Business & Economics: September 2008 Archives

Despite the announcement on Sunday that a bailout deal had been reached, I was pleased to see yesterday that the deal fell through. Good. The markets were down because people realized that the government wasn't about to pay $1 for assets that are probably only worth 50 cents. That's bad for the people who own those assets, but good for the taxpayers who were about to buy them at inflated prices.

Harvard professor Jeffrey A. Miron has written the best prescription that I've seen so far: the solution is bankruptcy, not bailout. I've been saying the exact same thing for weeks. Maybe I should be an economics professor?

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

Just go read the whole thing. It's concise and exactly right on every point.

Way at the end of this excellent Politico article about the political logjam over the financial logjam is a nugget of good news that I haven't read anywhere else.

The cost debate illustrates just how nuanced the massive intervention will be. Paulson has often stumbled this week when trying to describe its intent, and the clearest voice has been Bernanke, a former college professor who casts the whole effort as an unprecedented experiment in “price discovery” that will add not just capital but also precious knowledge to jump-start the credit markets.

With the bursting of the U.S. housing bubble, mortgage-related securities are caught in a vicious downward cycle, commanding only “fire sale” prices, Bernanke says. The government purchases, through a series of novel auction mechanisms, will help the market value these assets, he says. And this could be the spark needed to get markets working and the economy’s engine turning over again.

This explanation is very different from the “bailout” imagery that surrounds the debate. And the great challenge for both sides has been to find some path in between these two poles — able to satisfy the anger voters feel toward Wall Street but also leaving enough room for Bernanke’s experiment to function.

"Bailout" makes me cringe, but I'd really like to learn more about this auction experiment. Reading these few paragraphs makes me much more optimistic. Why aren't the details of the plan being reported accurately?

DEAR AMERICAN:

I NEED TO ASK YOU TO SUPPORT AN URGENT SECRET BUSINESS RELATIONSHIP WITH A TRANSFER OF FUNDS OF GREAT MAGNITUDE.

I AM MINISTRY OF THE TREASURY OF THE REPUBLIC OF AMERICA. MY COUNTRY HAS HAD CRISIS THAT HAS CAUSED THE NEED FOR LARGE TRANSFER OF FUNDS OF 800 BILLION DOLLARS US. IF YOU WOULD ASSIST ME IN THIS TRANSFER, IT WOULD BE MOST PROFITABLE TO YOU.

I AM WORKING WITH MR. PHIL GRAM, LOBBYIST FOR UBS, WHO WILL BE MY REPLACEMENT AS MINISTRY OF THE TREASURY IN JANUARY. AS A SENATOR, YOU MAY KNOW HIM AS THE LEADER OF THE AMERICAN BANKING DEREGULATION MOVEMENT IN THE 1990S. THIS TRANSACTIN IS 100% SAFE.

THIS IS A MATTER OF GREAT URGENCY. WE NEED A BLANK CHECK. WE NEED THE FUNDS AS QUICKLY AS POSSIBLE. WE CANNOT DIRECTLY TRANSFER THESE FUNDS IN THE NAMES OF OUR CLOSE FRIENDS BECAUSE WE ARE CONSTANTLY UNDER SURVEILLANCE. MY FAMILY LAWYER ADVISED ME THAT I SHOULD LOOK FOR A RELIABLE AND TRUSTWORTHY PERSON WHO WILL ACT AS A NEXT OF KIN SO THE FUNDS CAN BE TRANSFERRED.

PLEASE REPLY WITH ALL OF YOUR BANK ACCOUNT, IRA AND COLLEGE FUND ACCOUNT NUMBERS AND THOSE OF YOUR CHILDREN AND GRANDCHILDREN TO WALLSTREETBAILOUT@TREASURY.GOV
SO THAT WE MAY TRANSFER YOUR COMMISSION FOR THIS TRANSACTION. AFTER I RECEIVE THAT INFORMATION, I WILL RESPOND WITH DETAILED INFORMATION ABOUT SAFEGUARDS THAT WILL BE USED TO PROTECT THE FUNDS.

YOURS FAITHFULLY MINISTER OF TREASURY PAULSON

(HT: Randy Barnett.)

Bryan Wildenthal has the best proposal I've seen yet for federal intervention in the ongoing mortgage crisis. If there must be intervention, why not use taxpayer money to bail out homeowners instead of investment banks?

So, instead of the massive moral hazard -- and general unseemliness -- of putting taxpayer money on the line to bail out Wall Street banks and brokers at the top end of the pyramid, why not aim at the broad BASE of the pyramid?

