In a nearby thread, Dave Fitzgerald has pointed reasonable minds to some informed opinion about the bailout bill currently being urged upon us with such, um, urgency. In the interest of equal time, I thought I should offer some uninformed opinion.
My commentary on the plan is probably longer than the plan itself, but that’s not as unusual as it may seem: When it comes to grants of power, short and general is almost always much stronger than long and specific. Indeed, my main problem with the bailout plan is that it vests almost limitless discretion in the Treasury Secretary while giving him almost no guidance whatsoever on what policies we want him to implement. Placing an oversight board above the whole process may help eliminate arbitrariness or favoritism, but it does little to answer the underlying question of policy — and that, it seems to me is the most important question to answer if we really want to restore confidence in financial markets. People have to understand what our fundamental attitude is toward markets and risk.
Section 3 of the draft bill pretends to attempt an answer, directing the Secretary to stabilize the banking system and protect the taxpayer. But that’s not a policy, it’s a petitionary prayer. It’s also a cop-out by our elected officials. The crux of the problem is that people who say they know what it takes for us to stabilize the banking system also say that it requires us to spend $700 billion or more to do it. If even a tenth of that gets spent, it’s hard to say the taxpayer has been in any sense protected. And even if all $700 billion of it gets spent, there is no guarantee that the banking system will have been stabilized. After all, the previous market interventions were supposed to stabilize the banking system. We were told that they would. They didn’t. Why should we believe it now?
This might concern me less if the general direction of our national economic policy could be discerned from past market interventions. But alas, the current Treasury Secretary has vacillated wildly. First we bailed out Bear Stearns, at least long enough to sell it off. To be as charitable as possible, this was probably a genuine hardship for many Bear Stearns shareholders, and Treasury might have thought the other players would take it as a wake-up call. But a few weeks ago, we essentially nationalized Fannie & Freddie, apparently because the Russians and the Chinese were starting to get nervous about whether they would ever be paid for the debt instruments they were holding. In retrospect, maybe we should have been more alarmed when we concluded that the Russians and the Chinese had a better grasp on our predicament than Wall Street did.
After Fannie and Freddie, though, it was tough love. The feds told Lehman Brothers to go to Hell, and it did. Merrill Lynch got itself married off in a shotgun wedding. Then the government zigged again, essentially nationalizing AIG. It looks to me like the current legislation is intended to authorize a $700 billion zag to the “cash for trash” approach. What pattern are we supposed to see here? The only reliable rule seems to be that nothing bad is supposed to happen to Goldman Sachs. (No wonder Buffett’s putting $5 billion there — it’s a flight to safety!)
If there has to be an intervention, I can live with the AIG model, which as I understand it counsels action only when a widespread undervaluing of specific assets makes it genuinely possible to stabilize banking and turn a profit — for taxpayers — in the bargain. But I’d prefer to see some anti-socialism principles, like mandating that the government fund that’s doing the buying must get 50% of its capital from private investment. If the fund buys too much trash, capital dries up and the bleeding stops for the taxpayers. But we’re not doing anything like that. Instead, it’s to be all government, all the way, spending other people’s money. When the next credit scare pops up, I don’t expect any Treasury Secretary to turn a deaf ear to predictions that pension funds and retirees will lose their savings on the ground that he doesn’t see any way to turn a profit by buying up the assets. And no, I’m not comforted by the fact that both Democrats and Republicans will be represented on the oversight board.
Which brings us to my second major concern, namely that I don’t see what’s to stop the whole thing from happening again. Somehow, the risks have to be borne by the people who decide whether to take them, or else capitalism doesn’t work either in theory or in practice. How is this bailout supposed to reconnect the risk with the risk-taker? After the bad securities are off the books, won’t the CEOs still prefer double-digit growth to single-digit growth? Won’t they re-leverage themselves to do it? And indeed, won’t they be more confident than ever that when they take their largest risks, they are working above a federal safety net? Many financial types insist that the federal government had a solemn obligation to bail out Fannie and Freddie because Congress chartered them and the feds implicitly subsidized them and thus implicitly guaranteed them. Under this bailout plan, is there any major financial institution that is not implicitly guaranteed against failure by the federal government?
