September 19, 2008
QuickLinks: A Bloomberg Bailout Trio (And We'll Go With Worst)
∙ Paulson, Bernanke Expand U.S. Power to Rescue Markets [Bloomberg]
∙ Stocks Soar Worldwide on Bank Bailout, Curb on Short Sales [Bloomberg]
∙ Paulson Bailout Plan Is Either `Worst' Approach or `Giant Step' [Bloomberg]
First Published: September 19, 2008 4:45 PM
Comments from "Plugged In" Readers
bailing out tranches of trash?
our intelligence services should be able to figure out what was going on as finance went over the cliff?
you don't think so?
Posted by: irreverent at September 19, 2008 8:17 PM
In thinking about the outlines of the "bailout" that we've been presented so far, I was struck by the irony. Once again, I'm just amazed at how slick and smart the Fed is.
Everyone has been talking forever about how the Fed was going to bail us out, they were going to "print", "inflate it all away", etc. This would be akin to McDonald's deciding to give away its happy meals for free.
Look at how it's played out. The Fed (owned by its member commercial banks but ostensibly answerable to Congress and the Executive) has just consolidated almost COMPLETE control over the financial landscape. Before this year, there were powerful private companies (e.g., AIG) and investment banks that were beyond the control of the Fed. Now, practically ALL are gone. The commercial banks now control everything (with the sole exception of Goldman Sachs), with the Fed at their helm.
Here is the irony. The Fed is not bailing us out. "We" (the USG) are bailing out the Fed! Look at its balance sheet - how it has been sullied by all these crazy alphabet soup lending programs (note, "lending", not giving):
Now, after the "bailout" all this junk is going to be sitting right with the USG (the taxpayer/population) and my bet is that the Fed's balance sheet is going to be lily white clean again! Now that the losses are going to be stuck with the population, the Fed alone now can choose if, when and how much to inflate! Their member banks are now safe, and they have all the money (treasuries) and retain the ability to support or destroy the dollar without worrying about the impact of falling asset values.
My bet is that in the relatively near future we are going to start hearing about the need to "protect the dollar" and that in order to ensure that foreigners continue to trust and fund the United States' borrowing needs, we are all going to have to tighten our belts and accept the inevitability of higher taxes, lower standards of living, and lower house prices. I mean, the Fed no longer has to worry that falling asset prices will result in more bank losses - it's someone else's problem now!
Posted by: Satchel at September 19, 2008 8:18 PM
I think the real problem may become the foreign obligation, the debt which is owed outside the US.
We may control the empire, but could end up paying tribute to an exogenous financial elite (owns much of the debt).
Posted by: irreverent at September 19, 2008 8:27 PM
"we are all going to have to tighten our belts and accept the inevitability of higher taxes, lower standards of living, and lower house prices."
But I still wonder when the foreigners will say "no mas" to funding the empire.
Posted by: diemos at September 19, 2008 8:30 PM
"we are all going to have to tighten our belts and accept the inevitability of higher taxes, lower standards of living, and lower house prices."
How else are we going to move to living within our means? Though I still think that The Fed will inflate away some of the debt, which is effectively a tax on savers instead of income. There is no way to go from living beyond your means to living within your means without your standard of living falling.
How else could it play out?
Posted by: NoeValleyJim at September 19, 2008 9:08 PM
I am troubled by the way the media is covering this action. There seems to be near universal acceptance that every single step that Paulson and Bernanke have taken was necessary and correct. Where is the critical thinking and debate? Is Jim Bunning the only senator who will vote against this? Maybe in a few months when I see Maria Bartiromo do the inevitable fawning piece on Hank Paulson it will all make sense to me.
I completely agree with Satchel that the Fed and Treasury are now all powerful. Almost seems that it was orchestrated.
Posted by: FSBO at September 19, 2008 9:17 PM
Time to do so retroactive taxing of Wall Street executives who tossed out any notion of controlling risks in order to get fat bonuses and golden parachutes.
Posted by: Jamie at September 19, 2008 10:23 PM
"Almost seems that it was orchestrated."
Well, of course it was. I'm a pretty smart guy, and I have a lot of experience identifying and trading through crises. But I'm neither as smart nor as experienced as the top fraudsters who are engineering this. If all this was obvious to me in early Summer 2007 (the imminence of a crisis - the housing bubble was obvious as early as 2000 in CA, by 2003 in the rest of the country), it was obvious to *them* much much earlier.
I hope that by now people are coming around to the view that the Congress and Executive exert NO PRACTICAL control over the Fed. Whenever I wrote that the Fed was a "private" bank, I always got a lot of resistance. Did it seem to anyone that it wasn't just the Fed dictating what was going to happen at every step of this "crisis"? Does it look like Barney Frank, Chris Dodd and the other fools exercised any oversight?
And now the political debate is degenerating into two camps: the first (Demicans) want a more powerful, larger regulatory USG. The second (Republocrat) wants a more powerful private banking system with the power to "stop" these crises. The Fed and USG "power couple" are laughing themselves silly. Once again, after creating the mess, they come out of it stronger than ever, just like the 1930s.
BTW, good luck getting any significant cash (or retroactive "taxes") out of the executive fraudsters who did this. They WRITE the laws, after all! In fact, some of them are right back near to the seat of power already (including the original fraudster, Robert Rubin):
"In the aftermath of the U.S. government takeover, attention has focused on three Democrats with close ties to Obama who served as Fannie Mae executives: Franklin Raines, former Clinton administration budget director; James Johnson, former aide to Democratic Vice President Walter Mondale; and Jamie Gorelick, former Clinton administration deputy attorney general.
Johnson earned $21 million in just his last year serving as Fannie Mae CEO from 1991 to 1998; Raines earned $90 million in his five years as Fannie Mae CEO, from 1999 to 2004; and Gorelick earned an estimated $26 million serving as vice chair of Fannie Mae from 1998 to 2003"
Raines is an "advisor" to Nobama, Johnson was the head of his VP vetting committee, and Gorelick is (or at least was) rumored to be up for the Attorney General spot (that's who would decide to "go after" the executives).
