Why Bail? The Banks Have a Gun Pointed at Their Head and Are Threatening to Pull the Trigger
If you have a real story, you don't have to make up phony stories. That's pretty straightforward.
I've heard lots of phony stories. Much of the country's political and economic leadership has been running around raising the prospect of the Great Depression and a breakdown in the banking system (I actually had taken the latter seriously). These stories are absolutely not true.
There is no plausible scenario under which the no bailout scenario gives us a Great Depression. There is a more plausible scenario (but highly unlikely) that the bailout will give us a Great Depression. There is no way that the failure to do a bailout will lead to more than a very brief failure of the financial system. We will not lose our modern system of payments.
At this point I cannot identify a single good reason to do the bailout.
The basic argument for the bailout is that the banks are filled with so much bad debt that the banks can't trust each other to repay loans. This creates a situation in which the system of payments breaks down. That would mean that we cannot use our ATMs or credit cards or cash checks.
That is a very frightening scenario, but this is not where things end. The Federal Reserve Board would surely step in and take over the major money center banks so that the system of payments would begin functioning again. The Fed was prepared to take over the major banks back in the 80s when bad debt to developing countries threatened to make them insolvent. It is inconceivable that it has not made similar preparations in the current crisis.
In other words, the worst case scenario is that we have an extremely scary day in which the markets freeze for a few hours. Then the Fed steps in and takes over the major banks. The system of payments continues to operate exactly as before, but the bank executives are out of their jobs and the bank shareholders have likely lost most of their money. In other words, the banks have a gun pointed to their heads and are threatening to pull the trigger unless we hand them $700 billion.
If we are not worried about this worst case scenario (to be clear, I wouldn't want to see it), then why should we do the bailout?
There has been a mountain of scare stories and misinformation circulated to push the bailout. Yes, banks have tightened credit. Yes, we are in a recession. But the problem is not a freeze up of the banking system. The problem is the collapse of an $8 trillion housing bubble. (It was remarkable how many so-called experts somehow could not see the housing bubble as it grew to ever more dangerous levels. It is even more remarkable that many of these experts still don't recognize the bubble even as its collapse sinks the economy and the financial system.) The decline in housing prices to date has already cost the economy $4 trillion to $5 trillion in housing equity. This would be expected to lead to a decline in annual consumption on the order of $160 billion to $300 billion.
Given the loss of housing equity, I have actually been surprised that the downturn has not been sharper. Homeowners had been consuming based on their home equity. Much of that equity has now disappeared with the collapse of the bubble. We would expect that their consumption would fall. We also would expect that banks would be reluctant to lend to people who no longer have any collateral.
This is the story of the downturn and of course the bailout does almost nothing to counter this drop in demand. At best, it will make capital available to some marginal lenders who would not otherwise receive loans. We should demand more for $700 billion.
For the record, the restrictions on executive pay and the commitment to give the taxpayers equity in banks in exchange for buying bad assets are jokes. These provisions are sops to provide cover. They are not written in ways to be binding. (And Congress knows how to write binding rules.)
Finally, the bailout absolutely can make things worse. We are going to be in a serious recession because of the collapse of the housing bubble. We will need effective stimulus measures to boost the economy and keep the recession from getting worse.
However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.
While their argument is wrong, these are powerful voices in national debates. If the bailout proves to be an obstacle to effective stimulus in future months and years, then the bailout could lead to exactly the sort of prolonged economic downturn that its proponents claim it is intended to prevent.
In short, the bailout rewards some of the richest people in the country for their incompetence. It provides little obvious economic benefit and could lead to long-term harm. That looks like a pretty bad deal.
An additional argument against the efficacy of this giveaway insofar as reducing the balance sheet ambiguity currently created by the "toxic paper" (soon to be the property of Uncle Trick Willy), the five year "look-back" provision, to the extent it is not considered the manifest bullshit that it undoubtly is, will arguably create the need to account for the possibility of this future charge, etc. etc.
Moreover, since the recipients of Secretary Gramm's (gotcha didn't I) largesse will likely not be the commercial (fdic) insured banks but the flybynights, when the economy does still tank, the fdic will still have to work the money press 24/7 with the resulting extra *inflationary impact.
*And boy, do we need some inflation;it's the only even remotely progressive tax they will impose in this country--admitedly a blunt instrument, which can shatter the elderly pensioners, but a good run of 10% year on year will make all those mortgages good again...
September 29, 2008 6:41 AM | Reply | Permalink
Alright, Baker, why was it then, that a little more than 10 days ago when Paulson initially announced his plan, you came here and wrote a very long piece arguing for a different plan with many of the provisions that will be passed by Congress?