We might be better equipped to prevent this from happening again if we could agree on why it’s happening now, but we don’t. Republicans tend to blame liberal do-gooder laws like the Community Reinvestment Act. Democrats tend to blame Republican de-regulatory initiatives. I’m deeply skeptical of all explanations focused on only one of the two major parties. People on Wall Street seem happy not to talk much about the cause, almost as if this was some kind of natural disaster that is just bound to happen now and then. But a whole school of economics holds that this sort of bubble-bursting is the inevitable result of sustained credit expansion, and that the only long-term solution is to let asset values deflate. If these folks are right, then even if we manage not to reap the disastrous consequences now, we only succeed in postponing the pain until even more disastrous consequences occur next time. It is important to have some intelligent discussion about this, because a considerable number of people are willing to commit $700 billion to avert financial catastrophe and get ourselves back on the right course, but my guess is that far fewer of us are willing to commit $700 billion so that we can postpone catastrophe another three years at which time we can commit a trillion or two. Disaster relief is one thing, but only an insane person would spend money on hurricane relief that generates more hurricanes. I’m afraid that’s exactly what we’re doing.
My third major criticism of the bailout bill is the way the administration is trying to ram it through Congress, which I’m pleased to say has been marginally less supine and compliant than usual. We know that the most effective way to grab power is to grab it in an emergency. We also know that if you paint a dark enough picture of what will happen under Plan B, people can be made to prefer Plan A even if they don’t really think your dark picture is very likely to become a reality. So when I hear about a global financial meltdown, about pension funds going broke and senior citizens living on dog food, and I’m told that swift action is necessary, without the usual legislative compromises, it gives me pause. I can’t help but think of the $40 billion airline bailout after 9/11, the Patriot Act, the invade-first-inspect later approach to Iraq, the defense legislation that made it easier to declare martial law, etc. I even find myself a little surprised that I’m not being told that short-sellers hate us for our freedom. One knowledgeable friend told me that, until the AIG bailout was announced, we were within hours of a complete financial meltdown. Maybe so. Maybe this time the situation really is as serious as the administration says, but I just don’t believe it any more. I can’t believe it any more. Such are the wages of crying wolf.
Some would say that, whatever the merit of these concerns for an actual expenditure of $700 billion, my concerns are exaggerated here because in fact nothing like that expenditure will be necessary. According to these folks, it is not necessary for the Treasury to buy up all the trash; only to threaten to buy the trash. At that point the “market failure” we’re currently experiencing (note again the importance of settling the question of what caused this) will end, and financial markets will be fine and dandy. All they need is a little time.
I’ve heard arguments like this before. I think the most recent occasion was July. I was in Lake Tahoe, and I was at a craps table where everyone was losing. But our luck was bound to change; we just needed time. The casino staff seemed oddly unmoved.
Less recently, and more analogously, I heard this sort of argument from telecom execs back in 2001-2002. Sure, bandwidth had been way over built, and network capacity was dirt cheap, and retail prices were falling like rocks, but in time those infrastructure investments were bound to pay off. After all, everyone was still using the Internet, right? The market values didn’t reflect the true values. The companies just needed time. Where was the Treasury then? Was the problem that Goldman Sachs was untouched? I lost my shirt on some of those stocks. In fact, my monthly IRA statement continues to list the shares, along with a notation of the exact month in which they officially became worthless. Will the Treasury buy my trash? Where do I go for my check?
Congress will, of course, pass the bailout legislation. We don’t have the national stomach for any other course of action. And then the federal government’s balance sheet will be used for other bailouts of non-financial sectors in the future. Meanwhile our national debt — remember our national debt? — will continue to rise; the bailout legislation raises the debt ceiling to $11.3 trillion. Anyone care to talk about what happens when the nation is as highly leveraged as the investment banks on Wall Street? Will our friends the Chinese bail us out?