Bail them out, or let them sink?
I wonder what you've made of the political shenanigans in Washington over the past week.
There are two ways of looking at it, aren't there? You might take the view that members of Congress have been fulfilling their duties as elected representatives and carrying out the wishes of their constituents in trying to amend the proposed bank bail-out deal on offer from the US Treasury.
Or you might see it all as sordid electioneering, with each side seeking maximum party advantage in the closing stages of a close-fought Presidential campaign, even as the financial markets teeter on the brink of melt-down in the continuing uncertainty.
If you take the first view, you will find supporting evidence in the New York Times, which reports: "It has become abundantly clear that members of Congress are hearing from their constituents, many of whom are furious about the proposed rescue."
If you take the second view, you'll find support from Senate Majority Leader Harry Reid, who told reporters that John McCain's suspension of his campaign was unnecessary and he was "standing in the way" by returning to Washington from the campaign trail. "If we lose progress, it's only because of one man, and that's John McCain."
The focus for much of the public anger seems to be the income levels of some of the biggest banks' bosses. (And of course it hasn't exactly gone unnoticed that the US Treasury secretary Henry Paulson, in his previous life as head of Goldman Sachs, managed to squirrel away something in the region of $65 million in bonuses alone over a seven-year period.)
If I were a US tax-payer, I suspect I may wonder why my contribution to the Treasury might be used to keep some of these chaps in the manner to which they have plainly become happily accustomed. Especially as it would appear to be their mistakes, misjudgments and bad calls that got us into this mess in the first place.
So why not let them all go the way of Lehman Brothers? Well, like 'em or not, we need the banks. They provide our mortgages, they invest our pension plans, and they offer credit to the companies on whom we rely for goods and services. And there seems to be general agreement that however unpalatable the deal currently under discussion, doing nothing would almost certainly be a lot worse.
(Incidentally, one small anecdote: a local shopkeeper of my acquaintance was telling me recently that he had just acquired two more properties as his business expanded. The bank had approved his business plan, but at the last moment, withdrew its offer of a loan. That's the credit crunch in action.)
And there's still the thorny issue of how much the US Treasury's "septic bank" might be prepared to pay for the toxic debt currently poisoning the system. As my colleague, the BBC's superb business editor Robert Peston, points out: "If the bail-out is used to punish the banks, it probably won't save the global financial system; but if the banks aren't punished, then US tax-payers may well feel that their pockets have been picked."
© MMIX~RS~q~RS~~RS~z~RS~30~RS~)
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Let them sink then rescue the bits vital to the orderly conduct of trade and of the savings of the general public. This is the purpose of bankruptcy. It is designed over hundreds of years to do just this.
If the proposed scheme is implemented the market will ensure that the 700 billion us dollars is turned into executive bonuses p.d.q. and there is nothing that can be done to stop it.
The senior staff and directors must be sacked and their pensions and golden parachutes stopped. If the Poulson scheme is implemented (in its apparent present form- 9 am BST Friday 26th September) the directors will be protected at the cost of depositors and junior staff and that is not a sensible way to run the World!
On the prospects for the World - we have a decade or more of very hard times ahead no matter what is done - we stored up this problem when our governments deliberately turned a blind eye to the housing bubble in the US and the UK - make no misstate the UK's house priced MUST fall to half or less of the present value and many many people will suffer - there is no escape from this - short of engineering a huge rise in wage inflation which has the same effect, but just seems less painful!
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How about a smash and grab from the bank accounts of the perpetrators of this mess.
I'm sure they must have a few billion lying about between them.
I imagine that the public wouldn't be quite so p*****d off if they saw the geniuses who got us into this mess getting their comeuppance as well.... I know it would make me happier.
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I've given some thought to this. I think the President's plan is taking the wrong approach. The bottom line is that the banks should be allowed to go under and the government should find an entirely different way to deal with the credit crisis.
As I've posted before and elsewhere, in many ways the current crisis parallels the events and circumstances leading to the great depression of 1929. An asset class, in the case of the 1920s stocks, in the case of this era houses were overvalued in a bubble market. Huge credits were advanced to buyers of these assets using the overvalued assets themselves as collateral. When the bubble burst, the value of the assets could not pay off the debt. Holders of the debt faced bankrupcy and credit for everything else tightened. The current situation is in some ways worse than 1920s because the US government iteslf is already the single biggest debtor in the world. What's more, many Americans have already stretched their finances nearly to their breaking point on credit. If the government does not create more credit itself, the country and the world faces an economic downturn which could be described as a severe recession or even a depression.
Why did this happen? After 1929, the government investigated and realized that the unregulated issuance of credit was at the root of it. But at that time, the issuer of credit was the one left holding the bag so to speak, the ultimate loser when the borrowers defaulted on the loans. Today, the crisis is even worse because the creditors were allowed to repackage that debt and sell it to people too lazy or stupid to carefully examine what they were buying for their employers. So now, the lure of easy money through these defective instruments has spread this bad credit all over the world in quantities that are nothing short of staggering. The restrictions put on creditors after the depression to assure sound credit markets were removed in the 1980s and 1990s making the current crisis inevitable. In other words, the government itself forgot the lessons of history, removed the impediments to reckless credit that had been put in place to prevent it from happening again and so history repeated itself.