Posted by: Satchel at September 20, 2008 7:07 AM
Satchel - great characterization of the political debate over this. Some choice we have in November - although at least McCain seems to be more critical of the plan (although he just wants to focus on Fannie/Freddie and not his buddie Phil UBS (f-you & us) Gramm). But the Obama team is frightening - particularly the thought of Rubin back in charge. So if Obama doesn't pick Gorelick to be his AG, will it instead go to Kamala Harris? Criminals of all stripes could then celebrate.
How will the defense of the dollar and the continuing need to satisfy foreign investors play out? Tax rates will no doubt go way up (just like in CA). What about interest rates?
Posted by: FSBO at September 20, 2008 9:09 AM
The problem started with Reaganomics. It is Reagan that is coming back home to roost. And, McCain politics is are more closely aligned to Reagan than Obama's.
Posted by: chuckles at September 20, 2008 9:28 AM
This outcome was the inevitable result of deregulation. The Gramm-Leach-Bliley Financial Services Modernization Act, which was voted for by every Republican and signed by Clinton was the proximate cause of the breakdown. This is when the foxes were put in charge of the henhouse.
Blaming Frank and Dodd is kind of disingenuous when the GOP has been in charge of the White House for 20 of the last 28 years and Congress for 22 of them.
Phil Gramm, who went from authoring the repeal of the Depression era bank regulations of Glass-Steagall Act, to UBS Warberg, is now the lead economic advisor for McCain.
Same old, same old here. While Obama might not shake things up, we know that McCain will not, his campaign staff is full of the same guys who got us into this mess in the first place.
Posted by: NoeValleyJim at September 20, 2008 9:52 AM
There is so much blame to go around - but Satchel is right about who the winners are. It's just too bad we didn't allow the court system to work. With the Enron & Worldcom debacles, there was at least some measure of justice. Skilling and Fastow went to prison and Ken Lay is dead. Bernie Ebbers received a 25-year sentence at age 65. The largest public accounting firm in the world with a 100 year history was dissolved and some of its partners were indicted. Complicit banks were eventually forced to cough up billions in damages. The same fate should await many of the top people at Fannie, Freddie, Lehman, AIG, Bear Sterns, Countrywide, WaMu, all 3 rating agencies, etc, etc. And some members of congress and treasury officials should be recalled or impeached.
Paulson is letting everybody off the hook. Ford's pardon of Nixon is a joke by comparison. Even Putin doesn't have this kind of power.
Posted by: FSBO at September 20, 2008 11:43 AM
Ken Lay is dead.
...or so they say.
Posted by: EH at September 20, 2008 1:11 PM
"Blaming Frank and Dodd is kind of disingenuous when the GOP has been in charge of the White House for 20 of the last 28 years and Congress for 22 of them."
I don't really want to get into too much of a partisan thing here (I agree wholeheartedly with FSBO that there is enough blame to go around). That's what the fraudsters are hoping will happen. I am absolutely certain that it will.
But let's get the facts straight. The Republicans "controlled" Congress for exactly 11-3/4 years, not 20, and never even had a filibuster proof majority in the Senate at any point during that tenure. Prior to January 1995, the Democrats controlled the House for more than 40 years since January 1953 (83rd Congress)(for about 26 of those yeasr they also controlled the Senate). The Republocrats "lost" it in November 2006. The fraudsters count on the general disinterest of the American people in its own history, and they are never disappointed.
IMO the seeds for all this were sown in the 1930s with the growth of the large regulatory state. However, this latest fiasco really dates back to the Fed policy of monetary and credit inflation begun after the bank crises of the early 1980s. It may have been avoided as late as the late 1990s (by refusing to bail out LTCM and letting the US stock bubble collapse) or even possibly as late as 2002 by letting the US economy sink into the deep recession that was necessary to liquidate the foolish malinvestment of the 1990s. But EVERYONE - both parties - was making too much money. And the ever silly population actually thought that they were going to get rich off unproductive assets like houses.
People who think regulation is the answer can never answer the question: who is going to "regulate" the regulators? We've already seen the population is too disinterested and just not smart enough. A sound monetary system, and a competitive landscape where the smartest fight one another - rather than colluding to control a regulatory government that controls TOO MUCH of US GDP - is all you need. People should open their eyes and stop looking to government as the Messiah that will deliver them from every earthly worry.
The next few years are going to be quite a show, and I am really looking forward to it!
Posted by: Satchel at September 20, 2008 1:51 PM
. A sound monetary system, and a competitive landscape where the smartest fight one another - rather than colluding to control a regulatory government that controls TOO MUCH of US GDP - is all you need.
If this is "all" that is needed, then someone by now surely would have created such a system, yet I can think of no one anywhere in the world who has done so, can you?
Posted by: NoeValleyJim at September 20, 2008 2:09 PM
I don't really want to get into too much of a partisan thing here
Sure, that is why you only call out Democratic legislators only for blame and call Obama, "Nobama." I see entirely where you are coming from.
Just to "get the facts straight":
Since the beginning of the "Reagan Revolution" the Republicans have controlled The Senate all but 8 years of that time.
The Republicans have also controlled the House for 12 of the last 13 years:
Posted by: NoeValleyJim at September 20, 2008 2:19 PM
May I throw in a half-serious questions?
If you had a quarter of a million in cash at this point, what would you do with it?
Posted by: inthemarket at September 20, 2008 6:13 PM
I'm usually a big fan of your posts and analysis, but I was curious when you referenced Obama's ties to Raines ("Posted by: Satchel at September 20, 2008 7:07 AM"). Raines is not an advisor to Obama.
I checked out the reference you provided and it was an article written by Jerome Corsi (of Swiftboat and Obamanation fame). Are you kidding me? Corsi is a crackpot with zero credibility. I am going to check your references a lot closer in the future.
Posted by: Evan at September 20, 2008 7:55 PM
"and a competitive landscape where the smartest fight one another"
Competition. Like Tonya Harding sending her goon to take a crowbar to her rival's knee? Like Tony Soprano low bidding the medical waste contract because he plans to dump it in the ocean?
