2008-09-17

Socialism for the rich - continued

NYT:
Fearing a financial crisis worldwide, the Federal Reserve reversed course on Tuesday and agreed to an $85 billion bailout that would give the government control of the troubled insurance giant American International Group.

The decision, only two weeks after the Treasury took over the federally chartered mortgage finance companies Fannie Mae and Freddie Mac, is the most radical intervention in private business in the central bank’s history.

With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman Ben S. Bernanke convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan.

They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers generally expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.

What frightened Fed and Treasury officials was not simply the prospect of another giant corporate bankruptcy, but A.I.G.’s role as an enormous provider of financial insurance to investors who bought complex debt securities. That effectively required A.I.G. to cover losses suffered by the buyers in the event the securities defaulted. It meant A.I.G. was potentially on the hook for billions of dollars worth of risky securities that were once considered safe.

If A.I.G. had collapsed — and been unable to pay all of its insurance claims — institutional investors around the world would have been instantly forced to reappraise the value of those securities, which in turn would have reduced their own capital and the value of their own debt.

“It would have been a chain reaction,” said Uwe Reinhardt, a professor of economics at Princeton University. “The spillover effects could have been incredible.”
Okay, now for my "yes but".

I agree. AIG, like Fannie and Freddie, needed to be bailed out. By taking on the financial problems of one organisation, the Federal Reserve can then dilute its negative effects upon the economy. Rather than AIG getting a bullet in the heart, the Fed catches it, breaks it up into little pieces, and then hurls each little piece at taxpayers and businesses - hurting them but not killing them. In a massive financial emergency, such an action will help mitigate the negative effects of one company's distress. It is, in other words, a classic socialist action - the many paying for the pain of one.

Nevertheless, the Fed is playing with fire here. America's entire financial system is based upon free market ideas that sets aside direct government interference in the marketplace and desires less regulation imposed upon them by this government. With the American financial industry partly collapsing, it could be argued that if the government should turn up to mitigate market failure then the government should also be there when things are going well, regulating the industry and profiting from it through tax revenue.

At some point, the money paid by the Fed and the US Treasury for Bear Stearns, Fannie Mae & Freddie Mac and AIG has to be accounted for. Money has to be found to rebalance government coffers.

Of course, both the Fed and the US government share in the blame for the current financial mess. Both Congress and the White House have, since 2001, decided to be fiscally irresponsible and cut taxes during an economic expansion. Moreover, the Fed kept interest rates ridiculously low under Greenspan from 2003-2005 and has created negative real interest rates during that period and also more recently under Bernanke. Negative real interest rates were one of the reasons why an investment bubble formed, and one of the reasons why it has popped so badly.

But let's get real. Were any Wall Street bigwigs warning the Bush government to stop cutting taxes or telling the Fed to raise interest rates? No. It was pressure from the financial markets that dictated America's expansionary fiscal and monetary policy in recent years. While we can certainly find time to blame Bush, Bernanke and Greenspan for kowtowing to the market, we should also find time to blame the financial market itself for promoting such ruinous policies.

Which means that, of course, the financial markets are simply reaping what they sowed. They profited from a bubble, now they are paying for it popping.

Except that they're not - at least not at the moment.

Where is the government going to get the money to pay for their "socialism for the rich"? Will they raise business taxes? Will they increase the top tax rate? It is the rich who created this financial black hole, so why not make them pay for it?

Of course the government could simply increase income taxes on everyone, which will then burden everyone with the problems created by a few. The government could also decide to cut defense expenditure or health expenditure to cope with the increase in debt. They could also just print money if they want to and create a Weimar hyperinflationary event. Or they could just ignore the debt, keep borrowing whatever they need, and then watch the US Dollar eventually crash.

My solution?
  • Cut military spending
  • Raise taxes on the rich
  • Run a fiscal surplus to pay back public debt
  • Use monetary policy to keep inflation low
  • Create and enforce stricter financial regulation so this doesn't happen again.
  • And, of course, fire Bernanke.

8 comments:

BLBeamer said...