The money is there. I mean really, isn't it funny how when political leaders and powerful interests like Wall Street REALLY need cash, they somehow find a way to pull it out of the federal government's [ahem]?
To put it more politely: They just stick taxpayers with the bill. ...

America's population is about 300 million. Divide by 4 (typical household size) and you get maybe 75 million households. Even that doubtless overstates the number of owner-occupied homes covered by bank mortgages, with a value less than, say, $1 million or so (we should exclude the very wealthy -- if the $5 million La Jolla mansion is about to be foreclosed, I say tough luck -- John McCain, of course, would make $5 million the cutoff, having suggested that anyone under that is middle class -- whatever). And remember, you have to exclude the homeless, renters, nursing home residents, all the dependents who live in each mortgaged home, etc.

So, maybe 50 million owner-occupied homes, of middle-class or lower value, with mortgages? Close enough for government work.

Divide $1 trillion by 50 million and you get $20,000 -- not to be sneezed at! Over two years, that could cut almost $1,000 off every single monthly mortgage check in America! That amount of mortgage relief targeted directly at the millions of American taxpayers and homeowners of middle incomes and modest means would be an ENORMOUS shot in the arm to the economy (dwarfing the piddly recent "economic stimulus" checks). And it SHOULD mostly solve a crisis supposedly rooted in overextended mortgage lending, and securities built shakily on same.

I like the idea because I'm a homeowner/taxpayer that didn't borrow more than I could afford to pay. Why should I have to bail out idiots who lost their risky gambles without getting anything for myself? Plus, it makes more sense to feed the money into the bottom of the system rather than the top.

I'm not sure how this recommendation will come across, but let me state it the way it popped into my head: if you want to sound smart and also discover a new way to approach every aspect of life, read everything you can by Nassim Nicholas Taleb. Start with his take on black swans in the financial industry.

The California housing market is finally regaining some liquidity as banks drop their unrealistic expectations and home prices fall.

Home sales in California surged 13.6 percent in August as a flood of foreclosures drove down prices.

The figures released Thursday by MDA DataQuick showed 37,988 new and preowned homes were sold statewide last month, up 13.6 percent from August 2007 but down 3.8 percent from July.

The firm said 46.9 percent of all homes sold last month were foreclosed properties.

That helped send the statewide median home price plunging 35.3 percent to $301,000 during the year ended in August.

A lot of banks were holding onto foreclosed properties because they didn't want to have to account for the loss by selling the house. As long as they held the property, they could imagine that it was worth the full value of the foreclosed mortgage. That made the banks' holdings appear larger than they really were.

Banks have apparently realized that these houses were never going to regain their past value and decided that they were tired of losing money on them each month, so they're starting to unload the properties at market rates. That will put downward price pressure on individual homeowners, but aspiring homeowners will come out as big winners as prices fall.

Are we in the middle of a "Great Crash"? Better the middle than the beginning.

It is easy to change the financial system, I argued in my May 20 essay. The central banks can assemble on any Tuesday morning and announce tougher lending standards. But it is impossible to fix the financial problems that arise from Europe's senescence. Thanks to the one-child policy, moreover, China has a relatively young population that is aging faster than any other, and China's appetite for savings vastly exceeds what its own financial market can offer.

There is nothing complicated about finance. It is based on old people lending to young people. Young people invest in homes and businesses; aging people save to acquire assets on which to retire. The new generation supports the old one, and retirement systems simply apportion rights to income between the generations. Never before in human history, though, has a new generation simply failed to appear.

The world kept shipping capital to the United States over the past 10 years, however, because no other market could absorb the savings of Europe and Asia. The financial markets, in turn, found ways to persuade Americans to borrow more and more money. If there weren't enough young Americans to borrow money on a sound basis, the banks arranged for a smaller number of Americans to borrow more money on an unsound basis. That is why subprime, interest-only, no-money-down and other mortgages waxed great in bank portfolios.

As always, proper understanding seems to hinge on demographics.

Also note that Spengler wrote this a couple of days ago, presciently predicting the collapse of AIG.

Good morning, fellow AIG shareholders! If you're an American, you now own a chunk of the country's "largest" insurance company... not counting the debt obligations that make it insolvent.

The U.S. government seized control of American International Group Inc. -- one of the world's biggest insurers -- in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.

The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.