Every game needs an honest and competent referee. Even the game of free market capitalism.
Posted by: diemos at September 20, 2008 8:58 PM
No argument here. Limited regulation is fine. Central planning is not. The essential problem is what I identified (and NVJ skipped right over to ask a different question): how does one prevent the regulators from being controlled by the regulated interests, when the population is too disinterested and/or stupid to understand what is going on? It's a very tricky (perhaps insoluble) problem.
My answer is to make government as small as possible with as little influence over the evolution of the real economy. That way, there are less "goodies" to be had by controlling the regulators. It's probably impossible at this point, given the size and revenue and power of the USG.
I remember reading somewhere that the golden age for average Americans was sometime between 1895 and 1915. Because this was after the widespread appearance of indoor plumbing (a tremendous extravagance that hadn't existed on any scale for 5000 years of recorded history - not even Rome!), but before the institution of the income tax. Most people's only interaction with the Federal government was when they went to the post office :)
I always liked this formulation of the problem. There are questions about who said it and when, and whether it was the work of the same person, etc. But - whoever said it - it's about the smartest thing ever written about the problem that "a government large enough to give you everything you want, is powerful enough to take everything you've got":
"A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising the most benefits from the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world's greatest civilizations has been 200 years.
Great nations rise and fall. The people go from bondage to spiritual truth, to great courage, from courage to liberty, from liberty to abundance, from abundance to selfishness, from selfishness to complacency, from complacency to apathy, from apathy to dependence, from dependence back again to bondage."
Posted by: Satchel at September 21, 2008 6:26 AM
I appreciate any checking of references. I'm not infallible, and when I am wrong I am the first to admit it (unlike most here it seems).
However, although Corsi wrote that survey article, he is NOT the source. (He is a little bit of a crackpot, but he's not a reckless writer from what I've read, and usually sources everything.)
The source of the claim that Raines is an advisor to the Obama campaign (or "was" - Obama tends to throw overboard anyone and anything necessary to achieve his ends - like Rev Wright, Bill Ayres & Bernadine Dorn, ACORN, etc.) is the Washington Post. A staff writer named Anita Huslin back in July who QUOTED Raines as saying he gave advice to Obama. The Washington Post also ran an editorial in August, entitled "Tough Decision Coming", in which the editorial board wrote, "Two members of Mr. Obama's political circle, James A. Johnson and Franklin D. Raines, are former chief executives of Fannie Mae."
Franklin Raines is denying it. He is a known fraudster, who presided over an accounting fraud, and has now been slapped with a $30+ million fine. The Washington comPost is basically the mouthpiece of the DNC, though. Still, I guess I am more inclined to believe the Post I guess.
Believe me, I'm no McCain fan. And I don't think it matters too much ultimately who wins (the die has been cast), but I would enjoy seeing an empty suit like Obama lose that's for sure!
Posted by: Satchel at September 21, 2008 6:39 AM
While there is plenty of blame to distribute to the government, I think everyone is overlooking the main perpetrators of this financial maelstrom; the homeowner. It was the greed of the homeowner, and the aspirational behavior to live beyond one’s means that drove the bubble. The easy to flip, easy to afford, markets only go up attitude of the consumer, who are now quick to assign blame to rouge mortgage brokers, and greedy bankers; the lack of accountability for one’s actions is unbelievable, and their ability to rationalize their behaviors now is unconsciousable. The financial sector helped facilitate the crisis the same way a pusher contributes to the drug problem, but they weren’t creating the demand.
The politicians are quick to assign blame to the greedy financiers, but don’t dare mention the greedy homeowners. The quicker they can assign blame rather than solve the issue, the quicker they can deny their complicity in this mess. For a lot of people who are supposed to be intelligent, they were plenty stupid. As Sachtel has mentioned, the Fed now owns the financial sector, there is very little separation between the government and the financial sector today.
Posted by: marko1332 at September 21, 2008 8:08 AM
I just read this proposed Act, and I have to say that I am really amazed by Paulson's chutzpah.
Sec. 8. Review.
Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
He wants to be able to spend $700B with no oversight whatsover? He wants to be able to bail out foreign banks? Sorry, the fact that Goldman Sach's partner's bonuses are at risk this year does not constitute an emergency to me.
As to the question of who watches the watchmen, perhaps we should just go back to the regulatory structure we had for the 50 years after Glass-Steagell, when we had no significant bank failures, no need for big government bailouts and good economic growth that actually was widely distributed.
Right now, I don't know, but I am going to write Pelosi and tell her to vote no on this Big Handout to Wall Street.
Posted by: NoeValleyJim at September 21, 2008 8:31 AM
SATCHEL...Indoor plumbing did exist in Rome! In matter of fact, some people believe it led to the demise of the empire. Why? Because the pipes were made out of LEAD! Yep, many believe that a great empire fell from its citizens going crazy from the lead poisoning used on its indoor plumbing.
Posted by: chuckles at September 21, 2008 9:00 AM
1. What you are complaining about is the free market. It's really hard to make much money by going to work everyday and like, working. Speculating on houses became a great way for us dumb schmucks (i.e. "the main perpetrators of this financial maelstrom") to make money when houses were appreciating at a ridiculous (and nonsensical) rate. As Mac Dre said, "Don't hate the player, hate the game." And, who created the game? The guys we are bailing out. Unfortunately, it seems that they also hold the keys to our economy. I'll need to look for a Mac Dre quote to explain that.
2. I also knew a lot of seemingly intelligent people who were aggressively looking for houses so that they would not get 'priced out of the market.' They were not being greedy, they were afraid. They were trying to match the lifestyles of their parents. You know, grow up and buy a house.
At least I'm still renting, so I'm not to blame.
Posted by: Evan at September 21, 2008 9:01 AM
OT - Are you the same "evan" who posted a while back about that 835 Foerster property (how your mother-in-law thought you should buy it at $989K but you wisely decided to pass and keep renting)?
