Today, I was going to focus on what’s going on in America but I’m down with the flu so it will have to be for next week.
For the past couple of weeks watching Bloomberg’s been a riveting experience as experts try to grapple with the goings-on in markets in the US and elsewhere. Non-experts, too: Question for a Management Class makes for quite interesting reading.
And although some conservatives in Britain and America continue to make the ideological case against any government action as a response to the recent turmoil – governments necessarily do everything worse than the market – they have no alternative proposal about how to restore trust once it has gone. Trust is a reciprocal relationship, dependent upon a desire to be considered decent and honourable. Even in the dog-eat-dog financial markets, trust and integrity are matters of self-interest. However amoral you may be, it is in your interest to care about your reputation, because if you behave badly you will not do business with me – or others – on favourable terms again.
But the scale of the personal rewards now available in London and Wall Street – £15m-£20m at the top is the norm – along with the greed-is-good doctrine associated with extreme laissez-faire economics, has trashed the need for individuals to worry about integrity. They don’t need to be concerned about their reputations; they just need one deal or one year at the top and they need never work again. The incentive structure has so departed from one of the principal norms of fairness – proportionality between value added and reward – that it has eviscerated trust relationships and integrity.
Everybody tries to ‘game’ the system on their route to vast personal fortunes – whether short-selling, packaging up dud mortgages as prime mortgages or telling lies about their financial viability – and the result is that the system is getting wise. The best course today in any financial transaction is to presume zero integrity. Credit is drying up and with it the very lifeblood of the economy.
Worse, now that the system is in trouble, financiers are turning to taxpayers in the US and Britain for help without understanding the other key principal of fairness – that we will consider helping those who for no fault of their own get into trouble, but not those who freely created their own bad circumstances.
Hank Paulson certainly acted decisively in launching his plan, but the former Goldman Sachs CEO, who negotiated a special exemption from tax when he took the job, like his former Wall Street colleagues is not well endowed with the fairness gene. It polluted the very design of the scheme.
He knows that unless the US government does something comprehensive, the entire financial system is at stake, but his original plan was designed to bail out the system intact. It made no demands that any financial executives sacrifice pay or bonuses despite having driven their firms and wider economy to the point of bankruptcy. He does not want the government to provide new bank capital to help recapitalise a bust banking system. Instead, he wants the government to buy their toxic debt and so leave the banks unreformed. On top he wanted complete discretion to act as he chose without any oversight.
American economists of every persuasion signed a joint letter complaining not at the aim of the bail out, which is plainly vital, but for its lack of fairness. Conservative papers and politicians echoed the complaint. Suddenly, Wall Street is coming back to earth. The transactions from which it skims such riches are built on the savings of ordinary Americans to whom it has obligations, as it has to other Wall Street firms. What we know now about the yet to be agreed compromise is that Paulson has accepted Congressional oversight, will offer direct help to distressed US homeowners as well as banks, and will accept some constraints on the worst excesses of executive pay.
But the core proposal remains. The government will buy toxic debt rather than inject government funds into the banks’ capital base, in other words, reject even partially nationalising the entire US banking system as the Swedes had to in 1992. I don’t know – nobody does – whether the Paulson plan would be sufficient or whether ultimately the Americans will have to go for nationalisation. What I do know is that unless there is a radical and government-led change in ownership, structure, regulation and incentives so that the principles of fairness are put at the heart of the Anglo American financial system – proportionality of reward and fair distribution of risk – there is no chance of the return of trust and integrity upon which long-term recovery depends.
Republicans voted against the bill by a two-to-one ratio, and in the process rejected their own leadership, who had worked for nearly a week to craft a bill that could gain a majority. Nearly 100 Democrats also voted against the bill, spurning their leadership.
Many Republicans in the House were never persuaded that the credit crunch in the financial system is an impending disaster deserving of taxpayer aid. Politicians who had cut their teeth on free-market principles couldn’t accept the idea that the federal government should back up the banks who had foolishly bet everything on the housing bubble.
Or they didn’t want to face the voters in six weeks and explain why a Republican would vote for the biggest government bailout ever.
The result was that markets previously poised to celebrate, engaged in an orgy of selling instead, with something of an atmosphere not only of cutting already heavy losses, but of vengeance. In the days leading to the House vote, the weekend negotiations took place against a backdrop of analysts warning that if the market didn’t get what it wanted -a bailout anaylists previously said the markets viewed with unease- then the market would crash.
The market has been demanding a large scope bailout plan for weeks. The market has been chewing through financials one by one until it gets what it wants.
Let’s not kid ourselves, the markets are rigged. The bailout is a wimpy ass way to deal with the problem for sure, but a $1.2 trillion loss in market cap was just TODAY’s tradeoff. The market wants some extra rigging short-term and a meltdown is/was the trade-off.
