In response to the subprime mortgage crisis, President Bush has called for an $700 billion bailout: buying toxic debt from the firms that now hold it. That’s about $2000 for every American citizen, being used to buy assets that may end up being worth far less than the price the government is paying.
The whole thing is disturbing for a number of reasons. There is the constant moral hazard problem that emerges when government bails out people who behave in risky ways and lose. Then there is the degree to which this will further worsen the overall economic position of the American government: already badly strained by costs associated with wars in Afghanistan and Iraq, as well as tax cuts that were never matched with reductions in spending.
If there is any justice in the world, the bonuses paid to the current and former executives who ran the financial firms at the centre of all this will be clawed back in one way or another. This whole thing started because of financial instruments that let the top tranches of the riskiest loans be sold as low-risk assets; of course, the inevitable downside of bundling the safest portions of those loans was causing the riskiest portions to accumulate elsewhere. It remains to be seen what the full and final effects of all that uber-toxic debt will be.
So why then do we think the current federal bailouts are anything but a short-term band-aid for a much deeper wound: companies willing to take on too much risk with guaranteed government rescue if the risky investments fail?
Executives who took on risk when their calculation was in part determined by the assumption that a bailout like this would happen if things went quite bad, are guilty of treason: they knowingly put their own personal good into conflict with the common good.
The mother of all bailouts
By Richard Baldwin l VoxEU.org
THE “Paulson Package” is the “mother of all bailouts” according to Daniel Gros and Stefano Micossi writing on Vox late Saturday. They also point to three scary things.
First, the largest European banks are too big to fail, but may also be too big to be saved by their national governments. Deutsche Bank’s liabilities, with its leverage ratio topping 50, amount to 80% of German GDP. Barclays’ liabilities (leveraged 60 to 1 on its capital), are larger than Britain’s GDP. Imagine what the numbers are for UBS and Credit Suisse compared to Swiss GDP.
A defence of the Paulson plan
By Tyler Cowen on Economics
It’s always worth hearing from both sides:
This [the purchases of the Paulson plan] has the effect of modestly increasing the stated book value of these financial institutions. More importantly, with the toxic waste off the books, it improves the likelihood that an outside investor–Treasury itself, a sovereign wealth fund, even our man in Omaha–now feels able to value the enterprise. Hold your nose and admit it: the relatively few franchises that manage the capital raising and M&A activities of Corporate America are worth a lot.
To avoid the abuses of the English law (including executions by Henry VIII of those who criticized his repeated marriages), treason was specifically defined in the United States Constitution, the only crime so defined. Article III Section 3 delineates treason as follows:
Treason against the United States, shall consist only in levying War against them, or in adhering to their Enemies, giving them Aid and Comfort. No Person shall be convicted of Treason unless on the Testimony of two Witnesses to the same overt Act, or on Confession in open Court.
The Congress shall have Power to declare the Punishment of Treason, but no Attainder of Treason shall work Corruption of Blood, or Forfeiture except during the Life of the Person attainted.
Tristan,
Executives who took on risk when their calculation was in part determined by the assumption that a bailout like this would happen if things went quite bad, are guilty of treason
As listed above, the definition of ‘treason’ in the United States is tightly constrained. This was an intentional choice by the drafters of the Constitution to avoid the undue labelling of other offences as ‘treason.’
they knowingly put their own personal good into conflict with the common good.
This cannot possibly be the standard for ‘treason.’ Someone walking home from a bar who decides to urinate in an alley is putting their own good over that of society. Is that a treasonous act? I don’t think treason is just selfishness writ large. It is defined as the crime of making war against the state from within. Whether that is an acceptable thing to do sometimes or not (and the founders of the US would obviously say that it can sometimes be justified), it is something quite different from simple selfishness at the expense of others, or even reckless endangerment of others.
A closer metaphor for what the architects of this crisis did would be the directors of a car company that released large numbers of a novel type of brakes into the market that later turned out to be faulty. They may be guilty of negligence – even of criminal negligence – but they are not traitors in any meaningful sense of the word.
