would say that in order to optimize market efficiency, there should be a constraint on the relation of executive pay to the median employee income. This would prevent wastage of funds on a few executives who are not doing anything sufficient to earn such money, and force it to be invested elsewhere, or returned to the shareholders. Ordoliberalism is not an ideology seeking a socialist or command economy. Far from it: it is as liberal (not in the American political sense) as 19th century lassiez-faire capitalism, or classical liberalism, and, I think, more liberal than what has become of the Anglo-American system, which has slid towards this bizarre combination of lip service to producerism and the hyperextension of corporate consumerism, neither of which is inherently liberal.
I can’t find my citations on this stuff, but basically if you look at the ratio of median salary to top executive pay in the US versus all of the other liberal economies, it’s pretty absurd. Don’t quote me on this, but I think it’s something like 10:1 or 12:1 in places like Germany and Japan and a bit higher in England, but something like 30:1 or 50:1 in the US. I’m pretty sure this information is in Capitalism vs Capitalism, because I can remember writing the name of that book down in my notes during a lecture last year which covered the subject.
Executive malremuneration, however, while a significant issue in the overall performance of the American economy, is not intrinsically linked to remedying the current situation and therefore needs to be treated separately, as the current situation is time-critical. The fact that someone as terrible an executive as Carly Fiorina can make about half as much in compensation for being fired as a good executive like Henry Paulson (whose merit I previously argued) made after leaving in good standing to run the Treasury is to me more absurd than the actual figures, as stupid and irresponsible as they are ($20 million for her, ~$50 million for him).
Carly Fiorina is actually relevant into my thoughts on the election, so look for that in the coming days.
11 Comments
GMT-0500 12:09:31 0809.30 (Tue)
You know why the “bailout” failed?
Because, despite the fact that everything you said is correct, you can’t summarize it in a way that is both correct and convincing within 15 seconds. 😉
GMT-0500 14:42:52 0809.30 (Tue)
And that very inability is why Pence did not do his job in order to keep it.
GMT-0500 15:27:19 0809.30 (Tue)
Oh, and the reason I brought up the $18m golden parachute for the WaMu exec is, that a lot of people (myself included) don’t want to approve a $700bn “bailout” if a healthy chunk of it is going to go to a severance package for, say, Jamie Dimon should JP Morgan Chase go belly-up like the rest of them.
Then again, as the Economist pointed out, salary caps will make it extremely difficult to find good talent to take the helm in times like these.
GMT-0500 17:16:22 0809.30 (Tue)
Here’s an analogy which illustrates the problem as I understand it and the right solution…….Lets say you live in a town served by just one key road, which is right outside your front door. From time to time that road comes into need of being repaired so the responsible unit of your local Government will fix it and provide preventative maintenance on it too. While they will not leave you a bill for services rendered, the cost of services is prepaid via local taxes. Those fees are shared by many people, so each carries only a small burden. As the sole provider for this specific area or work, this unit operates fairly independently doing what it needs to when it needs to be done While regulated by outside parties it is not subject to any other authority to conduct its day-to-day business.
However, say without warning (as they do) a sink hole takes out the road, the bridge down the way, utility poles, sewage and waterlines, Cable TV, and all. Without that road local commerce and others members of the community, including you are for the most part cut off from being able to carry out their lively hood. While all are have prepared for bad times, until that road is fixed, they are going to “Starve” because the trickle of opportunity realizable at this point can not sustain them over the near or long term.
The question becomes what is the most important thing to do right away while the responsible party figures out how to repair the road “System”.
Of course the immediate beneficiaries are the trucks and those who use the roads, but in the end everyone is served by the repair. Further, as such work is beyond the capacity for already approved and in use instruments, the local entity needs to go to the proper authoring oversight group to approve their plan for creating a new instrument(s) for fixing the situation.