See "Posted by: evan at February 16, 2008 6:58 PM" here:
If so, let me again say you made a wise move. That property has been listed as a short sale at $849K forever, and if all is well in the universe it should fall into a well deserved foreclosure soon.
Posted by: Satchel at September 21, 2008 9:21 AM
"perhaps we should just go back to the regulatory structure we had for the 50 years after Glass-Steagell, when we had no significant bank failures, no need for big government bailouts and good economic growth that actually was widely distributed."
That's not possible with a private Federal Reserve. They time the cycles of inflation and deflation to whipsaw the population out of its savings.
Interesting that you mention the early 1980s as the beginning of the end (I'm sure you're thinking that that is because of "Reagan's Revolution", but you would be wrong there). That's the precise moment the Fed began a sea change in policy towards the encouragement of credit inflation as I noted in "Posted by: Satchel at September 20, 2008 7:07 AM" above in this thread. You can see that graphically quite nicely here (in my famous graph that I always post):
After the debt destruction wrought by the Depression, and the "liquidation" of 10s of millions of productive citizens in WWII, the US in the late 1940s was in a wonderful position to write the rules of the new world order, which it did. The "Pax Americana" was a wonderful and benign time (all in all), when a shattered Europe and Asia could rebuild under a largely peaceful umbrella of a United States that still devoted more than 10% of its MASSIVE GDP (relative to the rest of the world) to defense. (It's less than HALF that share now of course.) You often bring up Europe as a matter of comparison, but ask yourself what would have happened to European "growth" without the US umbrella (no need to ponder too deeply, just look at Eastern Europe 1950-1990). That "Pax Americana" is now crumbling, and the future is very uncertain.
Anyway, that is a long way of trying to hint at the factors that drove the great, balanced prosperity that the US enjoyed through the mid-1980s (not to say that there weren't huge distortions - of course there were - especially those wrought by the USG in the foolish "Great Society" experiment).
Since that period, "prosperity" has been increasingly driven by an illusion, the idea that "debt" creates wealth. (This is a basic flaw of Keynesian theory - the idea that debt and savings are interchangeable so that debt does not create distortions - for a devatating academic critique of Keynes and just how silly and incoherent his thoughts on economics really are, read de Soto's "Money, Bank Credit and Economic Cycles", pretty easy to find in pdf on the web.) Time for the deflation of credit/money now in my view (and I think that is what the Fed has been up to).
With those ideas, I'll sign off on this thread. I've written WAY too much!
Posted by: Satchel at September 21, 2008 9:49 AM
Hey Satchel. Yes, I'm the same Evan who didn't put an offer on that Foerster property. And, yes, it still comes up on my MLS searches a year later.
As for the relative crackpot-ness of Jerome Corsi, I'll choose to disregard your political posts and try to understand your financial analyses instead.
"Who knew the Republicans were Socialists." -- my dad
Posted by: Evan at September 21, 2008 10:05 AM
I don't think you can blame the homeowners for the financial meltdown: yes they were greedy and trying to get rich, but the finance people understood the risk they were taking.
The problem was caused by the confluence of several events, none of which by itself would have been enough.
The dot com meltdown was followed by 9/11. That could have pulled the economy down, giving the terrorists a great opportunity to claim victory. Greenspan probably wanted to make sure they couldn't claim credit for pulling an economy down when that economy had been seriously misallocating resources, so he pumped housing up.
As usual, borrowers were constrained by the money they could get: everyone had always wanted to borrow more. Subprime borrowers couldn't borrow much, because the sources of money, pension funds, needed AAA -rated bonds, not junk. So the financers took advantage of the opportunity to turn lead into gold by selling tranches. Not every sub prime borrower would default, so if you could split up the obligations to take the hit, with lower tranches taking the first hit, and upper tranches taking the last, the people at the top would have their AAA -rated bonds.
This worked for awhile, and the bankers were being paid huge bonuses. They did not want the bonuses to end.
But then competition set in: everyone started doing it and that pushed the interest rates down to where you couldn't really sell off the lowest tranches. They were actually losing money on each sale. But that would have stopped the bonuses.
So the managers of the investment banks did the unthinkable: they sold the lowest tranches to their own investment banks. The accounting rules allow that when you swap one asset for another, you don't have to recognize a loss, and because there was no secondary market for that junk, there was no price other than the one the banks had paid that the accountants had to use. So the banks could keep it on their books at full value.
Meanwhile, with the increased demand and the artificially low interest rates, home prices continued to soar. So the fact that the investment banks were holding the lowest rated tranches wasn't a problem - nearly all the loans were performing. So the bankers stepped up the process and held more and more of the stuff so that they could claim they had made huge profits and take big bonuses.
But in reality, they were losing money on every sale. Through the use of accounting, you can claim profits where none exist, but you end up running out of cash. When they ran out of cash, they went and got more, and kept the process going for another year, paying themselves bigger bonuses. Finally, they ran out of sources of cash.
And that brings us to the present day. Their cash is tied up in tranches that are worth ten cents on the dollar. If they sell them, or set up a market for them, they will take huge losses. Once the market price is known, the accountants will force them to write down the value of the assets. It's what held Japan back for years: they didn't want to take the write downs.
My sense is this is Paulson's plan. HE will make the market, causing the banks to write the stuff down because they will no longer be able to hide behind the fact that no other price exists other than the one they paid. When that happens, they will have no incentive to hold this crap and so they will sell it off. When they do that, the capital can be put to productive use again.
And then the bankers can pay themselves big bonuses again.
But blame the homeowners? Hardly. It was just the result of the system we have that everyone acted in their best interest. Even the shareholders acted in their best interest by looking the other way as the capital of the firm was plundered: it would have been more expensive than it was worth to any one shareholder to investigate. They relied on the boards, but the boards were reporting record profits so no one wanted to rock the boat and as long as housing continued to rise, there really wasn't a problem. And the board was under pressure to beat the results of the other financial firms who were doing the same thing, so they really couldn't stop it when the loans were all performing. So we are where we are.