What has changed you mind in the past few days?
Right now, I don't see any reason to think that any of you economists and financial experts, left or right, have a single goddamn clue. Do any of you know what you're talking about, or are all of making it up as you go along?
I would like to believe that some of you know something, since that would mean that we can actually make some decent policy. But if you don't, then we're all screwed.
If nothing else, help me out: Help me to understand how I can tell who I should listen to. How do I know which "experts" I can trust? You're seemingly random position changes is making it difficult for me to trust your substantive judgment.
September 29, 2008 7:03 AM | Reply | Permalink
Initially, Dean and a lot of people took the administration's word for the fact that the banks were in danger of truly imminent collapse and that's why the initial reaction was in favor of some kind of plan. The fact that, 10 days later, we're still around to debate things is proof that the system doesn't need all of this.
We were lied to.
Again.
September 29, 2008 7:14 AM | Reply | Permalink
That's a pretty shaky justification, Destor. Within the past few days, we have also seen the seizure of Washington Mutual. In any case, the simple counterargument is that the prospect of government helped has slowed the implosion.
Now, again, I don't know if that's true, but it's at least as convincing to me as the argument now popular among lefty bloggers that there is no problem here, no sirree, nothing to worry about.
Again, I want anyone, Baker, you, anyone, to give me something to work with. Give me something, some standard, by which I can judge the utility of proposals or statements. At this point, everything I read has a whiff of bullshit.
September 29, 2008 7:35 AM | Reply | Permalink
You're right about the whiff you're smelling. And that ought to be enough for you to understand that we are being sold a bill of goods. There is nothing magic about acting immediately except that, that is the only way a con job like the great heist they are engineering can be passed. With the passage of each day, the prospects that this raid on the treasury will be stalled or stopped increase and all to the good of the average American.
This, like the Iraq war resolution, the Patriot Act, and other "must pass right now do don't read it just pass it" legislation is an illegitimate act being passed outside the regular process because it could not possibly survive the scrutiny of Congress or the American people if either is allowed to take a sober look at what is going on, why, and what to do about it. The sky will not fall if some major banks fall. the average American's daily life and routine and that of their family will not change if Wall Street goes to hell in a handbasket. The average American is already surviving in bad times. If the rich suffer too it won't substantially alter the facts on the ground for John and Jane Q. Public.
But once we hand the predators $700 billion in free money you can be sure they'll be back and soon for a whole lot more. The ongoing theft of our children's future by these pigs will certainly have an impact on the lives of our common people and it will all be bad. This whole raid on the treasury you may recall is taking place in the wake of gigantic government expenditures to "rescue" other insolvent firms. Once the thievery begins, every crook wants a piece of the action. That is precisely what is taking place right now.
You can remain skeptical about it all, but the prudent choice here is not to fork over this vast sum to Bush/Paulson. The prudent choice is to put on the brakes and consider the situation and possible remedies like grownups instead of panicked children who don't know what to do so they simply throw and irresponsibly gigantic amount of money up in the air in hopes it might take care of things.
September 29, 2008 9:19 AM | Reply | Permalink
I agree with you. It does all seem like BS. But the burden of proof is on the people who want to spend $700 billion, I say. I'm not convinced and have been lied to too many times on trillion dollar tabs by this crowd.
As for the seizure of WaMu -- isn't that how it's supposed to work? Bank fails, government seizes it, sells off its assets to another bank and moves on. To me it's proof that we don't need to do anything out of the ordinary to solve these problems.
September 29, 2008 9:21 AM | Reply | Permalink
Take a look here, Reece.
http://krugman.blogs.nytimes.com/2008/09/26/crisis-at-princeton/
September 29, 2008 9:44 PM | Reply | Permalink
This is past irresponsible, and on to criminal.
September 29, 2008 7:34 AM | Reply | Permalink
There are two reasons why I have changed my view of the bailout. First, as I have tried to make as clear as possible, the worst case scenario (which I do not think will happen) is not the disaster I had earlier feared.
In fact, if the Fed does its job well, we would not even notice the disruption. They could bring about the orderly change in control as has been done at many banks that have failed and taken over by the FDIC. But of course that cannot be guaranteed.
The second reason is that the conditions that I described as necessary to make a bailout acceptable have not been met. This is still a party for wall Street. That is not a good use of taxpayer dollars.
September 29, 2008 7:54 AM | Reply | Permalink
What job? What disruption? What change in control? What conditions did you describe?
