Tuesday, October 07, 2008

Captains Not Courageous

We have leaders who are anxious. We have captains not courageous. Captains tumbling into madness -Midnight Oil "Bedlam Bridge"

From a speech given by Ben Bernanke today at the National Association for Business Economics 50th Annual Meeting, Washington, D.C. Comments from me in bold:

On the heels of nearly a year of stress in credit markets, investors' and creditors' concerns about funding and credit risks at financial firms intensified over the summer as mortgage-related assets deteriorated further, economic growth slowed, and uncertainty about the economic outlook increased. As investors and creditors lost confidence in the ability of certain firms to meet their obligations, their access to capital markets as well as to short-term funding markets became increasingly impaired and their stock prices fell sharply.
No. It wasn't a "lack of confidence in the ability," it was lack of ability, plain and simple. The firms were insolvent. Period.
The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector arrangements--for example, by raising new equity capital, as many firms have done, by negotiations leading to a merger or acquisition, or by an orderly wind-down. Government assistance should be provided with the greatest reluctance and only when the stability of the financial system, and thus the health of the broader economy, is at risk. In those cases when financial stability is threatened, however, intervention to protect the public interest may well be justified.
Bernanke and the Fed have never defined what "financial stability" is. How can you take action if you can't define the problem to begin with?
The difficulties at Lehman and AIG raised somewhat different issues. Like the GSEs, both companies were large and complex and deeply embedded in our financial system. In both cases, as the firms approached default, the Treasury and the Federal Reserve sought private-sector solutions, but none was forthcoming. Attempts to organize a consortium of private firms to purchase or recapitalize Lehman were unsuccessful. With respect to public-sector solutions, we determined that either facilitating a sale of Lehman or maintaining the company as a free-standing entity would have required a very sizable injection of public funds--much larger than in the case of Bear Stearns--and would have involved the assumption by taxpayers of billions of dollars of expected losses.
So Bear was OK, but Lehman wasn't? Was it simply the amount of money involved, or was it too complex to figure out? Or not complex enough to bother with? The question remains unresolved, and the decision appears arbitrary.
In the case of AIG, the Federal Reserve and the Treasury judged that a disorderly failure of AIG would have severely threatened global financial stability and the performance of the U.S. economy. That judgment reflected our assessment of prevailing market conditions, AIG's central role in a number of markets other firms use to manage risks, and the size and composition of AIG's balance sheet.
Again, an arbitrary distinction. I'm not criticizing the move, I'm criticizing the explanation. Even a stopped clock is right twice a day. When the government spends $80 billion on the bailout of one company, we need details.
All told, economic activity is likely to be subdued during the remainder of this year and into next year. The heightened financial turmoil that we have experienced of late may well lengthen the period of weak economic performance and further increase the risks to growth. To support growth and reduce the downside risks, continued efforts to stabilize the financial markets are essential. The Federal Reserve will continue to use the tools at its disposal to improve market functioning and liquidity.
How do you improve market functioning without becoming the market? How do you improve liquidity when solvency is the problem? Answer: you can't!
The intensification of the financial crisis in recent weeks made clear that a more powerful and comprehensive approach involving the fiscal authorities was needed to solve these problems. On that basis, the Secretary of the Treasury, with the support of the Federal Reserve, went to the Congress to ask for a substantial program aimed at stabilizing our financial markets. As you know, last week the Congress passed and the President signed the Emergency Economic Stabilization Act. This legislation provides important new tools for addressing the distress in financial markets and thus mitigating the risks to the economy... Notably, the legislation establishes a new Troubled Asset Relief Program, or TARP, under which the Treasury is authorized to purchase as much as $700 billion of troubled mortgages, mortgage-related securities, and other financial instruments from financial firms that are regulated under U.S. law and have significant operations in the United States.

The TARP's purchases of illiquid assets from banks and other financial institutions will create liquidity and promote price discovery in the markets for these assets. This in turn will reduce investor uncertainty about the current value and prospects of financial institutions, enabling banks and other institutions to raise capital and increasing the willingness of counterparties to engage. More generally, increased liquidity and transparency in pricing will help to restore confidence in our financial markets and promote more normal functioning. With time, strengthening our financial institutions and markets will allow credit to begin flowing again, supporting economic growth.
Magical thinking at its finest. If these assets were so easy to value, we wouldn't be in this mess. The only "price discovery" that will happen is finding out how big of a sucker the Treasury is willing to be. Since there's no way to price these disparate assets consistently, how will counterparties know when it's safe to lend? I just don't see how to connect the dots here.
These are momentous steps, but they are being taken to address a problem of historic dimensions. In one respect, however, we are fortunate. We have learned from historical experience with severe financial crises that if government intervention comes only at a point at which many or most financial institutions are insolvent or nearly so, the costs of restoring the system are greatly increased. This is not the situation we face today. The Congress and the Administration chose to act at a moment of great stress, but one at which the great majority of financial institutions have sufficient capital and liquidity to return to their critical function of providing new credit for our economy.
This goes to the heart of the problem. Nobody knows what the "costs of restoring the system" will be, or what the system should look like after this is all over. Clearly, something about the status quo was wrong, so the goal shouldn't be to "restore the system," but to repair it. No amount of liquidity can create solvency. He's treating the symptoms, not the disease. Until his approach changes, our economy will suffer.