So what do you do with your money? The rules of the game are changing. So you can do one of several things. You can do what Bill Gross of Pimco is doing, trying to anticipate what the new rules will be and then playing by those rules before they get changed. "Booya, Hank Paulson, just try to let Fannie and Freddie fail! So I'm buying their bonds on the discount because when the rules change and they get backstopped, their values will rise above what I paid when they were not backstopped and I'll make a fortune!" His Lehman bet didn't exactly work out, but he's doing pretty well otherwise. If you have this kind of knowledge, you can do pretty well.
For the rest of us who don't have a clear picture of where things are headed or don't have the insight into the complexities of the situation, now isn't the time to be thinking about making money until things shake out, because you are relying on luck, and for me at least, I'm smarter than I am lucky.
I'd just focus on not trying to lose too much of it and be ready to jump back in when things are clearer. You won't make as much this way, but you won't lose it either. Just try to get in early when you see the trends developing. You'll leave some money on the table, for sure, but the most of the people who make money in those very early days are more lucky than smart.
Posted by: tipster at September 21, 2008 10:34 AM
It is an odd sort of economic history that credits the Keynesian school for the inflationary monetary policy of the last two decades because it was the Chicago School that has held sway both at The Fed and in the halls of power. Cutting taxes in boom times is a Chicago School notion, certainly not something Keynes or any of his disciples would have recommended.
They do believe in deficit spending during recessions, but running deficits during expansions is entirely a modern and if I may dare say so, entirely a Republican, phenomena.
Somehow we had a long period of prosperity and relative economic calm without big government bailouts with a private Fed for a very long time. It is just when we got some whacky Ayn Rand followers in control of The Fed who decided to experiment with their untested ideas on the mostly unsuspecting public, that we began to see the extreme asset inflation that has characterized recent history.
Posted by: NoeValleyJim at September 21, 2008 4:24 PM
OK, I know I promised to stop writing on this thread, but come on! No one has jumped in to help poor NVJ on his economic history?
"but running deficits during expansions is entirely a modern and if I may dare say so, entirely a Republican, phenomena."
Huh? Did you ever hear of JFK, LBJ, and Jimmy Carter? Last I checked, they were all Democrats, presided over expansions (except Carter's last year), and ran deficits EVERY SINGLE YEAR. Of course, don't forget the granddaddy of all deficit spenders during rampant expansions, FDR, although he did have the "excuse" of WWII (good thing that came along to pull the US out of the GD, because as we all know by 1937 the New Deal had essentially failed, and the economy had dumped anew). Seriously, NVJ, how could you write this?
Here are the years that NVJ say never happened (positive GDP growth + deficit spending by a Democrat in the White House - and most of the time Democratic control over the House, where of course all spending bills originate):
Note that there were no recessions in any of those years last I checked (just from memory - and I know US econ history pretty thoroughly).
"Somehow we had a long period of prosperity and relative economic calm without big government bailouts with a private Fed for a very long time."
Sure. As I noted above, this period occurred after the back-to-back catastrophes of the Great Depression and World War II (the Austrians of course understand this - massive liquidation of the factors of production and the malinvestment of the 1920s). And after we get the next Great Depression, we'll have nice sustained growth under the Fed again! Let's hope this time we can avoid the "stimulus" that pulled us out of the last one :)
Posted by: Satchel at September 21, 2008 7:33 PM
Back on the topic of the "bailout", here is a fun Bloomberg article singing the praises of treasury bonds. Seems like the traders are betting on that sweet, sweet smell of deflation.
Posted by: Satchel at September 21, 2008 7:55 PM
Average Americans had it better between 1895 and 1915? That makes sense. At that point in time the USG had ample free land to give to people and large areas unsettled and unexploited. We could probably have the same these days if we had kept expanding our territory. Anyone up for conquering Canada?
Posted by: anon at September 21, 2008 8:59 PM
Here's a thought - rather than buying failed mortgages for twice what they're worth, let's seize the failed banks instead, and SOX the guys who cooked the books.
Cost to taxpayer - nothing.
Call your congressman, and express your displeasure at sending a Trillion dollars to people who think a Lexus is an economy car.
Posted by: Jim D at September 21, 2008 9:00 PM
On come on,
Without the bail out, it would be Great Depression 2. We all know it. The US economy will be wiped out, and forget about 700B or even 2T bail-out package, the lost will be decades of non-growth, and $ amount would be in 10's of trillions.
The funny thing is....I bet the Treasury will make money on this. Smart business buy at the bottom, when NOBODY else buys. That's exactly how you make a profit with investments.
The only reason some people are upset is because they want the housing market to crash more.
The only problem is, everyone and everything would be dragged down with it. Forget about your stock portfolio, or even money market, or even CD (imagine what kind of bail-out FDIC requires), or even savings account.
Why some people would wish for Great Depression 2 is beyond me.
And waiting for the foreign countries to say "no mas" to US Treasury? You certainly don't know the Chinese and Japanese economy. Export-driven economy means they will have trade surplus, means they will have foreign currencies surplus. It is not about whether they trust US. It is about what else can they buy. Gold? Euro? Oil?
China has 40 years to go before its economy turns into internal consumer driven. Then US will have to find the next big buyer for the treasury by then. Maybe GD2 will happen then.
Oh, by the way, if US hits GD2, what do you think will happen to the rest of the world? GD1 wasn't limited to a particular country, you know, and WW2 was to a large extend the consequence of GD1. So, I want to know how many people thinks GD2 would be peaceful.
Posted by: anon at September 21, 2008 9:17 PM
Well looky... Goldman Sachs is now in the clutches of the Fed too. And, perhaps a shotgun wedding for them and Morgan Stanley (to perhaps WaMu and Wachovia) coming soon.
Posted by: tony at September 21, 2008 9:24 PM
Goldman and Morgan Stanley realized that if Paulson made a market in their "illiquid securities" they would have to mark them down and be bankrupt, and took this way out to avoid that fate.
So now Paulson buys their crap and in return, they keep the remaining crap on their books at full value. So all we get is enhanced oversight over them, in effect, closing the barn door after the horses have all gotten out. They have just admitted they are bankrupt, so they had nothing to lose.