Article Three of the United States Constitution
Section 3: Treason
The Constitution defines treason as specific acts, namely “levying War against [the United States], or in adhering to their Enemies, giving them Aid and Comfort.” A contrast is therefore maintained with the English law, whereby a variety of crimes, including conspiring to kill the King or “violating” the Queen, were punishable as treason. In Ex Parte Bollman (1807), the Supreme Court ruled that “there must be an actual assembling of men, for the treasonable purpose, to constitute a levying of war”.
Under English law effective during the ratification of the U.S. Constitution, there were essentially five species of treason. Of the five, the Constitution adopted only two: levying war and adhering to enemies. Omitted were species of treason involving encompassing (or imagining) the death of the king, certain types of counterfeiting and fornication with women in the royal family of the sort that would call into question the parentage of successors. One important distinction is that the encompassing the death species of treason was most used by the English government to silence political opposition and was expressly excluded by the authors. In fact, James Wilson wrote the original draft of this section, and he was involved as a defense attorney for some accused of treason against the Patriot cause.
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Punishment for treason may not “work Corruption of Blood, or Forfeiture except during the Life of the Person” so convicted. The descendants of someone convicted for treason could not, as they were under English law, be considered “tainted” by the treason of their ancestor. Furthermore, Congress may confiscate the property of traitors, but that property must be inheritable at the death of the person convicted.
To some degree she is right, some on Wall Street acted irresponsibly. But they did not act alone. I find it condescending to presume that when a banker over-leverages himself he is being greedy and reckless, but when the average person buys a house they can not afford, they were misled and are the victim. Should we assign all the blame to whoever offered these hapless individuals credit? In that case we should really blame all the foreign countries that poured money into the US, causing the global savings glut. This empowered America to spend its way out of the last recession. It made credit easy and available and the last recession quick and relatively painless. When they wanted to invest in American assets should we have said thanks, but no thanks?
We seem to have developed an expectation that the world offers all upside and no downside. Credit should come easily even when we are not entitled to it. Perhaps taxpayers are paying a disproportionate price for this. But they are not merely saving the reckless fat cats; they’re saving themselves. That $700 billion may be a bargain compared to the cost of inaction. A deep and prolonged recession would hurt much more.
Mr Paulson has rightly noted that the cost of the programme should be well below $700 billion since some of the mortgages will be repaid. But it may be optimistic to expect it to turn a profit. Indeed, profit is inconsistent with the point of such a programme which is to socialise losses that would otherwise cripple the financial sector and toss millions of people out of their homes. The lack of an upside for taxpayers is one reason that some scholars, like Mr Elmendorf, favour the taking of direct stakes by the government in financial firms instead.
Profit is possible, of course. The market prices of many mortgage securities today reflect not just the likelihood of default, but a steep liquidity premium, because the paper no longer trades. The Treasury could conceivably buy something above market value but below fair value and hold it to maturity. But it could deepen the financial crisis by forcing institutions to recognise the assets’ deeply distressed prices.
Even if the programme is designed perfectly, it is no sure thing it will end the crisis. It does address the root problem, defaulting mortgages, and Mr Bernanke has long worried that bad debt would fuel a vicious circle of crippled lenders, constricting credit, weakening growth and more defaults. But that is not what happened last week. Losses on Lehman debt forced several money-market funds to “break the buck” (lower their net asset value below the sacred $1 per share), triggering a flight out of short-term commercial paper. Banks, forced to contemplate redeeming hundreds of billions of dollars in maturing commercial loans, began hoarding liquidity. Interbank lending froze. This generalised loss of confidence was many steps beyond the root cause of the crisis. Announcement of bail-out plans helped ease things, but the effect was purely psychological.
Buy My Shitpile: Hey Washington, can you buy my bad investments, too?
With our economy in crisis, the US Government is scrambling to rescue our banks by purchasing their “distressed assets”, i.e., assets that no one else wants to buy from them. We figured that instead of protesting this plan, we’d give regular Americans the same opportunity to sell their bad assets to the government. We need your help and you need the Government’s help!
Use the form below to submit bad assets you’d like the government to take off your hands. And remember, when estimating the value of your 1997 limited edition Hanson single CD “MMMbop”, it’s not what you can sell these items for that matters, it’s what you think they are worth. The fact that you think they are worth more than anyone will buy them for is what makes them bad assets.
No, Really, How Much Is $700 Billion?