Your number one and two should have been:

Force the CEOs, CFOs, and Senior VPs of the firms in question to cough up millions to at least make them feel some pain towards alleviation of their foolishness.

Let's also publicize the names of the politicians who were their enablers.

Another question: where were the auditors and analysts?

Noni Mausa said...

Business behaved badly, of course. but also the government allowed this to get to this extreme, but of course they are us (except when we want to borrow $20 till payday).

True, government may not have the formal power to do such-and-so to the financial sector, but informal actions like giving occasional speeches or interviews musing about the possibility of bubbles or malfeasance, pack quite a punch when the muser is the president. "Fireside chats" would be welcome right about now. I seem to recall that when Greenspan burped, the market trembled, and that was practically last week, as such things go.

A little off topic -- how exactly does someone "take over" something like Fannie Mae or AIG? Send in an army of people in suits? (hand to hand combat in the revolving doors and down the escalator...) If so where do these suited soldiers come from? Are displaced Fannie Mae people now scaling the walls of AIG, and vice versa? The more I think about it the more daunting it looks.

Noni

Luke S. said...

What really irks me is the reporting of the crisis as though it's some natural, unfortunate phenomenon that materialized out of nowhere to wreak havoc on various economies, and all the innocents caught up in it woke up one day and said 'oh noes! the crisis has come!'.

The best way to send a message about this kind of stuff would be to start trying and/or locking people up, and if there are no laws to try them under, create them. Currently it looks like the most senior people are sentenced to having to receive millions of dollars as punishment.

If I gave my savings to a financial institution, and they started using the money to bet on horses, I'd want them brought to justice.

That these financial institutions can do, well, even stupider things and hide behind the facade of white-collar respectability and the opaqueness of the complexity of what they do ('fancy instruments' to paraphrase Dubya.. *shudder*) is really, really annoying.

/end rant :)

One Salient Oversight said...

CEO pay can be a sore point for people but no matter how unfair it may seem - they get multimillion-dollar payouts even when their company goes bust - it is, unfortunately, a result of a free market system.

There are only really three people you can point fingers at here who can be directly blamed - George Bush, Alan Greenspan and Ben Bernanke.

George Bush because he pursued aggressive tax cutting during an economic expansion which helped create the housing bubble.

Alan Greenspan because he kept interest rates too low in the critical period when the bubble blew up. Negative real interest rates ensured that people with cash would invest it in anything that grew.

Ben Bernanke because he somehow couldn't see the crash coming until it was too late, for adjusting interest rates so low that negative real interest rates were created again and for being unprepared for dealing with the crash now.

BLBeamer said...

There are only really three people you can point fingers at here who can be directly blamed - George Bush, Alan Greenspan and Ben Bernanke.

Please. I am not an apologist for GW Bush, but can he really be only one of the three people in the entire world who can be blamed for this entire crisis? Really? There is blame for each of those guys, but let's not forget the Congress, both GOP and Dems. The Clinton administration has a small but key role in their "improvements" to the Community Redevelopment Act which, in a classic case of unintended consequences, enabled much of the sub-prime mess once Greenspan, Congress and the Bush administration decided that money did grow on trees after all.

I'm not sure that the CEOs getting multi-million dollar payouts is exactly a result of the free-market system. It is a result of that class of person successfully convincing directors' boards and Congress and the SEC to allow them to shift money from the shareholders to themselves.

I'm not convinced a true free market with complete information available would have the same result. But then, nobody but stupid leftists think the US has a free market in anything any more anyway. And we haven't since the Theodore Roosevelt administration.

Coffee Bean said...

I don't really grasp all of this stuff... I just know that I find it distressing.

The Scylding said...

I see this as the moment the US has to move to "Third Way" economics, as Roepke would have it, in the manner of the European Economies since the 60's. Will it happen / will it work. That remains to be seen...

The Scylding said...

Then there are these recommendations, which seem to make at least some sense to me, from a Nobel prize winner:
http://www.cnn.com/2008/POLITICS/09/17/stiglitz.crisis/index.html