The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

First, I say let these companies fail. Oh, I know, it'll be the end of the world! Really? One day after Lehman Brothers went bust Barclays wants to buy them. The financial system won't go poof if these companies fail... but a lot of our elites will be out on the street.

Second, that's exactly what should happen. Here's my suggestion for a bailout law: if your company is SO important that we have to bail you out to avoid a total collapse of the world economy (*cough*), then when we do so the top 1% of all earners go to jail. The CEOs get life sentences, and we can work our way down from there.

As you know, Jessica and I are having a baby in a few months, so we've been thinking about how we're going to invest in our kids' futures. Everyone at work is horrified when I tell them that we're not going to pay for our kids' collage. I know such a stance is evil and unAmerican, but hear me out.

1. People line up to loan money to college students; no one will loan Jessica and I money for our retirement. College loans are cheap, easy money with low interest rates and undemanding repayment schedules.

2. Our kids will probably be sick of my meddling by the time they leave the house.

3. There may be more efficient ways to invest in your kids... ways that most people don't think about but that can make an even bigger difference in their lives. For example, Jessica is planning to be a stay-at-home mom; there's an opportunity cost to that decision, and in the long run it will certainly be more expensive than paying college tuition.

When it comes to launching missiles in the Mommy Wars, Sarah Palin has nothing on Christopher Ruhm. On Thursday, the University of North Carolina, Greenboro, economist published a study showing that kids from high-socioeconomic-status families take a long-term hit when their moms work outside the home—at ages 10 and 11, they perform more poorly on cognitive tests and are also more likely to be overweight than those whose high-status mothers leave the workforce. ... "This comes down to a fundamental principle of economics: something has to give. We can't have it all," he says.

That's right. We think having a stay-at-home mom will be a bigger advantage for our kids than a stack of money would be when they turn 18.

It's hard to write robust software: computer programs are notoriously incapable of handling new, unforeseen situations. One of the primary purposes of artificial intelligence is to develop techniques that allow software to be as flexible as the human brain, to be able to make reasonable decisions in confusing circumstances with incomplete information. There are few more complex and confusing domains than financial markets, so it's not surprising that there are glitches in financial AI programs.

NEW YORK (Reuters) - Computers, unable to see the mold on an outdated UAL Corp (UAUA.O: Quote, Profile, Research, Stock Buzz) article, sparked confusion, a mass sell-off, and an emergency trading halt earlier this week that highlights the pitfalls of increasingly automated financial markets.

Shares in the parent of United Airlines plunged about 76 percent after a nearly 6-year-old news story on its 2002 bankruptcy filing appeared online on Monday.

UAL, which is no longer in bankruptcy, scrambled for a retraction and its stock later bounced back -- but for some investors, especially frequent traders, the damage was done.

The use of algorithms -- which allow computers to make decisions in fractions of a second -- appears to be a main culprit in the UAL case.

Experts said the automated programs were applied to both the reading of the outdated news story and the trading of shares based on that information.

Humans can make disastrously bad decisions too, of course, so we shouldn't be too quick to judge our artificial counterparts! The more intelligent our software becomes, the more prone it will be to human-like errors. Even if we do ever achieve human-level intelligence in a machine, there's no reason to believe it will be any more perfect or rational than our own intelligence.

(HT: Nick.)

And David Harsanyi knows what pisses me off:

The feds will rescue anyone, it seems, except those suckers who dutifully mail their mortgage checks in on time every month.

I go to work every day, whether I feel like it or not. I paid my way through school. I take care of my own problems. Stupid me.

These reliable citizens, in fact, soon will be propping up the for-profit businesses of Fannie Mae and Freddie Mac (not to mention Bear Stearns) in the de facto nationalization of a huge chunk of the mortgage industry.

Stockholders of Fannie and Freddie, for decades, have profited from an implicit taxpayer guarantee on their business, while pretending that such a pledge didn't exist.

Well, it does. We know this because as a reward for a feeble job done, executives may walk away with $15 million in severance pay.

You? The bailout allegedly will cost taxpayers approximately $200 billion. And, as you know, federal projections are always on target.

I say: screw them. Let Fannie Mae and Freddie Mac collapse. Would the bottom fall out of the economy? Good. We'd recover in a few years, and we'd be wiser for it. What's more, the people who made such dumb decisions would never be trusted with anyone else's money again.

Instead, the government grabs a shovel and scoops money from my pocket and gives it to idiots.

The gist of this article is that engineers are underpaid (who can argue?), but the salary statistics for dozens of other jobs are also quite interesting.