How To Solve A Crisis? Ask Steve Forbes

The one-time candidate for POTUS, Steve Forbes, writes in the latest issues of Forbes magazine about what should be done to avoid a Modern Great Depression.

The first prescription for a cure is to formally strengthen the dollar and announce it publicly. A year ago August the price of gold was more than $650 per ounce. In late 2003 it had breached $400. The Fed should declare that its goal for gold is around $500 to $550. That would stabilize the buck--and stability is essential if animal spirits and risk taking are to revive.

Also of immediate urgency is for regulators to suspend any mark-to-market rules for long-term assets. Short-term assets should not be given arbitrary values unless there are actual losses. The mark-to-market mania of regulators and accountants is utterly destructive. It is like fighting a fire with gasoline.

Think of the mark-to-market madness this way: You buy a house for $350,000 and take out a $250,000 30-year fixed-rate mortgage. Your income is more than adequate to make the monthly payments. But under mark-to-market rules the bank could call up and say that if your house had to be sold immediately, it would fetch maybe $200,000 in such a distressed sale. The bank would then tell you that you owe $250,000 on a house worth only $200,000 and to please fork over the $50,000 immediately or else lose the house.

Absurd? Obviously. But that's what, in effect, is happening today. Thus institutions with long-term assets are having to drastically reprice them downward. And so the crisis feeds on itself.

The SEC should immediately reverse its foolish decision to get rid of the so-called uptick rule in short-selling. That would provide a small road bump to the short-selling that's helping to destroy financial institutions.

At the same time the SEC should promulgate an emergency rule (which we thought was already the rule): No naked short-selling. That is, you have to own or borrow shares in a company before you can short it. The rules should make clear that short-sellers must have ample documentation proving they truly possess the shares at the time of the short sale. Otherwise, each violation will result in heavy fines. That wouldn't be a road bump but a wall of Everest-like proportions. Regulators should also be told to instruct banks to keep their solvent customers solvent. The last thing the economy needs right now is for the banking system to seize up.

The federal government should also consider setting up a new Resolution Trust Corp., which was devised during the savings and loan crisis nearly 20 years ago as a dumping ground for bad S&L assets. Today's bad assets could then be liquidated in an orderly way. And, finally, the financial industry should be encouraged to create new exchanges for exotic instruments. This would result in the standardization of these things, which would mean more transparency.

(h/t Scott L.)


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Jeffrey Miron, Harvard, Blames Fannie/Freddie Too

That's why I'm posting his article here. Because he agrees with me. Because I make no secret of my biases. Because I don't try to pretend I'm not biased. Because I haven't duped myself into thinking don't have any biases. It's called confirmation bias and WE ALL DO IT.

Jeffrey Miron in his own words:

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle.

Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government.

The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

Thoughtful advocates of the bailout might concede this perspective, but they argue that a bailout is necessary to prevent economic collapse. According to this view, lenders are not making loans, even for worthy projects, because they cannot get capital. This view has a grain of truth; if the bailout does not occur, more bankruptcies are possible and credit conditions may worsen for a time.

Talk of Armageddon, however, is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen.

Further, the current credit freeze is likely due to Wall Street's hope of a bailout; bankers will not sell their lousy assets for 20 cents on the dollar if the government might pay 30, 50, or 80 cents.

The costs of the bailout, moreover, are almost certainly being understated. The administration's claim is that many mortgage assets are merely illiquid, not truly worthless, implying taxpayers will recoup much of their $700 billion.

If these assets are worth something, however, private parties should want to buy them, and they would do so if the owners would accept fair market value. Far more likely is that current owners have brushed under the rug how little their assets are worth.

The bailout has more problems. The final legislation will probably include numerous side conditions and special dealings that reward Washington lobbyists and their clients.

Anticipation of the bailout will engender strategic behavior by Wall Street institutions as they shuffle their assets and position their balance sheets to maximize their take. The bailout will open the door to further federal meddling in financial markets.

So what should the government do? Eliminate those policies that generated the current mess. This means, at a general level, abandoning the goal of home ownership independent of ability to pay. This means, in particular, getting rid of Fannie Mae and Freddie Mac, along with policies like the Community Reinvestment Act that pressure banks into subprime lending.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

(emphasis added)


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Charles Calomiris & Peter Wallison On Fannie/Freddie & The Democrat Party

Add Calomiris and Wallison to the growing consensus on who is actually to blame for the current financial crisis--known in some parts as Modern Great Depression. Want the 'who's responsible' Spark Notes? Democrats (specifically Barney Frank) for enabling Fannie Mae and Freddie Mac--not Republicans and deregulation.

