The Meltdown (Part IV)
The Dow is see-sawing but the reality is that the Bailout of All Bailouts isn't working. Credit markets are largely still frozen. Despite all the money going directly to the big banks, despite all the government guarantees and loans and special tax breaks, despite the shot-gun weddings and bank mergers, despite the willingness of the Treasury and the Fed to do almost whatever the banks have asked, the reality is that credit is not flowing. It's not flowing to distressed homeowners. It's not flowing to small businesses. It's not flowing to would-be homeowners with good credit ratings. Students are having a harder time borrowing for their tuition. Auto loans are drying up.
Why? Because the underlying problem isn't a liquidity problem. As I've noted elsewhere, the problem is that lenders and investors don't trust they'll get their money back because no one trusts that the numbers that purport to value securities are anything but wishful thinking. The trouble, in a nutshell, is that the financial entrepreneurship of recent years -- the derivatives, credit default swaps, collateralized debt instruments, and so on -- has undermined all notion of true value.
Many of these fancy instruments became popular over recent years precisely because they circumvented financial regulations, especially rules on banks' capital adequacy. Big banks created all these off-balance-sheet vehicles because they allowed the big banks to carry less capital.
Paulson is recapitalizing the banks -- giving them money directly rather than relying on reverse auctions -- largely because he's come to understand that the banks have taken on so much debt that the reverse auction system he told Congress he would use(designed to place a market value on these fancy-dance instruments) will leave too many banks insolvent.
But pouring money into these banks, expecting they'll turn around and lend to small businesses and Main Streets, is like pouring water into a dry sponge. Nothing will come out of it because Wall Street is so deep in debt that the banks are using the extra money to improve their balance sheets. They're hoarding it because their true balance sheets -- considering the off-balance sheet vehicles they created over the past several years -- are in such rotten shape.
In other words, taxpayers are financing a massive effort to save Wall Street's balance sheets from Wall Street's previous off-balance-sheet excesses. It won't work. It can't work. The entire effort is merely saving the asses of lots of executives and traders who got us into this mess in the first place, and whose asses should not be saved at taxpayer risk and expense.
What to do? Immediately require the Treasury to stop the broad Wall Street recapitalization, and require Wall Street to lend the money directly to Main Street. At the same time, force Wall Street to write down its true balance sheets: Let the executives and traders take the hit. Let their shareholders and even their creditors take the hit for Wall Street's collosal irresponsibility. This is the only true way to restore trust. It's also the only way to save Main Street's small businesses, homeowners, students, and everyone else.
I'm glad to see that so many of your bobble head readers agree with this post. But, I have to ask, How is your idea of lending to Main Street different than what McCain proposed in the second debate?
The increasing amount of gray in my lap every time I go to the barber is evidence that I am getting older, so my memory could be failing, but didn't you call his idea of replacing bank-based mortgages with government-based mortgages idiotic? (you were right, by the way)
How is lending money directly to individuals different than what McCain proposed? What exactly would you be lending money to Main Street for? Which government agency would make these loans? Would collateral be required? Who would service the loans? How would one qualify? Would Interest income fund the administration necessary to oversee such a program? Would some portion of the $700 billion go towards this?
Where exactly is your empiric evidence that "deregulation" caused the current economic situation? Who was the last to pass major financial deregulation ? (Answer: Clinton). Who was the last to pass major financial regulation? (Answer: Bush)
The evidence I've seen suggests that market distortions occur when the government gets involved in markets rather than the reverse. For example, government felt executive pay was excessive, so it limited the deductibility of direct executive compensation. What happened? Increased incentive compensation in the form of bonuses and equity compensation resulted in precisely the opposite of what the government was trying to accomplish. How about the mortgage mess? Government got involved by saying "lower your standards" and a bubble began to build.
In both cases, industry took the government's mandate and made it more excessive through irresponsibility. But, it was the government that put us on both of those roads.
Why in the world should I trust the government to run a loan program when I'm not even sure it could find its way down a one way street with a map, a compass, and in-car navigation?
The interesting thing about the idea we're now criticizing is that it isn't Paulson's. It is Bernanke's.
I'm not judging his idea as good or bad. But, it is worthwhile to note that Bernanke's Ph.D. dissertation at MIT was on the causes of the depression and what could have been done differently.
Only time will tell if he is right. I take comfort in the fact that he's spent a lot of time studying that situation and that he has ideas based more on reasoning than politics.
anonymous matt