The people in Washington know very little about a lot of things. That is their specialty, their claime to fame. They know shit ass less than nothing about the stock market and the MOOD of America that matters (money). Today, you saw what a bad mood can bring from traders. Tomorrow and for the next week you will see what panic brings as the selling accelerates.
This crisis though is not about the stock market, it is about THE CREDIT MARKETS. There is NO access to capital. We are shut down for business. Way worse than after 9/11 when the markets were closed. At least than, we were out shopping at the request of our President. Now we are just deer in the headlights at the whim of the House of Reps and Congress and Senate who just seem out to punish the rich. Bullshit politics. Everybody has a chance to be famous. They are really punishing everybody else.
The FED is out of bullets and we have absolutely zero leadership or hopes of any leadership soon.
On that sobering note, as the New York exchange plunged (777 points), and then Asia, too (biggest drop since 1987), An analyst on Bloomberg dryly said, “Cash seems to be the safest place to put your money now.” Commodity prices had their biggest drop in 52 years (since the index began). The Australian Prime Minister issued a statement appealing to the US Congress to pass the emergency measure, a sentiment echoed by the Japanese Finance Minister.George W. Bush will address his countrymen shortly before the markets open on Tuesday.
This seems a colossal game of “chicken,” with political leaders answerable to voters pitted on a collision course with financiers normally dismissive of nations, sovereignty, etc., demanding a bailout from the political leaders, otherwise everything comes crashing down. It’s interesting that as today wore on, the analysist began to speak rather confidently of the bailout being passed by the end of the week.
The Republican nightmare is obviously straight out of the Hollywood version of populist Huey Long’s barely fictionalized movie biopic, All the King’s Men:
Whenever there is a systemic banking crisis there is a need to recapitalize the banking/financial system to avoid an excessive and destructive credit contraction. But purchasing toxic/illiquid assets of the financial system is not the most effective and efficient way to recapitalize the banking system. Such recapitalization — via the use of public resources — can occur in a number of alternative ways: purchase of bad assets/loans; government injection of preferred shares; government injection of common shares; government purchase of subordinated debt; government issuance of government bonds to be placed on the banks’ balance sheet; government injection of cash; government credit lines extended to the banks; government assumption of government liabilities.
A recent IMF study of 42 systemic banking crises across the world provides evidence on how different crises were resolved. First of all only in 32 of the 42 cases there was government financial intervention of any sort; in 10 cases systemic banking crises were resolved without any government financial intervention. Of the 32 cases where the government recapitalized the banking system only seven included a program of purchase of bad assets/loans (like the one proposed by the US Treasury). In 25 other cases there was no government purchase of such toxic assets. In 6 cases the government purchased preferred shares; in 4 cases the government purchased common shares; in 11 cases the government purchased subordinated debt; in 12 cases the government injected cash in the banks; in 2 cases credit was extended to the banks; and in 3 cases the government assumed bank liabilities. Even in cases where bad assets were purchased — as in Chile — dividends were suspended and all profits and recoveries had to be used to repurchase the bad assets. Of course in most cases multiple forms of government recapitalization of banks were used.
But government purchase of bad assets was the exception rather than the rule. It was used only in Mexico, Japan, Bolivia, Czech Republic, Jamaica, Malaysia, and Paraguay. Even in six of these seven cases where the recapitalization of banks occurred via the government purchase of bad assets such recapitalization was a combination of purchase of bad assets together with other forms of recapitalization (such as government purchase of preferred shares or subordinated debt).
In the Scandinavian banking crises (Sweden, Norway, Finland) that are a model of how a banking crisis should be resolved there was not government purchase of bad assets; most of the recapitalization occurred through various injections of public capital in the banking system. Purchase of toxic assets instead — in most cases in which it was used — made the fiscal cost of the crisis much higher and expensive (as in Japan and Mexico).
Thus the claim by the Fed and Treasury that spending $700 billion of public money is the best way to recapitalize banks has absolutely no factual basis or justification. This way of recapitalizing financial institutions is a total rip-off that will mostly benefit — at a huge expense for the US taxpayer – the common and preferred shareholders and even unsecured creditors of the banks. Even the late addition of some warrants that the government will get in exchange of this massive injection of public money is only a cosmetic fig leaf of dubious value as the form and size of such warrants is totally vague and fuzzy.
It would reimburse banks, home owners, and local governments for nearly 9 million foreclosures – It could prevent over 200 million foreclosures – It could buy 8.6 billion monthly Metrocards – The government could rebuild Katrina-ravished New Orleans and Gulf Coast… three and a half times – Roughly 538 Yankee Stadiums could be built – 5.4 million students could be sent to a public university – It equals nearly 520 times the amount of Amtrak’s current operating budget – It is $14 billion more than the U.S. spent during the Vietnam War
The political fallout, if any, is something else, altogether. I’ve been silent for some weeks because I’ve been trying to get beyond simply reacting to the news, and instead, trying to make sense of where we are and where we ought to go; I’ll attempt to start piecing my thoughts together when I’ve recovered from the flu.