How did the great depression end? It didn't end in the 1930s despite the government's best efforts with the limited understanding it had at the time. It ended in WWII when it had no choice but to create money by borrowing from the future to buy the war material it needed with money it didn't have. This happened after all of the failed banks that had loaned out money recklessly in the 1920s were long dead and burried. The fact that they were gone did not prevent recovery. IMO what the government should do is to use the 700 billion and much more if necessary to create credit directly to borrowers competing with the banks that failed and let them die. This will be a refresher lesson that the penalty for stupidity in running a business in a market economy is financial death. This is how the system was meant to work and works best. It should also reinstate all of the credit regulations it removed so that this does not happen again. The faliure of these huge institutions will be an object lesson to future generations of what happens when you forget the lessons of history. This does not mean there will not be painful consequences but the question is where will the pain be felt. Foreign governments and banks which loaned the US so much money directly and bought so much bad US credit also with reckless abandon should also feel the pain. This will be done by a huge round inflation which will pay them back pennies on the dollars they loaned out. Is this unfair? NO! The penalty for stupidity in handling money should be loss. A fool and his money are soon parted should be a lesson to everyone whether the size of the foolish loans is in the thousands or the trillions of dollars.
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#3 - MarcusAureliusII
As an analysis of what went wrong, you are absolutely spot on. The problem is what to do about it. I find it quite interesting that Barclays were prevented from taking over Lehman lock stock and barrel by the UK regulator but were able to sneak back in two days later and buy up the good bits for a fraction of the original price. Maybe there is answer here. Let the banks fail in the reasonable expectation that someone will take on the viable divisions, then simply throw what's left into Paulson's black hole.
As a bonus, the guys who did a half decent job will still end up with a job. The rogues who got greedy will end up on the scrap heap. Shame about the little guys with no control over policy.
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This comment was removed because the moderators found it broke the House Rules.
Oh, nearly forgot. I find in note worthy that 2 of the 3 credit/asset rating agencies, which were responsible for giving practically all of these packages a AAA rating, are refusing reporters only 1 issued a brief statement ... now that the issue has been drawn ... what about these guys? hmmmmm
Can anyone say kickbacks?
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MarcusAurelius makes an excellent suggestion about how to solve the current problem of credit strangulation stemming from the distrust of banks willingness to lend to each other due to the poor quality of their balance sheets caused by the widespread presence of CDOs filled with subprime mortgage loans. Paulson and Bernanke's bailout plan asks Congress to appropriate $700 billion to buy up these CDOs from the banks and by doing so hope that confidence will be restored in the credit system. This is an institution-centered top-down approach to solving the problem. A bottom-up approach in which the Federal government makes loans directly to distressed homeowners on very easy terms to keep up payments on their mortgages would raise the value of the CDOs held on bank balance sheets and renew confidence in the credit markets. A further advantage of this approach over the Paulson-Bernanke approach is that we can avoid moral hazard or a future repetition of the bad judgment by bankers which led to this gigantic problem in the first place.
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My suggestion is that the US government should temporarily go into the business of advancing credit competing openly in the market at a slighly higher but competitive rate for any and all good credit risk borrowers except for holders of sub prime mortgages where the government would decide on a case by case basis if there is reasonable risk at refinancing at more reasonable rates where the current owners accept selling these assets to the government at a discount. This would protect homeowners who are only marginally incapabile of paying for what they bought while allowing the worst loans to remain on the books of the lending institutions as a total loss. It would also result in foreclosure on homes bought by people who had no real prospect of paying for them. If the banks are unwilling or unable to advance credit, the government will prevent a freeze up in the credit market by being an alternative. They wouldn't undercut legitimate competitive bank rates but they wouldn't extract heavy penalties from trustworthy borrowers either. This will prevent a depression or serious recession due to a freeze up of credit while forcing the most reckless institutions to suffer the consequences of most of their worst mistakes. It may mean that some very large institutions will go belly up but who cares except their shareholders, executives, and employees. That's the penalty of carelessly running a business in a capitalist society but it shouldn't be allowed to hold the rest of the economy and society as a whole hostage to its blunders.
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#8 - MarcusAureliusII
Interesting idea but where is the money coming from? Taxation revenue from the corporate sector will decline with the economoy in the short term and there will be an increased dependency on personal and indirect taxation. You appear to suggest that the government takes tax dollars then lends them back. This may alleviate distress amongst those in trouble with mortgage debt but at the expense of those who have managed it wisely and I am not sure how recycling existing money helps to recapitalise the markets.
This is not a criticism. It is a serious question. I would be interested on your take.
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"the economoy in the short term" should have read "the economy in decline in the short term" - Sorry.