Here's the article:

Many monumental errors and misjudgments contributed to the acute financial turmoil in which we now find ourselves. Nevertheless, the vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess.

How did we get here? Let's review: In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

It is important to understand that, as GSEs, Fannie and Freddie were viewed in the capital markets as government-backed buyers (a belief that has now been reduced to fact). Thus they were able to borrow as much as they wanted for the purpose of buying mortgages and mortgage-backed securities. Their buying patterns and interests were followed closely in the markets. If Fannie and Freddie wanted subprime or Alt-A loans, the mortgage markets would produce them. By late 2004, Fannie and Freddie very much wanted subprime and Alt-A loans. Their accounting had just been revealed as fraudulent, and they were under pressure from Congress to demonstrate that they deserved their considerable privileges. Among other problems, economists at the Federal Reserve and Congressional Budget Office had begun to study them in detail, and found that -- despite their subsidized borrowing rates -- they did not significantly reduce mortgage interest rates. In the wake of Freddie's 2003 accounting scandal, Fed Chairman Alan Greenspan became a powerful opponent, and began to call for stricter regulation of the GSEs and limitations on the growth of their highly profitable, but risky, retained portfolios.

If they were not making mortgages cheaper and were creating risks for the taxpayers and the economy, what value were they providing? The answer was their affordable-housing mission. So it was that, beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates, indicating that originators were scraping the bottom of the barrel to find product for buyers like the GSEs.

The strategy of presenting themselves to Congress as the champions of affordable housing appears to have worked. Fannie and Freddie retained the support of many in Congress, particularly Democrats, and they were allowed to continue unrestrained. Rep. Barney Frank (D., Mass), for example, now the chair of the House Financial Services Committee, openly described the "arrangement" with the GSEs at a committee hearing on GSE reform in 2003: "Fannie Mae and Freddie Mac have played a very useful role in helping to make housing more affordable . . . a mission that this Congress has given them in return for some of the arrangements which are of some benefit to them to focus on affordable housing." The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

In light of the collapse of Fannie and Freddie, both John McCain and Barack Obama now criticize the risk-tolerant regulatory regime that produced the current crisis. But Sen. McCain's criticisms are at least credible, since he has been pointing to systemic risks in the mortgage market and trying to do something about them for years. In contrast, Sen. Obama's conversion as a financial reformer marks a reversal from his actions in previous years, when he did nothing to disturb the status quo. The first head of Mr. Obama's vice-presidential search committee, Jim Johnson, a former chairman of Fannie Mae, was the one who announced Fannie's original affordable-housing program in 1991 -- just as Congress was taking up the first GSE regulatory legislation.

In 2005, the Senate Banking Committee, then under Republican control, adopted a strong reform bill, introduced by Republican Sens. Elizabeth Dole, John Sununu and Chuck Hagel, and supported by then chairman Richard Shelby. The bill prohibited the GSEs from holding portfolios, and gave their regulator prudential authority (such as setting capital requirements) roughly equivalent to a bank regulator. In light of the current financial crisis, this bill was probably the most important piece of financial regulation before Congress in 2005 and 2006. All the Republicans on the Committee supported the bill, and all the Democrats voted against it. Mr. McCain endorsed the legislation in a speech on the Senate floor. Mr. Obama, like all other Democrats, remained silent.

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

If the Democrats had let the 2005 legislation come to a vote, the huge growth in the subprime and Alt-A loan portfolios of Fannie and Freddie could not have occurred, and the scale of the financial meltdown would have been substantially less. The same politicians who today decry the lack of intervention to stop excess risk taking in 2005-2006 were the ones who blocked the only legislative effort that could have stopped it.

(emphasis added)


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Jeff Frankel Grudgingly Supports The Modified Paulson Plan

Frankels is at Harvard (for those of you who care about such things).

Here's his analysis of the plan:

When the Treasury came out with its $750 bailout plan on September 22, I thought it lacked so many necessary ingredients that it deserved a thumbs down.

But in the negotiations between the Treasury and Congressional leaders over the course of last week, most of the missing ingredients were inserted. Starting with the additions that were most necessary on the merits, and moving toward the ones where the necessity was more political, they were:

· Institutionalized oversight of the Treasury, which had previously been startlingly absent.