Admittedly, I have not been able to read everything that has been written here over the past several days. But early on you argued that it wasn't a crisis if Treasury wasn't willing to agree to the provisions you laid out. While that's an interesting argument, it is not a sufficient method of gaining knowledge about the nature of the crisis. By analogy: I'll agree that evolution is true if you agree that it is Lemarckian.
Part of the reason I'm pissed right now is because of the election. Look, this is OUR election. We're on the verge of making a major change to this government, and hopefully, to reverse the course of the past 8 years. We're going to have a Dem President, and Democratic control of Congress.
But then here comes the Democratic cavalry, ready to cut down the progressive party right at the moment of victory. Across the web, lefties are using this to argue against Democrats, and by doing so, they're not only hurting the party, but hurting the country.
Now, Mr. Baker, I'm sure you realize that this is a done deal. Whatever you think is the right thing to do, it ain't gonna happen. This is what we're getting. So, what are you going to do Thursday morning when the President signs this?
Can we all agree to not commit the ritual suicide that accompanies every Democratic near victory?
September 29, 2008 8:14 AM | Reply | Permalink
All the more reason to question the urgency of passing this bailout. A $700 billion commitment will tie the hands of the next administration significantly. We're a little over a month away from the election. Would things truly deteriorate so badly that we can't address insolvent banks without this bailout over the next two months?
As others have noted, the Merrill deal, the WaMu purchase, and now the Wachovia purchase suggest that troubled firms can be salvaged now with existing mechanisms.
Frankly, the cynic (realist?) in me is wondering if the urgency isn't that Bush is now very likely to be replaced by a Democratic president and congress. So whatever deal they can get now is likely better for troubled financial firms (in terms of their own solvency) than what they might expect in January. But note that the public interest isn't in the solvency of any particular firm(s); it is in the financial system itself remaining sound. If Citigroup can buy Wachovia, JP Morgan Chase can buy Washington Mutual, and Bank of America can buy Merrill Lynch (albeit in some cases with some government assistance), perhaps the bailout isn't really so necessary after all.
September 29, 2008 10:12 AM | Reply | Permalink
I gree heartily with you Mr. Baker!
I have written Obama's Senate office in strong opposition to this (to put it kindly) ripoff of the taxpayer. Are you not one of Obama's advisors on such matters? Will you be urging him to change his position on the great American robbery? I certainly hope so.
If he comes out in opposition the heist is dead in the water. So will you be working to get him to change his position on this?
September 29, 2008 8:39 AM | Reply | Permalink
That should be: I "agree" heartily with you...
September 29, 2008 9:09 AM | Reply | Permalink
However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.
Why don't we bring an end to the Iraq war and give ourselves a nice big peace dividend?
Mr. Baker, you continue to suggest that the assets the government is buying are so bad that that the bailout is just $700 billion down the drain. Maybe you're right and maybe you are wrong. But could you give us an argument? Others are, as you know, arguing that many of these "troubled" mortgage-backed securities have a lot of value, even though the market cannot currently price them, and that the US government might actually turn a profit from the bailout. How do we know who is right.
By the way, it seems to me that Obama's argument for taxing the rich and ending the war, to finance some good old Keynesian stimulus in the form of things like infrastructure rebuilding and green energy development, just got a whole lot stronger. I'm not afraid of the Washington Post. They haven't been winning the debate this whole election season, so why should they start now?
As Reece said, it's hard to know whom to trust in this situation. But at the current time, I trust Warren Buffet more than I trust you.
September 29, 2008 9:29 AM | Reply | Permalink
The root issue is that what these securities will ultimately pay out is unknown, and dependent on many factors, including how deep the recession is, and where the real estate market goes next. Clearly most mortgages are not in default, but the more that do default (and the lower recoveries we might see from further real estate price declines) would cause the value of many assets to plummet. And since these securities are sliced and diced in many different pieces (and seniority levels) certainly some of the more junior assets may indeed become worthless, while more senior assets, which had once been given AAA ratings, are at greater risk of principal impairment.
Could the Treasury buy assets at a premium to market prices and still turn a profit? Maybe - depending on the premium and future economic conditions (and how much of a risk premium you want to use to present value future payments), it's possible that it could. It's also possible that it would be saddled with very large losses, if it turns out that even current market prices are too optimistic for these assets. There is undoubtedly significant risk in using so much federal money to buy assets.
I like Buffett a lot (heck, I'm even a shareholder), but he has a vested interest in this bailout passing, especially after his $5 billion investment in Goldman Sachs. That doesn't necessarily mean he's wrong about the severity of the crisis. But it is true that the solution he's advocating will be financially beneficial to Berkshire Hathaway.