About 12 Bill Gateses.
By Juliet Lapidos
For historical perspective, consider that the Marshall Plan, which helped finance the recovery of Western Europe after World War II, cost the United States about $13 billion. Of course, in 2008 dollars that’s more like $100 billion. And Niall Ferguson has estimated that as a comparable share of the U.S. GDP, it’s more like $740 billion.
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Lastly, in apocalyptic terms, $700 billion really isn’t all that much. If nothing is done to change the way we finance Social Security, the trust fund reserves will be exhausted by 2041. This means that, in 75 years, there’ll be a shortfall of $4.3 trillion—or about six bailouts. According to the Stern report (issued by U.K. economist Sir Nicholas Stern), global climate change could cost the planet $9 trillion (or 12.86 bailouts) if we don’t address the problem within the next decade or so.
No, Really, How Much Is $700 Billion?
About 12 Bill Gateses.
By Juliet Lapidos
For historical perspective, consider that the Marshall Plan, which helped finance the recovery of Western Europe after World War II, cost the United States about $13 billion. Of course, in 2008 dollars that’s more like $100 billion. And Niall Ferguson has estimated that as a comparable share of the U.S. GDP, it’s more like $740 billion.
…
Lastly, in apocalyptic terms, $700 billion really isn’t all that much. If nothing is done to change the way we finance Social Security, the trust fund reserves will be exhausted by 2041. This means that, in 75 years, there’ll be a shortfall of $4.3 trillion—or about six bailouts. According to the Stern report (issued by U.K. economist Sir Nicholas Stern), global climate change could cost the planet $9 trillion (or 12.86 bailouts) if we don’t address the problem within the next decade or so.
Subprime mortgage primer — online comic
POSTED BY MARK FRAUENFELDER, SEPTEMBER 24, 2008 2:19 P
When stuff gets complicated, I rely on profanity-spewing stick figures to explain it to me in terms I can understand. This 45-page online comic explains the subprime mortgage mess in about 2 minutes. The Subprime Primer
The Daily Show with John Stewart
September 23, 2008
Clip 1 of 4
John Stewart: After Katrina, after Iraq … I didn’t think there was another area that these guys could screw up.
John Oliver: It wasn’t easy. It was like finding a vein on a failure junkie.
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JS: You’re saying the president here won’t be satisfied until American children are eating roadkill?
JO: Until they’re fighting over roadkill. Until roadkill is the prize for the strongest American children.
JS: But why?
JO: Legacy, John. We all know he’ll never be ranked as the best president. But he could still, if he works hard enough…
JS: Be the worst?
JO: The last.
Stunt Man
John McCain’s latest crazy, brilliant, desperate campaign tactic.
By John Dickerson
Posted Wednesday, Sept. 24, 2008, at 9:23 PM ET
It’s not clear what, exactly, McCain is going to do in Washington. He doesn’t sit on any of the relevant committees, and everyone is already deep in negotiations. Still, he’s coming anyway. It doesn’t make much logical sense. The only way to understand it is politically: In a presidential campaign, the surest sign that a candidate is playing politics on an issue is when he claims not to be playing politics on an issue. The only way for McCain to convince everyone that his intentions are 100 percent pure is for him to drop out of the race completely. A campaign doesn’t end—and its distracting affects don’t disappear—just because one candidate says so.
“It appears that financial institutions earn money on transactions (say fees on your mother-in-law’s checking account) and lose everything taking risks they don’t understand.”
October 6, 2008
Treason and the U.S. Economic Crisis
Posted by northernsong
In the past, I’ve formulated this argument:
In situations where your own personal good comes, not simply into contradiction with the common good, but with the possibility of other people pursuing their own personal good, a crime has been commited. For example, it’s not a crime if I catch a fish which someone else could have caught. However, if I steal the copper from all the fishing boats to sell it for cash, this is a crime. In the first case, my catching the fish means someone else can’t catch it. In the second, me catching the copper means others never get to catch fish.
Bailouts Are Inevitable, Even Desirable
Stop complaining about the “moral hazard” problem and enjoy the rescue.
