Book club cont'd, cont'd: "the same lesson will keep being learned"
Hello again--
Some questions and comments from over the weekend, and some proffered (if belated) answers and replies:
liberal jim wrote that we are likely in for yet more government bailouts of large financial firms over the years and decades. "Unless you have a way of changing human nature the same lesson will keep being learned until the market prevents a government bailout," he noted.
Yes. This is a problem. The bailouts that began in 2008 are the precedent, not the Dodd-Frank law that is supposed to prevent future bailouts.
The politicians may vow, "no more." It doesn't what they say. Conventional-wisdom academia/economia has determined that the bailouts were a resounding success.
The experts will counsel future politicians that the first thing to do in a financial panic is guarantee lenders to the financial industry and inject capital into large financial firms. And future politicians, not wanting to question authority -- that is, staff -- in a crisis, will listen.
It doesn't help matters that President Obama has now appointed William Daley, until recently a bigwig at JPMorgan Chase, to be his White House chief of staff. JPMorgan Chase would be a fine company -- if it were subject to free-market forces. It is not. Global market participants understand, via the precedents discussed above, that it enjoys a permanent backstop from the U.S. government.
We need to change this perception and reality -- and the only way to change it is to have high-level business people, not bankers, in the White House. Obama should be taking the counsel of entrepreneurs and executives who know what it's like to be dependent on finance and to feel that they are losing talent and capital to an industry that enjoys unfair Washington subsidies.
Daley, on the other hand, is more likely to operate under the principle that what is good for JPMorgan Chase is good for America. (In fact, that's actually true. Market discipline of finance would be good for both. But that is not how he'll see it should the financial crisis flare up.) That is not his fault, and doesn't require any financial corruption on his part. He just brings his own background with him, as everyone does.
Daley should come back as a key staff member once Washington has made it clear, via precedent, that lenders to large financial firms will consistently shoulder their share of losses in the future. Not before.
***
Rob Long wrote of his married-couple conservative friends from Wall Street:
She thought the [bailouts] were atrocious and would only teach the wrong lesson to financial institutions, that bailouts will always be forthcoming, and that unmitigated risk has no downside. He told her that without federal intervention at that time, they'd be selling apples in the street. Who do you think was right?Or are they both wrong?
No, they were both right (as Claire suspected), and that is the problem.
***
Said John Prather:
The part that is so hard for the casual observer to understand is the incredibly rapid rise in the use of derivatives ... and the millions of "strands" that interconnected the banks, investment houses and insurance companies. In the past there were "firewalls" that would have prevented or at least inhibited these strands to occur. It was the fear of the unknown effect of this interconnectedness that drove the intervention.
Yes.
These derivatives were like a giant knot, gently entwining financial firms and the global economy within it at first. But then panicked financial markets started to tug at loose ends of the knot, trying to unravel it, but only tightening it further until they began to choke the individual financial firms and the economy itself.
More practically: in 2008, people feared that AIG might be bankrupt. They then had to fear that the institutions on the other side of AIG's trades -- that is, much of global finance -- might be bankrupt. Then, they had to fear that the institutions that were on the other side of those institutions' trade's might be bankrupt, and so on and so on, until nobody wanted to put any money in the financial system absent government guarantees.
This is why we need public exchanges to serve as central counterparties to various financial parties' derivatives trades. Because market participants would understand that the exchange has the capacity to absorb the bankruptcy of any one trading firm, the focus would remain on the trades, not on the individual counterparties to the trades.
Requirements for firms to trade their derivatives on exchanges -- and to put up some cash behind these bets -- facilitate free markets. A free-for-all in which financial firms can make tens of millions of bilateral trades with one other behind closed doors may seem free, but it's not, because it allows firms to escape the threat of bankruptcy and its attendant discipline.
It's like traffic rules. We all know we've got to stop at red lights and go at green. Absent such rules, we wouldn't feel more free. We would live in fear, and would get into more accidents that would demand more emergency medical attention.
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Comments :
May '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
I somewhat agree with you, but I believe we have simply put off paying the piper, making the eventual day of reckoning even bigger. We've effectively transferred the problem from the private sector to the public sector, the ultimate bailout causing the ultimate debt bubble. We're just kicking the can down the road, with interest.
Also, as of yet, it doesn't seem that we have learned our lesson very well. Some of the same shenanigans that caused the problem are still going on.
Until we get some very high-level executives (and lower level folks too) who ran these financial firms, in jail for criminal fraud, I don't see the situation changing. We'll have to bail them out again soon. And who's going to bail out the government when it comes to that?