And what a coincidence: they cannot be shorted.
Posted by: tipster at September 21, 2008 9:35 PM
"It is about what else can they buy. Gold? Euro? Oil?"
And all those chinese factories are going to switch over to producing stuff for the chinese a lot sooner than you think if what you think is 40 years. Handing us money to be the "consumer of last resort" does not have a bright future.
Posted by: diemos at September 21, 2008 10:01 PM
The New Deal policies of FDR were spectacularly successful, reducing unemployment from 30% when he took office to under 8% by 1938, when you include the WPA employment. There was a mini-recession at that point, but the economy was growing strongly and unemployment dropping again rapidly well before US involvement in WWII. The economy grew at phenomenal rates during the New Deal, between 9 and 11% yearly. And that was all before the wartime stimulus and deficit spending. FDR's biggest deficit before 1941 was $3B.
I am sure you know all this, you can quote your dubious World Net Daily sources if you prefer, but if you want, I can back all that up. Just go to the wikipedia page for more details.
Clinton inherited a large budget deficit and reduced it considerably. It took him a few years to work it down to nothing, that is true.
All of these other budget deficits you refer to were extremely small, less than $10B before Nixon:
The first big budget buster in peace time was Reagan, as is easy to see here. The other one is Bush. Bush has kept much of his deficit spending off the books, his increase in the National Debit is actually much larger:
Your graph of overall debt doesn't even look that bad when compared to GDP:
The top graph is the one you seem to be concerned with when it the bottom one that is a more accurate portrayal of the situation.
Posted by: NoeValleyJim at September 21, 2008 10:36 PM
The New Deal was actually overwhelmingly successful (and popular) , I don't know where you get the idea that it was not.
Posted by: NoeValleyJim at September 21, 2008 11:02 PM
"Without the bail out, it would be Great Depression 2. We all know it."
Two points on this attitude.
First, if another Great Depression is coming, there is ZERO that the government and/or the Fed cann do about it. Why are people always so willing to believe that the SAME PEOPLE who got us into this mess are smart enough to get us out of it? Wouldn't it be more wise to listen to the many people who analyzed this problem, saw it coming, and have some proposed solutions than to trust the same fraudsters who got us into it and have lied about it all along (if this was obvious to me, it was obvious to them, believe me)?
Second, the fraudsters are counting on this sort of blind panic by the masses. I've written many times, people are so overextended on mispriced assets and risk (houses, stocks to a lesser degree, relaince on future government benefits that WILL NOT BE THERE in 30 years, etc.), that they are willing to become comlplicit in a fraud that they do not understand.
Here is a link to a sensible proposal from a money manager that I respect very much and have mentioned on this blog a bunch of times, which was also highlighted on the Mish blog today (Mish is also pretty good, but a little more of a "bombthrower"):
Mish link today:
Although NVJ's econ history is often muddled, I agree with him on sending a letter to one's congresscritters. They'll just throw it in the trash (the fix is in) but it can't hurt I guess.
Posted by: Satchel at September 22, 2008 6:46 AM
The Hussman and Mish letters to congress are powerful and logical - it's depressing that most senators and members of congress will swallow the Paulson line without any consideration of these far superior alternatives. The key issue was raised - why would be ever put our trust (and trillions of dollars of taxpayer money) behind the cast of characters that got us into the mess? Why would we expand the role of the Fed and Treasury in this manner?
Posted by: FSBO at September 22, 2008 7:26 AM
^^^Because Bernanke and Paulson were NOT the people that got us into this. The responsible parties left and these guys came in with a mess to fix.
Posted by: anon at September 22, 2008 7:34 AM
See even Mish the libertarian is calling for stimulative spending on infrastructure now. If we are going to blow $700B, we might as well get some new bridges or something useful for it.
Let the giant casino that Wall Street built go away and fire all the people who built it. The quants can get retrained into useful jobs designing highways or computer chips. I have no idea what an unemployed IB could do, probably retire early and spend extra time on the links, but if he gets in dire enough straights, we can always put him to work digging ditches.
Posted by: NoeValleyJim at September 22, 2008 10:45 AM
I agree NoeValleyJim, some of these bright minds who are ruthlessly playing a zero-sum game could instead be contributing to the national productivity.
The market as constructed today has a tremendous amount of brainpower simply figuring out ways to divert cash rather than create it.
I've heard it explained that the market players are contributing to the economy by setting a proper market price for assets. But as we've seen the price doesn't always reflect the underlying value.
And how valuable is "setting the market price" ? Certainly it has value, but is it equal to the billions that the financial industries consume annually ?
Posted by: The Milkshake of Despair at September 22, 2008 2:27 PM
I think some of those hedge fund quants can be put to work making SS more stable. What's up folks?
"Socketsite: now with less leverage"
Posted by: dub dub at September 22, 2008 2:54 PM
deflation strikes SS?
btw Satchel, you had stated elsewhere many times that the Fed cannot inflate their way out of this one.
But what you didn't see coming was a 700 billion dollar appropriation for inflation purposes.
Still betting on deflation? I was a deflation bear, and now I'm switching camps to a reflation bear, with the distinct possibility of becoming an inflation bear (in which case real estate will be a good place to hide).
Posted by: enonymous at September 22, 2008 3:18 PM
Don't forget that you can have inflationary pressures and still get deflation if the deflationary pressures overwhelm the inflationary ones. The mere existence of inflationary pressure is not enough to guarantee inflation.
Look at 0% interest rates in Japan. That was HUGELY inflationary, but they still got a 10+ year deflationary recession. Anyone who thought real estate was a "good place to hide" when Japan turned up the inflation heat got a rude shock.
Posted by: tipster at September 22, 2008 4:09 PM
Because Bernanke and Paulson were NOT the people that got us into this
Not entirely true.
Bernanke was on the Fed from 2002-present (chairman since 2006). so he could have done something while on the Federal Reserve Board of Governors to improve oversight throughout the heat of the bubble.