That’s where we are right now. There is a problem in the financial “System”. Direct beneficiaries of a “Bailout” may be banks and Wall Street firms, but that’s only because they are the ones who are the biggest users this “road”. Its actually the banking system which is being “Bailed out”
Further, as the US Department of Treasury is solely responsible what is the US Banking System, it is solely responsible for oversight of the various instruments required to make it sound. In the event the day should dawn when a systematic originated problem (legislatively required “bad loans”) produce a significant level of “Poison loans” which result in a significantly reduced capacity of banks in the system to conduct normal day-to-day business, either the Treasury takes action, or everyone here and around the world (The US is no small town..We are the world/we are the children) will “starve” for access to capital (hint significant period of deflation, hello “Great Depression”). Unfortunately, because there is not a preexisting instrument to use, the Treasurer has to go to Congress to obtain special permission to create one. Such an instrument should be solely administered by the Treasurer, and not in conjunction with anyone else.
Here’s what the instrument should be – A special bond with a three year life span. Something that people and institutions can buy in the open market. An instrument limited in scope to buying specific type of Mortgage backed securities. Then all should profit from the disposal of those assets, “IF” they are in large measure presently undervalued. “IF” they are not then the loss is spread out over many parties across the word and meanwhile the system is fixed and business got back to normal over the course the three year period which everyone profits from. An instrument that includes a better then treasury bond monthly return and which can be sold and then redeemed at it termination.
What do you think about that…..
Anyway…that’s what I am thinking….
While that particular unit may not be run as efficiently as it might be if it were a private institution (Hence many local governments subcontract out such repair to private sector organizations) your tax burden is
GMT-0500 18:42:45 0809.30 (Tue)
As I understand it, the $700 billion is coming from China, Dubai, and the Saudis at marked interest. No, this has not been said nor do I imagine it may ever be “said” in our lifetimes. But my understanding is that the USA is very much so entering into its very own New Deal, only it’s on the receiving end of the Deal this time. Think about it: what did the New Deal do for Britain? It preserved their very existence. At what cost? Decades of potential economic growth (which may have allowed Britain to remain a supreme world power alongside the Chosen Two of the 20th Century instead of being dumbed down with war-torn France and Germany) — decades of growth all funneled into New Deal repayments to the USA. Indeed, if we took away Britain’s repayments to the US, one must ask himself how much slower our own economy might have grown throughout the 1950s and 1960s and 1970s.
But Britain was in between a rock and a hard place and so it chose the rock — and the US government must now respond similarly. If we borrow $700 billion in foreign loans, we (further) entrench ourselves in the 2nd-class citizens’ role of the 21st Century. If we do not borrow $700 billion, our economy will enter into a Great Depression and so will those economies which have become hopelessly entangled with ours — which includes the very loaners I mentioned above and then some. (Meanwhile Putin is surely enjoying this show very, very much.)
As per Matt’s sage source, and as per common sense, friends, no man who holds the power will ever willingly relinquish it as it is those men who submit to any means to achieve the ultimate end — prosperity — who hold power, and men such as these are not the same men as those who would step down without a fight. Label this mindset as “baseless” or “conspiracy theorizing” all you want: I believe this is to be true, I believe that you believe this to be true as well, and I want to therefore emphasize that this is a 2nd reason to accept that ultimately the US government is going to go through with the bailout whether it’s in the best interests of all or not. (And I’m not saying it isn’t in our best interests — see above!! — but I’m just saying that even if you suspect the ulterior motives of Ben Bernanke and others that you should still accept that Wall Street’s moguls will make this happen. They will spill our blood before they spill one drop of their own, p-e-r-i-o-d. The Warren Buffets and Bill Gates of the world are few and far between!)
There are other matters to address, as well, but I think this is enough on the plate for now. Suffice to say,
a) I agree with Ben that the “bailout” is inappropriately and negatively misnamed but
b) I heatedly disagree with him that it is this glorious, ethical, economically non-traitorous solution to the dilemma at hand. Far from it, the bailout is nothing short of the lesser of two economic evils. Our leadership has decided that it would be better for our generation and our children’s generation to pay off a several trillion dollar debt to foreign investors over the course of the next 50 years than it would be to watch the American miracle crumble before our very eyes.
