IS CAPITALISM AND THE CONSERVATIVE RATIONALE FOR IT DEAD?
I hate economic news. Much of it is so dry I want to set a fire to it just to be entertained. Not understanding a lot of it also makes following it a bore.
But neither am a I a complete idiot. I can read and comprehend economic news if the subject is laid out and explained by someone who knows what they’re talking about.
Enter Brad DeLong who I have taken to reading lately given that the end of the world as we know it might be upon us. I used to read Kudlow but the guy was so relentlessly upbeat I got an overdose of sugar and had to swear him off for a while.
DeLong is a happy medium between Paul “The Sky is Falling” Krugman and Larry “Don’t worry be happy” Kudlow. Krugman has been predicting catastrophe for so long they kicked him out of the Cassandra Club for being wrong so often. Kudlow has been seeing the light at the end of the tunnel for so long that he’s been declared legally blind.
And forget trying to make your way through MSM business reporting. Unless you want to feel like your brain has been dropped in a vat of molasses where everything is murky and hard to navigate, stay away. Stay far away.
Which brings us to Mr. DeLong who has a lot of kewl graphs to explain the few real stats that he uses to amplify what he’s talking about. If you are reasonably intelligent and don’t mind re-reading a post a couple of times, I highly recommend his commentary for those of us who have trouble understanding capitalism’s more arcane forms.
We all know about the sub-prime mortgage crisis which is pretty easy to grasp. Greedy lenders gave a lot of money to risky borrowers evidently believing that housing prices would continue to go up 7% a year forever. The debate over bailing out the industry has been interesting. Do we reward companies who took a flyer on bad risk loans? Or do we reward the borrowers who didn’t read the fine print and got themselves in over their heads?
Rewarding stupidity or ignorance is not the way of capitalism. In a perfect capitalistic society, those who make their own bed should lie in it - even if it means a company goes belly up or people have their houses foreclosed on.
But what kind of capitalistic society would allow a multi-gazillion dollar corporation who may have overextended itself because its risk assessors got it wrong, collapse and take the entire financial system with it?
Mr. DeLong explains the dilemma:
Yet we are still in significant trouble. Why? Especially “why” because nothing terribly bad has happened to the real economy: unemployment has not risen much, production and incomes have not fallen, wildfires have not annihilated all the houses of California’s Riverside County driving their inhabitants into Bushvilles in the arroyos of the California desert–normally we would require that something bad have happened to the real economy before the financial side is in such a state.
We are in such a state because:
* Quantitatively- and analytically-sophisticated Wall Street teams greatly overestimated their capability to assess and manage risk.
* Institutions greatly overestimated the extent to which the QaASWSTs (risk managers) were assessing risk as opposed to simply writing out-of-the-money puts they could not value and claiming they had lots of alpha.
* Investors greatly overestimated the extent to which institutions understood what their teams were doing.
And now we have something significantly worse than a financial-accelerator-deleveraging creating a credit crunch.
In short, if I may be so bold as to sum up Mr. DeLong’s analysis, the huge investment companies who manage the hundreds of funds that invest in securities were overconfident in their ability to manage everything from the risk of mortgage securities to the effect the bursting of the housing bubble had on the value of their portfolios.
They just got it wrong, that’s all.
So sorry. We’ll try harder next time, we promise. But in the meantime, would you please, Mr. Bernanke, pull our asses out of the fire?
The Federal Reserve took dramatic action on multiple fronts last night to avert a crisis of the global financial system, backing the acquisition of wounded investment firm Bear Stearns and increasing the flow of money to other banks squeezed for credit.
After a weekend of marathon negotiations in New York and Washington, the central bank undertook a broad effort to prevent key financial players from going under, including the unprecedented offer of short-term loans to investment banks and an unexpected cut in a special bank interest rate.
As part of the deal, J.P. Morgan Chase, a major Wall Street bank, will buy Bear Stearns for a bargain-basement price, paying $2 a share for an institution that still plays a central role in executing financial transactions. Bear Stearns stock closed at $57 on Thursday and $30 on Friday. J.P. Morgan was unwilling to assume the risk of many of Bear Stearns’s mortgage and other complicated assets, so the Federal Reserve agreed to take on the risk of about $30 billion worth of those investments.