· Provisions so that the taxpayer would share in the upside potential of banks and other financial institutions, rather than just socializing the losses. These provisions should allow the possibility that the government could recoup most or all of its short-term losses as has often ultimately been true in past unpopular bailouts.

o First, by giving the government equity stakes in the banks that sell their bad loans to the Treasury.

o Second, by having the president in five years submit legislation to recoup the cost from the financial sector if the taxpayer is still in the red at that point.

· Limits on executive compensation, especially golden parachutes, at banks taking advantage of the opportunity to dump their bad loans on the Treasury.

· Dividing the $750 billion into three slices over time, which at least offers the congressional negotiators a little bit of cover.

· A provision for possible government insurance of mortgages instead of acquisition of them. This was a bone thrown to the Congressional Republicans who had blocked the plan several days ago; I don’t know why they would want this provision, but at least it can’t do much harm.

Some other proposed provisions, from both the right and left, were left out, and for good reason in most cases.

(h/t Ryan D.)


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Barney Frank Ought To Win The Fannie/Freddy Blame Game

I'm going to keep banging this drum until the true story is told. This is a government caused problem and the primary sponsors were Democrats and the main Democrats were Senators Chris Dodd, Barack Obama, Hillary Clinton and Rep. Barney Frank. They helped craft the legislation and culture the enabled Fannie Mae and Freddy Mac to tip the economy into crisis.

There should have been better regulation of Fannie & Freddy. President Bush tried to do it in 2003 and John McCain tried to do in 2006--only to be stonewalled by Democrats.

When you have an institution--like Fannie or Freddy--that has overt backing by the federal government, which takes away the risk of bad investments, you must--MUST--couple that with regulation that ensures these pseudo-governmental institutions do not make bad investments that put the whole economy at risk.

Democrats pushed Fannie & Freddy to buy risky mortgages and stonewalled initiatives to regulate Fannie & Freddy so they didn't meltdown.

This is what happens when Democrats' governmental philanthropic whims become public policy.

(h/t DrewM @ Ace of Spades)

UPDATE: David Boaz blogging at Cato @ Liberty hammers on some of the same things I've been writing about for the last few weeks:

A page one Washington Post headline reports, “Credit Crisis Has Given Obama a Distinct Edge.” Which must be really frustrating for McCain, because McCain did try to reform Fannie Mae and Freddie Mac back in 2006. Obama, meanwhile, as I reported at the American Spectator, received more donations from Fannie Mae in four years than any other senator (except Banking Committee chairman Chris Dodd) received in twenty years. That’s quite an accomplishment–more money from a primary creator of the financial meltdown in just four years than senior members of Congress like Nancy Pelosi, Barney Frank, Richard Shelby, Spencer, Bachus, John Kerry, and Roy Blunt got in entire 20 years that the Center for Responsive Politics tallied. And of course, Obama chose former Fannie Mae CEO James Johnson, who was found to have jiggered the books, to head his search for a vice president.

Shouldn’t somebody in the media ask Obama why he was Fannie Mae’s favorite senator?

Hey media elites, how about this: How about you do your jobs and pose this question to Barack Obama?


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'A Brief Education On The Subject Of Financial Reporting'

Like Matt P., I've heard a lot of people blame "mark to market" and other financial reporting issues for part of the current crisis. I've only taken one accounting class and my brother helped me get through that one. Fortunately, I've got lots of friends with degrees in accounting and one of them (the aforementioned Matt P.) wrote the following for our benefit:

I heard a talk show host blaming "arcane accounting policies" this morning for part of the crisis. I later heard that Rush jumped all over that yesterday as well. Knowing a little bit about the subject of accounting, I sent an email off to one of the hosts. While it is a minor hiccup in the entire financial episode, if you would like to have a brief education on the subject of financial reporting, below is a copy of the email that I sent.

It amazes me that you and other talk show hosts have picked up the newest talking point of the financial "crisis" being exaggerated or even caused in part by the "mark-to-market" accounting, as you call it. As a student of accounting, an employee of an "evil" international accounting firm and having been involved with the financial statement presentation of reputable companies such as CONSOL Energy and UPMC, I feel that I have some limited authority to talk on the subject. I'll admit that accounting standards are far from perfect; however, to blame the marking-to-market of securities as one of the reasons for the crisis is akin to blaming speculators for the spiking oil prices in that it is simply the manifestation of problems that have already or are expected to occur.