September 29, 2008 10:37 AM | Reply | Permalink
"I trust Warren Buffet more than I trust you"
This is not meant as a shot at Buffett's integrity, but he expressed his support for the bail-out the day after he agreed to throw 5-billion into Goldman Sachs. He is hardly an objective voice in this present crisis.
I think the issue with Dean's commentary here is that it unfairly dismisses the thinking behind the bail-out. It is true that we don't know what will happen if there is no bail-out. Of course no-one is blessed with that sort of foresight. But Paulson and Bernanke have been, literally, begging Congress to pass some sort of deal because they think the risk posed by inaction is simply far too great for the overall health of the economy. They've done their own cost-benefit analysis, and now we know what the product of that is.
When Dean writes - "There is no plausible scenario under which the no bailout scenario gives us a Great Depression" - well, the plain fact is Bernanke and Paulson do see a plausible scenario.
My view, written here before, is that Bernanke and Paulson believe the bail-out is a critical initial step in recapitalizing the system. (This is where I have diverged for once from Paul Krugman's analysis - Krugman for much of last week was chiding B and P for not talking about recapitalization, I feel he rather foolishly presumed this was not their objective.) I think there is a logic to it, and there is certainly a necessity in crafting very careful, detailed legislation to design a bail-out of the industry.
I'm afraid I can't buy Dean's assertion that doing nothing is an option - I think the risks are too great of not trying to break the vicious cycle of delevering. Whether the plan we see today has merit is a debate worth having; but the need for a government-led initiative to recapitalize banks is surely established. The "why" is plain to see, the "how" is what the world is waiting to have set out.
September 29, 2008 11:38 AM | Reply | Permalink
But, Eddie-george, your arguement boils down to a question of trust. You believe Paulson and Bernanke, and others are asking whether we should believe them. I, myself, am conflicted.
It is an exact analogy to the lead up to the Iraq war. Back in 2002 I knew that George Bush was an idiot. But back then I actually thought Cheney and Rumsfeld and Rice deserved the benefit of the doubt when it came to something like the questions of whether Iraq posed a threat. And the clincher for me was Colin Powell. Boy, if even Colin Powell (who I knew was somewhat of a contrarian within the administration) was on board with this thing, then I guess it really must be necessary.
I was taken in by these lying bastards then (not that I could have stopped the war, but it kept me from getting a sign and marching with the anti-war protesters -- or calling my Congressman, or writing a letter to the editor, etc.).
As President Bush so aptly put it, "Fool me once, shame on you, fool me twice, eahh, we won't get fooled again!"
I find myself with the exact same feeling now -- that is, these guys (Paulson and Bernanke) know better than I about this stuff. So I'm inclined to give them the benefit of the doubt.
BUT now I'm an order of magnitude more skeptical (and cynical), and I don't trust anyone associated with this administration at all.
So it does make sense that we should at least ask for a better explanation. I'd like to hear what they told Congressional leaders two weeks ago Thursday night. Just what do they think will happen if we don't pass this bill right away? (Somehow the hearings they held never really got that information out on the table, did they?)
I find this situation really, really frustrating.
-- ARG
September 29, 2008 2:28 PM | Reply | Permalink
Sure it’s a done deal.
The Democrats went into the negotiation with the attitude we want oversight. And of course, the less regulation crowd, balked at that notion.
So on and so on. In the end a compromised was reached. Okay we’ll give you Oversight capabilities. DOH!
Oversight should have been a given anyway. So what was, the tit for tat?
They now talk about the possibility of another stimulus package.
How about if you’re going to bail out the banks, you bail out consumers.
As it stands now, consumers who may have made purchases at a determined rate are now going to see those rates, rise significantly.
Profits for the bank.
Any excuse will do for the banks to raise the rates, on the unpaid balance.
Of course the banks will be solvent again, off the backs of trapped consumers, thank God it wasn’t on the backs of the taxpayer. (Sarcasm)
Help in the form of Credit Card Rates freeze, would allow Americans; to get out of their financial mess. Just as we are helping the banks out of their mess? Maybe
Citizens can make a choice as to whether to cut up the cards, thinking seriously about the use of credit cards for sustainability.
Since it appears there will be no wage increases soon. Our Nations Tax base destroyed, as Ross Perot told us would happen, with a giant sucking sound of good paying jobs going abroad.
I wonder if our economy can actually survive without credit being available for consumers. Because if you’re a manufacturer of products to be sold, and the consumer, "say’s not till I have the cash will I purchase."
Freeze the Rates, and by doing so many will be able to pay off the debt sooner,
By doing so, wouldn’t they be in a more favorable position to stimulate the economy again?