GMT-0500 18:52:00 0809.30 (Tue)
Boy, that big block of bold text above sure is hard to read. ¬_¬ Let’s try that one more time:
1) Everybody wants to be prosperous.
2) Nice guys seeking prosperity play by the rules.
3) Bad guys seeking prosperity play by the rules.
4) If there is no Nice Guy in a position of power greater than the Bad Guys’, or if there is one but he has a hands-off “laissez-faire” approach, then it follows that as time approaches infinity that all or nearly all of the power will be concentrated in the hands of a few incredibly powerful men with no moral scruples.
If you reject this logic, then you may as well quit reading. Otherwise, given the above:
let us say that we have 10 bankers, all of them powerful and all of them immoral. Let us say that these bankers make deals amongst themselves, and some of the bankers make investments that are particularly stupid or which due to just plain “bad luck” happen to go sour. These bankers lose everything and in turn the smarter bankers also feel a big punch to the gut. Given the opportunity to saddle somebody else with the burden, they will jump on it. PERIOD.
I must now re-emphasize before I hit “Submit Comment” — this post is all to explain Argument #2 in the reply above, for the partial list of Arguments Why The Bailout WILL Happen. I’m only trying to explain, “If you believe that this really is a banker bailout, this is how and why it’s happening.” Beyond that? I’m making no claims. I think this is much bigger than a mere bailout, even if it perhaps got started that way.
GMT-0500 18:52:41 0809.30 (Tue)
Darn it! Should go without saying, But #3 in the reply above needs to say “Bad guys seeking prosperity do not play by the rules.”
GMT-0500 19:35:36 0809.30 (Tue)
I’m having a difficult time following your logic, Ryan. Yes, part of this expropriation will be funded by the Chinese and Arab governments, because they buy Treasury bills. But so do other governments, and all sorts of other investors. And, the Chinese and Arab governments have been buying t-bills irrespective of this crisis and the rate at which they do it is unlikely to change, unless if by change I mean that the Chinese government (the world’s largest sovereign investor) invests less in t-bills since even as it stood several months ago the Chinese central bank was overburdened with foreign currency reserves. edit: No, this is not a “banker bailout.” Please refer to … everything I’ve written in the past 48 hours.
Matt: what we must understand is that in order to effect a change in the way that top executives are compensated, the whole corporate culture (namely executives’ expectations of remuneration) must itself be changed, which will not happen overnight. As big as $18 million sounds, it is one one-thousandth of a percent of
anno 2008edit: FY 2008 US individual income tax receipts. Even if we say that this bill will be paid solely from individual income tax receipts (which, as I mention obliquely above, is unlikely to be the case), and that funding bill would go directly to Washington Mutual’s general funds where it would be used to pay for that particular golden parachute, even a single person making $100,000 a year would pay less than one White Castle hamburger costs. This is based on that person paying $21,978 in federal personal income taxes, of which .00144% is 32¢. The last time I checked this was two cents less than a Slyder by 2¢, and 9¢ less than first-class postage. Yes, it is still taxpayer money which should not be spent in this manner, but even with my very unrealistically generous assumptions the cost to the taxpayer is trivial.Edit: I think that it is probable, especially if the election results in a Democratic administration, that certain executives will be brought up on charges by the Justice Department, but only after we are out of the worst of this crisis. That will be the time when these executives will get what it is that they deserve. Not now.
GMT-0500 20:12:18 0809.30 (Tue)
Father Figure — not sure anyone will want to buy up something specifically linked to the bad debt of mortgages which will be defaulted on. I’ve often wondered, though, if we could just have everyone with an ARM convert to a fixed (for the same amount) and the difference could just be sent as a bill to the government. Too much room for abuse? I don’t know.
Nazz — did you mean the New Deal or the Marshall Plan? 😉
Ben: Sure, it’s a drop in the bucket when we’re talking about $700bn, but it’s still an egregious miscarriage of justitude.
GMT-0500 21:45:55 0809.30 (Tue)
You’ve got my back, T-Bone.
GMT-0500 20:51:27 0904.3 (Fri)
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