Implications of No 2008 Bailouts/Stimulus

[moda0306]

I hope I didn't misrepresent any side on the issue.  I find this to be an extremely interesting topic, because of the vast degree of disagreement there appears to be on what is a relatively simple statement.

If anyone feels I grossly misrepresented one of the possible outcomes, let me know.

[Indices]

People think the government is separate from the market. It's not. It is part of the market. If the SHTF by hook or by crook, there will be government spending. The people demand it. The worse things get, the more government aid they demand. Look at these recent tornadoes. People in Alabama, probably the most right wing part of the country, are demanding federal aid to rebuild their homes. Gov. Perry of Texas recently demanded that Obama give him federal aid for various state issues.

There are no libertarians/free market followers in the foxhole.

[AdamA]

Very interesting poll.

To me, the biggest determining factor would have been how many bank or money market fund defaults there really would have been.  If people couldn't get their money from their brokers or their banks, I think it would have initiated a huge confidence crisis.

[MediumTex]

All depositors could have been made whole, it would have just been a matter of taking the next step of putting the insolvent banks into receivership.

[AdamA]

All depositors could have been made whole.

How?

It would have just been a matter of taking the next step of putting the insolvent banks into receivership.

Would have taken some time though, right?

[smurff]

Well, more bad bankers would have gone to jail. And the current scandal over robo-signing mortgage documents and deeds would have sent another set of bad bankers to jail. Their bonuses would have been divvied up to pay off the lawsuits.

[MediumTex]

All depositors could have been made whole.

How?

With the same money the Fed used for QE1 and QE2.

I'm talking about depositors here, not shareholders or bondholders.

[moda0306]

MT,

Aren't we picking winners or losers then?  If we're going to let bonds fail, what about cash and CD's held by shaky institutions?

[MediumTex]

MT,

Aren't we picking winners or losers then?  If we're going to let bonds fail, what about cash and CD's held by shaky institutions?

No, what I am saying is that you provide the FDIC depositor protection that everyone expects.  If, however, I own a Goldman Sachs bond, I would lose my investment if Goldman Sachs was forced into bankruptcy due to insolvency (a corporate bond isn't covered by FDIC insurance).

I'm not talking about picking winners and losers--I'm just talking about using the existing bankruptcy procedures to wind up the affairs of insolvent institutions.

As William Black describes it: "you need a process for getting the insolvent institutions into receivership and the guilty executives into jail."

[Lone Wolf]

As William Black describes it: "you need a process for getting the insolvent institutions into receivership and the guilty executives into jail."

Yes, this is it.  The bad debts have to be cleared, one way or the other.  If a debt can't be paid, it must be restructured.  The only other option is to deny reality.  What MT is proposing is the opposite of picking winners and losers.  It is letting losers lose and letting winners (those that made wise decisions) reap the rewards.  Instead, the losers became basket-case government dependents and the winners became suckers.

The stakeholders in insolvent institutions made poor decisions and should lose money.  Entities that survived 2008 because they behaved more carefully would have the opportunity to purchase the remaining assets of these institutions.  This places those assets under more qualified custodians.

Failure to let this happen creates moral hazard.  If I can offer 10% returns while you are offering only 6%, I'm likely to get more business than you do.  But if my yield-chasing means that 1 year out of 5 everything blows up and I lose a ton of money, I (and my stakeholders) need to be the ones facing the pain for that, not you.  Otherwise, I will always have the incentive to behave the same way... and eventually so will you.  That's what got us where we are today.  It's why moral hazard isn't some small, abstract problem.  It is the problem.

In a free market, you take your own risks and receive your own rewards.  If we don't let that happen, we're just prolonging the pain.

[moda0306]

LW,

I think systemic risk is where your argument about the behavior of individual institutions may falter.  When institutions become so big that their individual failure will blow a hole in an entire market, they alone don't bear the risk of loss, and they know it.

Is there a mechanism for preventing from these institutions from becoming that large to begin with that you agree with?  What natural (free market) forces do you think work to prevent problems of systemic risk and TBTF, or do you think these things develop due to non-market forces?

To me, it seems like TBTF/systemic risk will develop naturally, regardless of any misallocation of resources, and at that point that institution knows it can play by a whole new set of rules... I guess this gets down to regulation, not bailouts, but it's part of the same conversation.

[AdamA]

With the same money the Fed used for QE1 and QE2.

I'm talking about depositors here, not shareholders or bondholders.

That seems so very logical and obvious.  Why didn't we do that?

[moda0306]

Adam,

They can't just pass out cash willy-nilly... the banksters have to properly allocate it... like they did when they loaned $400,000 to a janitor for his McMansion.

[Jan Van]

Is there a mechanism for preventing from these institutions from becoming that large to begin with that you agree with?  What natural (free market) forces do you think work to prevent problems of systemic risk and TBTF, or do you think these things develop due to non-market forces?

Isn't that why we should let them blow up? That's what would prevent TBTF (painful as it may be (might have been) (will be?) )...

[Jan Van]

There are no libertarians/free market followers in the foxhole.

That reminded me of this pic: http://www.google.com/imgres?imgurl=htt ... CBwQ9QEwAQ

[MediumTex]

Is there a mechanism for preventing from these institutions from becoming that large to begin with that you agree with?  What natural (free market) forces do you think work to prevent problems of systemic risk and TBTF, or do you think these things develop due to non-market forces?