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The plan would make the government a competitor in the credit markets. Not the lowest cost creditor except for homes already in trouble but reasonable. The money would come from the taxpayer but it is a loan on credit worthy investments, not a wholesale giveaway for any and all garbage sold at absurd prices. A government owned corporation would assess the risk. Banks which still can and will grant credit would survive. They can't refuse or they will die. Those in deep trouble will also die. The scheme would put the consequences for business failure where it belongs, on the businesses that failed while preventing a credit freeze up. When those banks fail or decide to get rid of their non performing assets, they would be auctioned off or the government would buy them at fair market value or below but only selectively. Credit for homeowners in trouble would be made on somewhat more than usually lenient terms but not recklessly. Those whicih are hopeless because the homeowner never had any assets with which to buy a house in the first place would go into default at the mortgage holder's loss.
Members of both houses of both parties announced within the last few hours that they have come to an agreement in principle. It will be interesting to see how that works.
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It will indeed. Thanks for the clarification. Sounds lake a good plan to me.
In view of the fact that another UK bank has gone today (a small one admittedly), we should consider your scheme over here. I have long argued that we should be bailing out the little guys, not the corporate incompetents.
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While attention was focussed on the bail-out, Congress also voted on Saturday to allow the U.S. to provide nuclear materials to India.
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Richard_SM @ #13
Your comment appears to be vaguely critical of the US Congress? A rather naive criticism I would suggest!
I see the US deal with India as good common-sense business for the US and India. Helping a friendly India that is outside of the Non-Proliferation Treaty may sound strange but as India is jam-packed full of Thorium Deposits, it might be useful to have Democratic India on-side for the future development of Fusion Reactors in the USA.
It should also be noted that India, as part of the deal with the USA is agreeing to the UN Nuclear Watchdog being free to inspect India Nuclear facilities so there is a possibiltiy that India may even agree to sign up to the Nuclear Non-Proliferation Treaty in due course.
By contrast, Russia is already (and has been for some while) been actively supporting Iran to become a nuclear state, has deliberately blocked the UN from imposing further sanctions upon Iran to counter the fear that Iran intends to develop weapons-grade uranium, and Iran is much more of a threat to the safety of the world than India . . . Iran's President having an avowed desire to eliminate Israel.
Two wrongs do not necessarily make it right but in the case of India - they already have their own nuclear armaments so America is not exactly proliferating nuclear technology - just catching two (or more) birds with one stone . . . . and I, for one, do not blame the Americans - they have every right to look after their own self-interests.
Russia on the other hand is playing an extremely dangerous game that could not only backfire on predominently-Christian Russia but, alternatively, lead to World War III if Israel does,as I would anticipate, launch pre-emptive attack on Iran (when Israel's Iranian Nuclear Capability Red-lines are crossed) which will inevitably cause Israel - and the US - to be attacked by Iran which will in turn take all NATO member countries to war with Iran and any allies that may take Iran's side in the resulting conflict.
I know to which Nation's political gambits I would rather have any criticism directed - and it is not the USA, India or Israel.
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#13 - Richard_SM
Nuclear technologies - not materials. India has plenty of raw material as Menedemus points out. Enrichment and processing will doubtless be on the agenda but I have not seen the small print yet.
Menedemus.
India has had good relations with Russia in recent times so, if the Americans have sealed the deal, I would regard that as a major commercial success for them. Certainly it works in foreign policy terms and I think the Americans can be congratulated in this case on a job well done.
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Bail them out or let them sink? Looks like Congress has decided for now to let them sink. The American people are fed up with the way the markets have run roughshod over them. It's payback time, time for high rolling bankers to wind up in the poorhouse. The economy will recover when the Treasury devalues the currency by printing a mountain of cash. Today the government created 600 billion in addition to the 700 billion bailout that was rejected. 600 billion hardly made a dent, the markets didn't even flinch. Try about 6 to 12 trillion. This will devalue the US dollar by around 50 to 75 percent in domestic buying power and will bankrupt much of the outside world, especially China. Europe will take a big hit too. There is nothing anyone can do about it at this point, it's far too late for quick fixes. The choice is stark, depression or a big round of inflation. I still like my idea above about the Federal Government going into the credit business as slightly higher rates than the banks still willing to lend offer. When the gas goes out of the balloon, the markets will adjust the prices of real estate to reflect their actual worth in the new reality.
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World wide pressure, and evolution in action. Change is coming, and not by means of our presidential election, but the inner hollows of our humanity. When we start to truly peer into these problems, I hope we pull away from what we see with resolve and diligence ... not more ignorance. Hopefully this won't lead us into WWIII, but if it does ... I'll find a cozy fire some place and read some of my favorite quotes.
"The true measure of a man is how he treats someone who can do him absolutely no good."
- Samuel Johnson (1709-1784)
"Human history becomes more and more a race between education and catastrophe."
- H. G. Wells (1866-1946)
"Nothing in the world is more dangerous than sincere ignorance and conscientious stupidity."
- Martin Luther King Jr. (1929-1968)
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