The Fed “is working to promote liquid, well-functioning financial markets, which are essential for economic growth,” Chairman Ben S. Bernanke said in a conference call with reporters last night. Treasury Secretary Henry M. Paulson Jr., who was deeply involved in the talks though not a formal party to them, indicated support for the actions.
We are bailing out lenders who made risky loans. We are bailing out some homeowners who should never have received the kind of loan so dependent on the rising value of their investment and a sellers market. We are bailing out Wall Street giants who failed in correctly assessing the risk in buying certain kinds of securities. And the Fed is pouring cash into the financial system to head off any problems in the near future.
Is this capitalism? Not the sort that conservatives are always talking about.
And DeLong thinks that eventually, we may have to bail out a lot more homeowners at the bottom in order to stabilize things at the top:
If the U.S. government has a vehicle to buy up (at a discount from face value) and then manage home loans that look shaky, and if it can set the price of such loans, it might be able to do so in a way that not only rescues the financial system but makes money for the taxpayer.
[snip]
If I were working for the Treasury right now, I would be saying: make this happen on Monday. There isn’t time to set up a new bureaucracy–a HOLC, which is what Alan Blinder wanted to do as of three weeks ago. So use an existing bureaucracy: Fannie Mae. If I were Treasury Secretary Hank Paulson, I would spend the weekend building a legislative vehicle to introduce Monday morning on an emergency basis to give Fannie Mae the resources and the mission to undertake this mortgage rescue operation, and I think Fannie Mae is the right institution for the task: why does it have its government-sponsored status and guarantee if not to be used for purposes like these at times like these?
And if I were Ben Bernanke and Tim Geithner, I would be spending this weekend thinking about how to first thing Monday morning punish bear speculators on Bear Stearns, Lehman, and others by pushing their CDS spreads back to more normal levels. It seems to me that people on Wall Street need to be taught that betting that the Fed will not intervene to stabilize or that its interventions to stabilize will be unsuccessful is an unhealthy thing to do.
Basically, DeLong is arguing for Fannie Mae to come in and scoop up a lot of this bad paper and manage it on its own with the risk devolving to the government, rewarding both the little guy and the big guy for risky behavior.
Let’s remember what is at stake in a financial meltdown. We’re talking about hundreds of billions of dollars - real money, not government fantasy money. Those billions come from the money taken out of your paycheck for a 401K or some other retirement vehicle. It’s that $500 you put into a mutual fund every quarter or the dividends you invest in a risky bond fund. It’s the retirement savings of little old ladies and little old men. A meltdown would mean catastrophe for a lot of people.
So, the government must intervene and reward everyone who screwed up by bailing them out of trouble.
Was it trouble that could have been foreseen? I don’t really know enough to say for sure but common sense tells me that if banks and most mortgage companies turn someone down for a home loan and then your company goes ahead and lends the money anyway, it would seem pretty certain that both lender and borrower are aware that this is something more than just an iffy proposition. We don’t want a financial system where there must be a dead certainty that the borrower will not default. But neither do we want a crapshoot like a lot of these mortgages apparently were. Isn’t there a happy medium somewhere?
As for the Wall Street investment companies who bought these mortgage securities one might want to inquire as to how we got into this mess given that risk analysis is a large part of what these people do. DeLong points out that the risk managers got it horribly wrong. What’s to stop these guys from doing something equally stupid in the future?
If we’re going to throw true capitalism out the window - and make no mistake, that is what we’re doing with these bail outs - then the conservative rationale for capitalism goes with it.
Low regulation, open and free markets, individual and corporate responsibility - this is the conservative mantra when defending and promoting capitalism. I subscribe to this view of economics because it works as any resident of a capitalist country could tell you.
But now we are faced with the largest bailout in history and must question those comfortable assumptions. Maybe we need new regulation to prevent this from happening again. Maybe we need better monitoring and thus less “free” markets by the government. And what good is “individual and corporate responsibility” if the economy would be prostrate if we followed that dictum and just allowed economic Darwinism to rule the day and watch as millions lost their savings and millions were thrown out of work?
This entire post is probably making some of you more knowledgeable readers chuckle at my ignorance but how capitalistic a country can we really afford to have? And if the conservative rationale for capitalism is undermined in this fashion, what can replace it?
Perhaps on the micro level, capitalism will survive. But in the great, big, globalized world out there where governments can intervene in markets at the drop of a hat it’s difficult to see how true capitalism can flourish.