By Tim Harford
Updated Saturday, Oct. 4, 2008, at 7:50 AM ET
This perspective can suggest lessons for today’s bailouts. The government will not help you replace your possessions if you smoke in bed and your house burns down, but government-funded fire engines will put out the blaze, moral hazard or not. That is partly because fire can spread, and your neighbors should not suffer for your carelessness. The same motive lies behind the current spate of rescues. It is also because a civilized society tries to save people from accidentally burning themselves to death. If the consequence is a little more carelessness, so be it.
A second lesson is that remedies for moral hazard will always be imperfect. Insurance companies could fight moral hazard by checking that your behavior is consistently safety-conscious. Because that’s impractical, deductibles have to serve as imperfect proxies. The current bailouts are a strong argument for tighter regulation, but regulators cannot be everywhere, any more than a claims adjuster can ride around in your car all day. Bailouts can save the innocent as well as the culpable, but even when they don’t, it is fantasy to expect governments to refrain from them. It is useless to pretend otherwise: Bailouts are inevitable, and sometimes they are even desirable. The moral hazard they provoke is also inevitable. The final lesson: Insurers get paid for the insurance they provide; it would be nice if the taxpayer were shown the same courtesy.
Cartoon on the financial crisis and the environment
Economic Distress and Fear
Part of the debtor mentality is a constant, frantically suppressed undercurrent of terror. We have one of the highest debt-to-income ratios in the world, and apparently most of us are two paychecks from the street. Those in power — governments, employers — exploit this, to great effect. Frightened people are obedient — not just physically, but intellectually and emotionally. If your employer tells you to work overtime, and you know that refusing could jeopardize everything you have, then not only do you work the overtime, but you convince yourself that you’re doing it voluntarily, out of loyalty to the company; because the alternative is to acknowledge that you are living in terror. Before you know it, you’ve persuaded yourself that you have a profound emotional attachment to some vast multinational corporation: you’ve indentured not just your working hours, but your entire thought process. The only people who are capable of either unfettered action or unfettered thought are those who — either because they’re heroically brave, or because they’re insane, or because they know themselves to be safe — are free from fear.
Here is an unusual twist on outsourcing: IBM is offering employees facing layoffs the chance to take IBM positions in countries like India and Brazil. The positions pay dramatically less, but the costs of living are also much lower.
The initiative is called Project Match.
“The current peasant revolt, which blurs indignation at the underlying inequities and the search for culprits in the catastrophe, has been far too categorical. Let’s say you work for a bank in the more prosaic areas of consumer banking, private wealth management, corporate underwriting, investment banking, credit cards, or trading. You might well have had a poor year last year and seen your bonus vanish. But you also may have worked hard, managed risk effectively, and earned money for your firm that was wiped out by losses in esoteric forms of finance. It may be reasonable to deny anyone at a money-losing business a bonus, but it’s irrational and malicious to suggest that one and all deserve a scarlet letter. Government-mandated salary caps risk institutionalizing failure, creating new perverse incentives, and deterring talent when it is most needed. A CEO who can turn around Citigroup—which could save tens of billions in taxpayer funds—is worth a lot more than $500,000.”
US unveils new $1.5 trillion plan
US Treasury Secretary Timothy Geithner has unveiled a comprehensive bank bail-out plan worth at least $1.5 trillion (£1.02 trillion).
Under the plan, the size of a key Federal Reserve lending program will be expanded to $1 trillion from $200bn.
In addition, a public-private investment fund of $500bn will be created to absorb banks’ toxic assets and could be expanded to $1 trillion.
“US Treasury Secretary Timothy Geithner has unveiled a comprehensive bank bail-out plan worth at least $1.5 trillion (£1.02 trillion).
Under the plan, the size of a key Federal Reserve lending program will be expanded to $1 trillion from $200bn.
In addition, a public-private investment fund of $500bn will be created to absorb banks’ toxic assets and could be expanded to $1 trillion.”
It’s pretty laughable that anyone would believe you could print this much money without causing inflation. The thing we don’t know is how much inflation will be caused – paradoxically, the better the stimulus works (i.e. people start buying again), the worse the inflation will be (i.e. higher demand plus higher supply of money pushes prices up). If inflation stays around 5%, I’ll admit, there’s no catastrophic problem. But, if it hits 10%, 15%, then the interest rates will have to be adjusted to encourage people to invest in anything but the things which are going up in value, i.e. commodities. And at that point, how exactly will the US maintain its projected debt to GDP level of 70-80% when the stimulus is all paid for?