Isn't that why we should let them blow up? That's what would prevent TBTF (painful as it may be (might have been) (will be?) )...

Simply enforcing the existing antitrust laws and imposing sensible reserve requirements would prevent TBTF in the first place by not permitting such large concentrations of risk in the financial sector in the first place.

The problem is that the regulators have been utterly captured by the industries they are supposed to be regulating.

[TBV]

There are no libertarians/free market followers in the foxhole.

That reminded me of this pic: http://www.google.com/imgres?imgurl=htt ... CBwQ9QEwAQ

Funny link!  But you know, the critique of faith as an irrational impulse can just as easily be applied to faith in the saving grace of government bailouts, market stimuli, etc.  Aristotle argued that true statesmen reject the folly of pursuing momentary satisfaction at the expense of an enduring good.  But man is weak, so we cling to cheap money, soft landings, and all manner of Wimpy "I'll-gladly-pay-you-Tuesday-for-a-hamburger-today" schemes.

[Lone Wolf]

Look at these recent tornadoes. People in Alabama, probably the most right wing part of the country, are demanding federal aid to rebuild their homes. Gov. Perry of Texas recently demanded that Obama give him federal aid for various state issues.

There are no libertarians/free market followers in the foxhole.

The problem is that people have already paid for these things with burdensome federal taxes... yet we should expect them not to use these services?  This wouldn't make them principled.  It would merely make them fools.

Now that Obama has decided not to declare a disaster area in Texas, can citizens of the state receive a refund on their federal taxes for the services they have already paid for?

For example, I might believe that a private garbage pickup service would do a better job than my current municipal service.  However, I am forced to pay for the municipal service.  Should I send them away, hire my own service, and get double-charged?

Is there a mechanism for preventing from these institutions from becoming that large to begin with that you agree with?  What natural (free market) forces do you think work to prevent problems of systemic risk and TBTF, or do you think these things develop due to non-market forces?

I believe that these things primarily develop due to non-market forces.  I can't think of any more unnatural entities than Fannie and Freddie!  (Okay, maybe the Federal Reserve.) 

Without moral hazard, excessive risk-taking will be punished by the markets early and often.  If you blow it, you get wrecked and someone smarter gets what's left of you.  This will tend to enforce market discipline and, I believe, help to prevent any entity from getting into such an unstable state.  As for law, certainly no FDIC-insured (aka heavily subsidized) entity should be able to take on such excessive levels of risk.

Given that we have the system we have (meaning, a fiat currency with fractional reserve banking), I have no problem with the Central Bank stepping in when necessary to facilitate the bankruptcy process and acting as a "lender of last resort".  That should be sufficient to allow the market to clear bad debts (with those who invested unwisely facing the pain for their decisions.)

[TBV]

Look at these recent tornadoes. People in Alabama, probably the most right wing part of the country, are demanding federal aid to rebuild their homes. Gov. Perry of Texas recently demanded that Obama give him federal aid for various state issues.

There are no libertarians/free market followers in the foxhole.

The problem is that people have already paid for these things with burdensome federal taxes... yet we should expect them not to use these services?  This wouldn't make them principled.  It would merely make them fools.

Now that Obama has decided not to declare a disaster area in Texas, can citizens of the state receive a refund on their federal taxes for the services they have already paid for?

For example, I might believe that a private garbage pickup service would do a better job than my current municipal service.  However, I am forced to pay for the municipal service.  Should I send them away, hire my own service, and get double-charged?

Is there a mechanism for preventing from these institutions from becoming that large to begin with that you agree with?  What natural (free market) forces do you think work to prevent problems of systemic risk and TBTF, or do you think these things develop due to non-market forces?

I believe that these things primarily develop due to non-market forces.  I can't think of any more unnatural entities than Fannie and Freddie!  (Okay, maybe the Federal Reserve.) 

Without moral hazard, excessive risk-taking will be punished by the markets early and often.  If you blow it, you get wrecked and someone smarter gets what's left of you.  This will tend to enforce market discipline and, I believe, help to prevent any entity from getting into such an unstable state.  As for law, certainly no FDIC-insured (aka heavily subsidized) entity should be able to take on such excessive levels of risk.

Given that we have the system we have (meaning, a fiat currency with fractional reserve banking), I have no problem with the Central Bank stepping in when necessary to facilitate the bankruptcy process and acting as a "lender of last resort".  That should be sufficient to allow the market to clear bad debts (with those who invested unwisely facing the pain for their decisions.)

+1

[Wonk]

"Capitalism without bankruptcy is like Christianity without hell."

-Frank Borman

Truer words were never spoken, imo.

[AdamA]

"Capitalism without bankruptcy is like Christianity without hell."

-Frank Borman

Truer words were never spoken, imo.

Ha!  That's great.

[Jan Van]

"Capitalism without bankruptcy is like Christianity without hell."

-Frank Borman

Truer words were never spoken, imo.

Ha!  That's great.

Sorry, but that made me think of this:

Pastor Rob Bell: What if Hell Doesn't Exist?
http://www.time.com/time/nation/article ... cle?chn=us