Paulson was the CEO of Goldman Sachs, one of the biggest abusers of the current financial system.
That said: I do agree that there are far more people to blame for this mess than just these 2 men, although when history is written it will indeed be these 2 that take the fall for the entire debacle.
Posted by: ex SF-er at September 22, 2008 4:12 PM
I find it hilarious that you can say that the Republicans are less responsible for the huge budget deficits. Between Reagan, and the two Bush's they represent about 2/3's of our national debt. And most of that is due to the tax cuts that were supposed to bring in more revenue than they lost. Prior to Clinton bringing down the deficit in his final years (by several hundred billion dollars), the last surplus was around 1971 during Nixon's term--around the time of a recession. Face it,the republicans are so much in the pocket of the rich that they create wars to help their friends (Cheney) and game the system to make them even more wealthy, which result in financial crises in which the taxpayers must bail them out so they can stay rich.
Yes, let's vote for McSame and keep this going, so we can all be living on the street in two years.
Posted by: Jack M at September 22, 2008 4:13 PM
I have to say I'm disappointed in you. Not only do you use the terms "inflation" and "deflation" in the same way the hoi polloi do, but you insult me by saying this (just kidding :)):
"But what you [Satchel] didn't see coming was a 700 billion dollar appropriation for inflation purposes."
Not only did I see it coming, but I was specific in my predictions and just about nailed the timing and the dollar figure. I posted the details a number of times on SS. Read these posts (short excerpts are included) if you care:
"Then, Congress creates the agency that will purchase the bad debt that is now sitting on the Fed's books as collateral for the loans it has been advancing to banks and non-bank institutions."
Posted by: Satchel at March 24, 2008 7:01 AM
“I agree with diemos' conclusions broadly, but I will stick with $1T loss for private lenders/investors, with some of this passed onto the taxpayers (maybe $500B), with the homemoaners absorbing the rest of the $5T loss....Posted by: Satchel at February 2, 2008 6:28 AM"
"I'll bet almost anything it goes down like this in the end….By later this year , a government agency will be set up to buy the toxic crap at 50 cents on the dollar when it's worth maybe 10 cents....Posted by: Satchel at March 17, 2008 5:35 AM"
I'm just trying to play my role in this fiasco by sharing with SS readers the benefit of the experiences I've amassed as a trader. I've done this for a living for 15 years and so far it's all unfolding as I thought it would, at least in broad outines.
If you think this is a "reflation" scheme, I urge you to purchase equities and as many houses in SF as you can swing! Also, buy oil (I'm looking for a good short entry point). Last, PLEASE buy commercial REITS :)
Posted by: Satchel at September 22, 2008 4:40 PM
Personally, I'm peeved that the SEC, the Fed and countless other players conspired last week to boost the share prices of WaMu and Wachovia, thereby erasing my nice big gain on my Put options.
Although I am still up on WM puts due to increased volatility.
I was also reviewing McCain's record during the last fiscal fiasco (the S&L crisis), and based on his stellar non-performance there, I am considering voting for Obama instead.
Posted by: Jimmy (Bitter Renter) at September 22, 2008 5:21 PM
Put me in the deflation side of the equation.
-The CPI should show declines YOY shortly, noting decreasing pressues from inflation, as lower oil, commodity, and food prices are compared with rising prices of 08
-The USD will get stronger as Europe and Asia cut rates to deal with the economic slowdown
-The consumer is under great pressure and does not have money to spend, thus putting pressure on stocks. The consumer is/was 2/3 of the US economy
-No job growth, actually negative, pressures on wages
-The real estate and credit bubble bursting is creating the deleveraging of assets
-US housing market, both new and existing will decline in starts and resales; more inventory, more pricing pressure
-The new housing bill eliminates all down payment assistance from builders, which is estimated at 15%+
-We now have a two year wave of Alt A foreclosure, the new sub prime; more writedowns for us the tax payer
-Taxes will rise, taking money of out the pocket of the consumer
So I don't see how any inflationary pressures can exist in this market. Since the majority of the assets in the US are held by the top 5%, it should be schauenfraude escatsy moment for the Demos. The middle class; lower, mid, and upper are scewed since their primary asset is their home.
Hopefully things will get better my 2012, a good time to be in cash and cash equivalents, because there will be some great buying opportunities.
Posted by: marko1332 at September 22, 2008 6:00 PM
I am swayed by the deflationary arguments too - it seems likely that most asset classes will decline (equities, real estate, commodities). Question though - in the Hussman letter to congress cited above, Hussman stated at the end that "a major expansion of government liabilities is invariably followed by multi-year periods of extremely high inflation". Would this necessarily be the case this time - perhaps with a significant lag? Or was he just pointing out yet another potential reason to oppose the Paulsen Plan?
Posted by: FSBO at September 22, 2008 7:04 PM
The official definition of "inflation" does not include property appreciation. If you remember, during the boom days, the inflation was quite low.
So, using the same formula, we will see high inflation (in term of pricing for food, clothes, transportation, and rent) going up, in a large part because the cost to make them in China and transport them from China is going up.
Meanwhile, the asset price will go down - but that's not factored in "inflation".
I said one year ago - we will see high "inflation" for the next few years so the price of everything else will catch up with the RE.
Posted by: John at September 24, 2008 8:04 AM
I always think it is best tothink in terms of the money supply, rather than "price inflation" or "price deflation". The USG will just monkey with the stats in order to hit the number it wants to show.
It's worth noting that it took Japan about 4 years after the bursting of their equity and real estate bubbles to register the first year on year geenralized price deflation numbers (and they were always pretty mild). I expect that we will (officially) show zero "inflation" or even very mild "deflation" sooner, because much of the transfer payment complex (social security especially) is tied to various measures of CPI.
About "price inflation" catching up to real estate, I wouldn't count on it. Real estate in Japan has gone down something like 60% in nominal terms (up to 80% in real terms in many places because of the mild price deflation), and I would expect US real estate to get clobbered, though probably not quite that bad. Looking at how this is starting to shake out, I am thinking SF real estate will go down MORE than the 30% on average that I originally thought.