It just sounds like a recipe for disaster to me.
Rep. Kanjorski: $550 Billion Disappeared in “Electronic Run On the Banks”
By Mark Frauenfelder on Economy
U.S. Taxpayers Risk $9.7 Trillion on Bailout Programs
By Mark Pittman and Bob Ivry
Feb. 9 (Bloomberg) — The stimulus package the U.S. Congress is completing would raise the government’s commitment to solving the financial crisis to $9.7 trillion, enough to pay off more than 90 percent of the nation’s home mortgages.
Bears in the finance-media zoo
Two real financial thinkers venture into CNBC fantasy world; comedy ensues
Posted by Tom Philpott at 2:44 PM on 23 Feb 2009
Okay, this is priceless — and anyone who wants to understand not only our economic calamity but also why we’re still screwed has to watch it. Oh, and don’t worry — it’s also absolutely, laugh-out-loud hilarious (in a bittter sort of way).
Nouriel Roubini and Nassim Taleb are two of our most trenchant and learned commenters on finance. It’s time to start listening to them — if Obama is serious about running a centrist administration, it’s a scandal that he tapped Robin Rubin acolytes Summers and Geithner, not Roubini and Taleb, to run economic policy.
No More Whining
Two months ago, gas cost $4 a gallon. The media had another heyday, telling us all we were going to certain doom as no one could afford to get to work.
Now that gas is back to half that, and its lowest prices in decades, or possibly ever, does the media even mention it? No; they cook up another fear-and-doom concept about something else and run with it to keep us all glued to our TVs and Tivos, which keeps their Arbitron and Neilsen ratings up to keep their ad revenues up. Arbitron and Neilsen may mean nothing to you, but mean everything in broadcasting: just one point means billions of dollars to a TV network.
How cheap is gas today? Adjusted for inflation, $2 a gallon today is the same as 40¢ a gallon in 1973! Gas is at least as cheap as it has ever been. Yay!
Not only is gas cheap, remember how the media was trying to scare us all into paralysis when home prices were rising a few years ago? All they showed us were young families unable to purchase homes, but never the zillions of nice, normal people who were able to raise their families someplace safe, and see their investments grow at the same time. All we heard were numbers telling us how fewer people could afford to buy homes.
Now that home prices have gotten a lot more affordable for all of us, more people can afford homes than ever. It’s good times once again!
The curse of politics
Apr 16th 2009
From The Economist print edition
Financial crises can drag on because efficient remedies are politically unpalatable
AS THEIR banking crisis approaches Japanese proportions, Americans can take comfort from the fact that their political culture is more capable of finding a solution. Or can they? Today’s anti-banker backlash bears a striking resemblance to the voter outrage that stymied efforts to fix Japan’s banking system in the 1990s. Indeed, an enduring lesson of financial crises is how political constraints interfere with economically efficient solutions.
For example, America’s Treasury and the Federal Reserve began examining options to use public money to buy up illiquid mortgage assets and to inject capital into financial institutions shortly after rescuing Bear Stearns, a failing investment bank, in March 2008. But it was another six months before they acted on those plans. “There was no way we could go to Congress without the American people understanding we faced a crisis,” says Henry Paulson, the treasury secretary at the time.
Is TARP Profitable?
The huge government bailout could have cost taxpayers $700 billion. Now it looks like it might break even.
By Daniel Gross
Posted Friday, Aug. 28, 2009, at 1:26 PM ET
The Troubled Asset Repurchase Program, the controversial $700 billion package passed in the heat of last fall’s presidential election campaign, wasn’t presented as a bailout of a failed system. Rather, then-Treasury Secretary Henry Paulson and his allies touted it as an opportunity for the taxpayer to profit by making investments in name-brand companies. Indeed, during the Great Panic of 2008, American taxpayers reluctantly made a series of very expensive investments in blue-chip companies—Fannie Mae and Freddie Mac, the insurer AIG, General Motors. Since these bailouts were designed to halt failure rather than stimulate growth, the return on most of these efforts has been largely intangible.