September 23rd, 2008

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I seem to be contrarian

OK, I have come to loath the proposed bail out legislation as it recapitualtes every single bad behavior by this Administration -- create a crisis via neglect, then demand sweeping and unreviewable powers to solve the problem.

But I disagree with the theory that we would need to overpay for the securities in order to get the financial system working again. Here's why.

As I understand it, we are not "replacing" the capital needed to keep the financial system going. The problem is not the existence or non existence of cash. There is plenty sloshing around. The problem is that no one wants to lend to anyone because of the uncertanty over how much bad debt is out there. Because the probablity of payoff of these securities, and at what level, is unknown, they cannot serves as the security for finacial transactions. Worse, because those borrowing money have an unknown and unknowable liability, no one want to lend them money, as who knows if they will be able to pay it back.

The point of the U.S. buying the securities is therefore not to recapitalize the system, but to allow holders of mortgage backed securities (MBS) to ditch the drag on their books without a total write down. This can be done by buying for some fraction on the dollar of the face value of the securities, because it is actually valuable for the firms to have a defined loss and move on than to have an undefined loss that hangs over them indefinitely. This is why I proposed something like this to deal with the subprime loan meltdown over a year ago -- before it infected the rest of the market.

[Someday, someone will explain to me why people who can blab at conventions endlessly about "the butterfly effect" and "chaos theory" and blah blah blah seem utterly unable to appreciate the horrible complexity of today's financial markets and keep reducing this down to the willing buyer and the willing seller? It's like not acknowledging the externalities of pollution. Oh wait . . . . ]

What I object to is handing over unlimited and unreviewable power to an Administration with this track record. I think the U.S. will actually make money, in the long run, by assuming control over the securities. But the cost of administering this project is going to be hellishly huge (if done right) and the re-privatizaion of the securuites needs to be handled in an appropriate fashion. If history the past is prologue, this administration will not only outsource the management of this to inefficient contractors who line their own pockets while foreclosing on widows and orphans, they will sell off the securities at a loss to the financial industry once the crisis is solved in exchange for some hookers and blow.
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I rather liked this piece on why it's not the fault of bankers.
(nb:sarcastic article blaming bankers)

Actually, I do not think it is the "fault" of bankers. I think it is the fault of people who like the happy story about rational investors and willing buyers and willing sellers and who conveniently ignore how these transactions impact the rest of us.

Mind you, I find the willful ignorance of the folks who follow talk radio appalling. Yes, I'm familiar with why this is so much better than the truth, blah blah. I didn't say I was surprised. I said it is appalling. The notion that banks were "required" to lend to "those people" (and y'all know who "they" are) because of "affirmative action loans" is so unsupported by anything vaguely like a factual basis that I almost wish I could give these people the world they deserve for making decisions on such theories.

Everyone loves the "free market" until it turns around and bites you in the patootie. Then where did all the rational actors go? The sad truth is that everyone in the chain of events behaved in an economically rational manner, including the "stupid borrowers" and the more stupid lenders. As the British Economist Paul Klemperer observed, policy needs to be sufficiently robust to handle real people. Any policy based on theory that does not take this into account will fail.

But it saddens me to see what a nation we have become. A small and frightened people who will turn on their neighbors rather than reach out to one another. But this is what happens in the absence of real leadership. What made FDR a great leader was not his economic theories (he didn't have any, he glommed onto Keynsian theory because he had advisors who used it to justify his basic desire to create jobs and took good ideas where he found them). It was his fireside chats and his ability to inspire confidence in a badly frightened people by appealing to their better selves. Countries with leaders like that avoided fascism and weathered the crisis. Countries with charismatic leaders who used fear to their advantage went fascist. Countries with weak leadership became prey.

We have a capacity for greatness. But who will inspire us? This is the potential tragedy of our age, as well as its potential triumph.