The parallels with the period 1929-1932 are getting eerie. My experience is that not many people know too much about the Great Depression, and especially about all the (then) unprecedented interventions by the Hoover administration and "liquidity" flooding by the Fed in late 1929 through mid 1931. There was no "liquidate everything" that Mellon wanted, instead an opting by the Hoover administration for a chorus of "let's save workers' incomes and screw corporate profits" (how did that turn out?). For people who are interested, I would really recommend Murray Rothbard's "America's Great Depression" (available on the web in pdf), especially pages 209ff. We are going down the exact same road, and what's old is new again!
Posted by: Satchel at September 24, 2008 9:17 AM
That outage was painful... I've been curled up in a fetal position clutching my GLD and SLV certs for the past couple of days waiting for SS to come back on line. If the Paulson Plan does not succeed, what do folks think about continuing to let them “bury the bodies” at the Fed? At least there is the pretense that the toxic junk is not owned by “we the people” (just swapped out through the TSLF on 28 day terms). The only problem (which is probably why the Paulson Plan came about) is that the Fed is getting low on Treasuries (see the recent $50B “injection” by the Treasury). Or is this just unsustainable?
Posted by: EBGuy at September 24, 2008 10:23 AM
Didn't you argue against the "price inflation to catch up RE" last year?
Well, it already happened over the last 12 months.
I will bet another two to three years of high "inflation". I am sure next August we will revisit the numbers again.
Posted by: John at September 24, 2008 1:50 PM
Thought you might get a kick out of this article. You keep telling us that the plan is to dump the losses on the little people. I keep trying to point out that that only works until they start hanging bankers from lamp posts.
Posted by: diemos at June 26, 2009 9:24 PM
I keep trying to point out that that only works until they start hanging bankers from lamp posts.
I did see that article, and as you can imagine I love stuff like that! Note, though, that it was Europeans who did it.
Sadly, the American sheeple seem to have lost all will to resist. Too fearful I guess, and too complacent. Did you see that Goldman Sachs is planning on paying record bonuses this year - the largest in their 140-year history? And that Citibank is planning of raising base salaries by up to 50% so that their "valued professionals" don't have to suffer? My best friend from my trading days is pretty high up at BlackRock and he tells me that it's the same story there - they're literally minting money as the "manager" for huge chunks of the Fed's balance sheet.
Looks like there is still plenty of wool to be shorn. It was an absolute stroke of genius for the Wall Street elite to support Obama - it seems that the plan to stuff the losses with the people is being executed perfectly, and there won't be any real criticism. Next step will be to have Bernanke removed (or not reappointed), so that one of the original gangsters (Summers) will control the Fed while his protege (Geithner) has Treasury. I bet that even these guys couldn't have imagined how well the plan would work when they were dreaming about it in the mid-90s! Robert Rubin is smiling ear to ear I'm sure :)
Posted by: LMRiM at June 27, 2009 5:45 AM
Your post also jogged my memory on an absolutely hysterical article from last week up here in one of the Marin fishwraps, and makes a wonderful contrast with the article on the German pensioners and how they handled their fraudster.
Reeling from the shock of learning that Madoff stole everything he and his wife socked away for retirement, the 61-year-old motivational speaker who lives in Nicasio says he listened in awe as his friends talked about what they call GOMs—Gifts of Madoff.
The first two people who spoke said, "I wouldn't do anything differently," Weinstein says. "The acceleration in their spiritual growth and how awake and alive they were feeling at the moment—no amount of money can buy you that."
And these are people who were millionaires the week before.
It's really worth reading the whole article. It makes me want to get back into active money management after all these years. It's almost criminal not to take advantage of such suckers! Bravo Bernie!
Posted by: LMRiM at June 27, 2009 6:04 AM
We may disagree a bit on whether or not people around here are bigger suckers than people from elsewhere. But, I'm sure we'd agree that this is the most foolish rationalization of extremely foolish behavior that either of us have heard of in a long long time, if ever.
In fact, given that New York seems to "export" a lot more fools (and if these examples are well-educated inheritors, how foolish are the average joes?) to the Bay Area than it imports, I may be coming around to your premise that people really are more foolish around here. ;)
In any case, at least these people can commiserate with others down on their luck here...
I'm guessing you've cycled by there without realizing it was there.
Posted by: nnona at June 27, 2009 1:07 PM
What was surprising to me was not that the wealthy and powerful, when faced with a "systemic" risk to their own situation, changed the rules to their benefit, but that so many were shocked and surprised by this.
To me, there appears to be a clubby oligarchy that runs the show. They all went to the same schools together, almost all of them were born to wealth and they are reluctant to admit new members, though they compete fiercely amongst themselves. There are rules that they follow and when someone like Madoff egregiously violates them, he ends up getting hung out to dry, though not literally hung.
But when there is a serious risk to a whole group, like during the financial meltdown, they all stick together to preserve the groups power. How can this be a shock to anyone? It has always been this way throughout human history, except for the very rare case of a French or Russian Revolution.
It is to be expected I guess that the amoral hedge-fund types, who thrived in an environment of deregulation, should proclaim any effort to reign in the excesses of the Aughts (2000 decade) a failure, even before the details have been negotiated, but I think we should at least wait until the ink is dry to pass judgment.
Posted by: NoeValleyJim at June 27, 2009 3:38 PM
"We have people in marketing and software. We have a lot of REALTORS that live out here. So THOSE are the people we're seeing for the first time" (caps added by me)
The article posted by nnona really reminds me of how many emails I have been getting from former classmates from college who are really getting close to the edge of financial devestation. The story they all seem to tell is the same for many have been without work for over one year, have had no prospects, and are now looking for almost anything, even if it pays only 40% of what they were getting in 2007. Those of us who are not in these situtations should be thankful and also concerned which might explain the huge growth in savings amongst those with jobs.
I travel a lot for work and, am I the only one who thinks the airports seem very empty this summer compared to past years?
Posted by: anoncensorious at June 27, 2009 5:49 PM