Edited on Jan 18, 2011 at 6:49pmMay '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
I also like your traffic lights analogy. For markets to be orderly, they need some amount of order imposed on them. Otherwise it's a free-for-all, which history has proved time and again results in a lot of people getting ripped off. Government can't solve all problems, and often messes up the ones it tries to solve (or creates other ones) but basic time-tested rules, such as transparency and not leveraging past a certain limit, seem to me to be quite reasonable and necessary.
Sep '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
Don't you think deposit insurance was sort of the original sin in all of this? I think the fall of Lehman was not as injurious as the Reserve money mkt breaking the buck because of their Lehman exposure. That is what made the counterparty credit risk inside AIG so frightening. People who had their savings in uninsured money funds came to view those funds as just as safe as insured deposits, however, I also believe that there were runs on insured deposits at Wachovia and Washington Mutual so the insured creditors may not have made the distinction either. Do you think we would be better off if those deposits had been wiped out? Maybe they all would not have lost everything like they did in the 30s and we'll never prove the counter-factual.
Jun '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
In the presence of Sarbanes Oxley, Nicole, you want to establish yet another public market. I say good luck to that. It's so bad now that no companies want to go public on the NYSE or any other board in the US. Still, I'm all for a derivatives public market, maybe in London or Tokyo, but definitely not in the States. There is no denying that some public means of evaluating and trading exotic financial instruments such as derivatives is necessary, but I can't see it ever happening given Governmental regulatory over-reach and US tax rates. It's a non-starter. As for putting folks in jail, I agree, Chris, but respectfully suggest that we start with Barney Frank and co. You're looking for crooks in all the wrong places.
Edited on Jan 18, 2011 at 7:02pmRe: Book club cont'd, cont'd: "the same lesson will keep being learned"
Thanks, Nicole. But if they were both right -- it was both a necessary and a corrosive intervention -- how do we install a publicly traded (and transparent) derivatives exchange? And isn't that the great flaw of last year's "reform?" That it did nothing to address what really went wrong in 2008?
Jan '11
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
It is with great trepidation that I disagree wtih the experts - but here's my take. If it took a one time bailout to right the ship, no problem, I'm jiggy with that. But bailouts as far as the eye can see - er, maybe not. Should the government of Holland have continuously bailed out the tulip speculators of the early 1600s? Would the Dutch today be saying, "Look, these tulips are the bomb! We've been saying so for nearly four hundred years!".
Jul '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
Um, so what if they're selling apples in the street?
If my business fails, that's where I'd be, if I were listless and unambitious.
Let them sell apples!
Sep '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
We need to change this perception and reality -- and the only way to change it is to have high-level business people, not bankers, in the White House. Obama should be taking the counsel of entrepreneurs and executives who know what it's like to be dependent on finance and to feel that they are losing talent and capital to an industry that enjoys unfair Washington subsidies.
Bush had plenty of big business people in his administration and its stance was not fundamentally different. Note that when the car companies came calling he whipped out the peoples check book. Big business, big banks, big labor, and big government has for many years been wed in a corrupt relationship. I cannot accept your assertion that replacing bankers with business people would change reality or the perception of it. Criminal prosecution of some of these culprits might be a good first step.
Sep '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
I view the “bailout” scenario differently. It is simply the government choosing winners and losers. The people who worked hard, live frugally, saved, and placed their money in safe deposits (T-bills) got screwed. People, who leveraged, spent and in some cases engaged in fraudulent activity got rewarded. What lesson is to be learned here? I find it strange in all that has been written about how necessary the bailouts were no one ever mentions the people who were hurt by them.
Jun '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
Another rule of politics pop its ugly head out of the mire: Business people in politics are there to promote existing businesses, and not to improve the business environment in general. If they do both it is either due to coincidence or bad planning.
Oct '10
Re: Book club cont'd, cont'd: "the same lesson will keep being learned"
Michael Tee: Um, so what if they're selling apples in the street?
If my business fails, that's where I'd be, if I were listless and unambitious.
Let them sell apples! · Jan 19 at 5:13am
Thank you. It never ceases to amaze me how some people (and I don't know whether that includes this particular couple or not, to be fair) will complain about "moral hazard" out of one side of their mouth, but the moment they actually risk failure are all in favor of being subsidized. IMHO, this is the actual, central issue: we've gotten so accustomed to government guarantees and subsidies that the thought of even temporary job loss, let alone Schumpeterian destruction of an entire industry (Detroit, anyone?) has become literally unthinkable. As long as that remains true, you'd better believe the bailouts and money printing will continue. At least until the underlying insolvency has infected the entire economy and the grinding halt becomes worldwide.