smf said...

No one acknowledges that high 'false' demand created an oversupply of certain commodities.

And keeping the prices high is not the solution.

If 40% of cars were bought by HELOCs, it follows that the elimination of HELOCs will take down demand for cars. And that demand will not come back, regardless of what anyone does.

And those involved should remember that bubbles will typically undershoot the bottom.

And the 2005 numbers will not be seen again.

patient renter said...

The Federal Reserve believes that, whenever possible, such difficulties should be addressed through private-sector

The very existence of the Federal Reserve and its manipulation of interest rates is contrary to letting things be "addressed through the private-sector", or through the market.

Interestingly, most (maybe all?) of our problems would not exist without the Federal Reserve and its interest rate manipulation. I missed where Bernanke mentioned that in his speech.

Max said...

Call me naive, but I can't believe Bernanke is this stupid. When the Fed Chairman minces words like a politician, we're in trouble.

It's like the entire government is afraid to tell us the truth. Why do they treat us like children?

patient renter said...

I can't believe Bernanke is this stupid

Personally I can. It is truly astounding to see that someone like Bernanke, being so educated and experienced, could be so absolutely and terribly wrong about so many glaringly obvious things, yet nobody can deny that Bernanke, Greenspan, Paulson, and nearly an entire industry of economists and analysts were dead wrong on the housing bubble and everything significant that followed.

The only two explanations I have are that either these people simply live too deep within a bubble of formal anlysis to see the common sense view of what is really going on (think Greenspan, circa 2005, with charts sprawled out all over his office concluding that there is no housing bubble), or they really are just stupid. Either way I don't really care. It's inexcusable.

smf said...

We have all witnessed people who gauge their intelligence according to the number of degrees in front of them.

I have always told my kids that personal worth is measured by what you DO, not by what a paper says who you are.

smf said...

We have all witnessed people who gauge their intelligence according to the number of degrees in front of them.

I have always told my kids that personal worth is measured by what you DO, not by what a paper says who you are.

Anonymous said...

"either these people simply live too deep within a bubble of formal analysis to see the common sense view of what is really going on...or they really are just stupid."

I'll offer another explanation: they are evil. I know it sounds trite and dated to use such terms, but this is what really fits. It's not that Greenscam didn't know there was a housing (mortgage finance) bubble, of course he knew there was one because he created it. And he did it on purpose, knowing full well what the ramifications of this policy would be.

How do I know this? Greenscam's early work shows very clearly that he was a good economist and knew all about bubbles, inflation, and what money is and what credit is and how all of these things work together. He knew very well that a massive credit expansion would have to be followed by a horrific credit bust. The real question is why? Why would he do this if he knew what the outcome would be? If you answer this question, then you understand the nature of our monetary system and the Federal Reserve.

Here is Greenscam's own words concerning honest money:


Most folks won't recognize the writing style and positions as being the same as the politician and pigman bankster that later headed the Federal Reserve.

patient renter said...

Darth - I think that's as valid a reason as any. I'd heard about Greenspan's early work, but not actually seen it till now. From Greenspan's piece:

Deficit spending is simply a scheme for the confiscation of wealth.

...similar to how the Federal Reserve is a scheme that was created by banks to allow banks to collect interest on money which doesn't exist.

The man truly went to the dark side, eh?

Anonymous said...

PR, yep. Hard to believe someone that actually knew so much about how money and economics actually work could sell out like that. A lot of folks think that Greenscam was either an incompetent fuddy-duddy or senile or something. Nothing could be further from the truth. He knew exactly what he was doing and did it anyway, and then lied about everything constantly.

The pigmen have unlimited resources, so they can buy any politician or hitman that is required to get the job done. Not so hard when you can print your own money!

smf said...

Those who were selling this crap were justifying their actions by noting how 'rich' they were making their clients.

Imagine the realtor selling to the strawberry picker, probably believing that her actions would allow her client to 'build up equity' and all the other PR stuff.