September 29, 2008 9:32 AM | Reply | Permalink
I could have told you that without even knowing the details....
September 29, 2008 9:36 AM | Reply | Permalink
Oh, I get the headline. Its from Blazing Saddles. "(He's) crazy, he just might pull the trigger!!"
E-mail/call your congressional reps And Obama campaign.
Worst. President. Ever.
Wall Street free market greed (google 'predator lender') mixed with McCain/Graham de-regulation...
Every one who voted for Bush or will vote for McCain will have to stand around the same barrel fires under bridges as the rest of us, but you will have a MUCH harder time explaining when your kids in rags ask you "Daddy, why did this happen to us"?
September 29, 2008 10:23 AM | Reply | Permalink
Hey, comrades, Baker is good, but he's not the Oracle, ferhevensakes! He makes mistakes, doesn't pay proper attention etc. Those of us for whom the phrase "regression analysis" if frightening can read his stuff, but we're still required to think for ourselves. And surely we should have learned by now that just because economists--either singly or in groups--tell us something doesn't make it so.
September 29, 2008 10:36 AM | Reply | Permalink
Amen Brother Peon....LOL
September 29, 2008 10:49 AM | Reply | Permalink
Dean -
I recently came to the same conclusion based on the following:
http://www.federalreserve.gov/releases/h6/Current/
The most recent M1 and M2 data don't show much of a contraction, especially if you look at prior years in Sept/Oct.
What is missing here is the September data - does it show a sharp drop? That would be cause for concern. The Fed is no longer tracking M3, and a case can be made that M3 is contracting, but that's not a collapse in the system, it's a flight to safety.
Now for the commercial paper markets. The spreads here do look quite bad:
http://www.federalreserve.gov/releases/cp/
but look at the increase in CP issued by non-financial companies - it's up. This means other lenders are getting into the market.
I've also looked at the TED spread and borrowings at the FED, which spiked up dramatically, but this just indicates banks are borrowing from the Fed rather than each other, which is how this is supposed to work.
I've written previously that I believe due diligence needs to be done, and I'm frankly baffled at how/why little data has been shared by the leadership. This makes me hesitate. My conclusion is I'm not seeing a collapse, though I am seeing short-term borrowing costs go up. I'd prefer some analysis and data from our leadership before handing them the keys to the safe, and causing problems for the next administration, who may very well need the classic Keynesian solution to stimulate the economy with domestic government spending.
September 29, 2008 11:19 AM | Reply | Permalink
Well, let me now ask the Oracle a question. Suppose that the banks are holding out the money to get their bailout--putting the squeeze on us, so to speak. Couldn't the government just spew money into the economy to counter them? How would it do that?
September 29, 2008 11:25 AM | Reply | Permalink
Why bail indeed?
That said, its hard not to give up hope. The Democrats have folded the tent and given into Bush and Wall Street again. This bailout is the precise wrong thing to do. It is really just a roll-over bill, rolling over trillions in bad debts to the not-so-distant future. It buys months at most, perhaps only weeks or even days.
Look to your past, Dems - FDR.
Would FDR have bailed out the banks? Deregulated them (overturning Glass-Steagall), as well as transportation and energy? Embraced NAFTA and CAFTA, free trade, cut tariffs to almost nothing, sunk the Bretton Woods fixed Exchange Rate system which threw open the door to the speculative sharks to attack nat'l currencies, therefore nat'l sovereignty?
Its 35 years of idiotic and criminal destruction of almost all of FDR's reforms that have created this looming meltdown and depression, not some bad mortgages. Giving a blank check to the predators and some regulatory reform around the edges will NOT fix anything.
No reform of the present system will work, because it is dead. Declare it dead, put it into bankruptcy reorg, freeze foreclosures. Separate legit banking functions from investment banking functions (a new Glass-Steagall). Write off the $100's of trillions in derivatives, CDO's etc. Raise the discount rate to above that of London and the EU to protect the dollar, at the same time Congress must issue 1-2% credits in the trillions of dollars to non-speculative, productive investments for vital infrastructure - energy, transportation, water projects, nat'l health care. Bring together Russia, China, Japan, India, Brazil and whoever else wants to survive and convene a conference to create a Bretton Woods II system.
Unleash the productive force of the US constitution and labor to fix these problems now, while there is still time. The int'l financial oligarchy will use this bailout and its ultimate failure to further loot the built up wealth of the world if we give them the chance. That way lies more war, austerity and fascism. This is the last chance to avoid a new dark age of civilization. Do Obama and the Dems have any historical understanding of what we truly face?
September 29, 2008 11:52 AM | Reply | Permalink