Here are a couple of items to think about:

(1) What is the alternative to the "mark-to-market" method of accounting for securities? If accounting principles stated that equity securities should be held at a historical cost, people would be out there berating the accounting world for not telling them what was happening. So we say, "The value of these securities can be reasonably estimated through open market transactions. So let's look at the prices for which they are selling on the exchanges." We went to the open market that says that the securities held by these companies are near worthless. What other basis can you give me that I could reasonably use as a value other than (a) historical cost (which would lead to complaints) or (b) open market transactions (which apparently has led to complaints)?

(2) What about the potential value of the assets behind the securities? Although the market is deciding the value based on the perceived potential value of the assets behind the securities, let's discuss. Contrary to what it seemed you were indicating this morning (admittedly, I was unable to hear the entire segment), the potential value of the assets has no valid basis in accounting. Can you imagine the trouble and liability any firm would take on if it decided to value its assets at the "potential" value? Say I have an old machine sitting in the back that has the potential to produce $10 million in garden gnomes a year. Does that mean I have a multi-million dollar asset that I should have on my books? Not if I can only sell the asset for $1 million and there is no current demand for garden gnomes.

Well, there are millions upon millions upon millions of mortgage-backed securities out there. There's a chance that you could dissolve the securities and sell off the mortgages or properties and get more than what the market says the securities are worth. Sounds like an opportunity for an investor to me, but I'm not going to stake my reputation for faithful representation on a chance. That investor will still be purchasing the security at market prices, which tells me that the market price is all that this security is worth to that firm holding it.

(3) What is it that accounting is really supposed to accomplish? Accounting standards as you are discussing, related to external financial reporting, are a basis for presenting historical (not even real time, let alone future) information. The best public companies still take a number of weeks to pull together full financial statements with a few more weeks of auditing before being able to file with the SEC.

One also needs to realize - as anyone who has taken basic accounting 101 should know - that these investments are held on the balance sheet, which is a snapshot at a point of time, attempting to faithfully represent the assets, liabilities and equity of a firm as of a specific date (see #2). As a result, this is simply a reflection of what the market is thinking now. If the market changes its mind tomorrow resulting in an increase in the value of mortgage-backed securities, then companies would be back in business, right? Take another snapshot and see where it puts you.

At the end of the day a number of companies (upon whom the responsibility lies - along with Washington politicians) made poor operational decisions. To blame the way that accounting rules display the results of these poor decisions is to shoot the messenger and take focus away from where true responsibility lies.

Please don't just jump on the bandwagon.

Thanks to Matt P.


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Economic Crisis: Enemy Of The Good

Ace, of Ace of Spades HQ, one of the few blogs I read on everything, thinks conservatives are wrong to oppose the bailout. He is afraid of a New Deal in the aftermath of a modern Great Depression.

Steve Forbes on Michael Medved: "I’ve never been an alarmist…I’ve never seen a situation as dark as it is today...people genuinely don't understand the magnitude of what is before us."

Like I said in the comments: I am not an economic alarmist myself and I get my take from people who aren't economic alarmists.

So when they suddenly become economic alarmists, I'm alarmed.

Incidentally, don't mislead yourselves into thinking I'm unaware that I'm taking an unpopular position and it could cost me traffic, and readers, and therefore salary.

100-1 against. I know this. I know this is a Schiavo-level split, the same sort of split that caused readers to abandon some blogs.

So I do know that I could actually gain traffic and readers by rah-rahing the KILL THE BILL position.

But I can't. Because I honestly think most conservatives are very wrong on this.

And not only are they very wrong, they're very wrong with possibly dire consequences. And not only that, there's the possibility that all faith in capitalism will crater and we'll have three generations of real socialism.

I have to be honest. I cannot be 100% sure, but I'm sure enough that I'll risk losing a lot of readers: We are in trouble. There is a chance that a crisis will not lead to a vicious-circle deleveraging and halt to a lot of economic activity, but the odds that it will seem much greater.

So I'm not taking this position to annoy people. Or because I have money in stocks. I don't own a single stock. And my credit's bad, so, honestly, this kind of doesn't really affect me. I've been on a pure cash personal economy for years.

I'm taking this position because I think it's right.

I can be persuaded that we must do something in order to forestall a far greater socialization of the market in the aftermath of a Modern Great Depression. That's just pragmatic politics.

Whatever plan eventually passes, I maintain my insistence that it be two things: Simple & Targeted. In these instances, where government programs, plans, & policy fits this criterion, government intervention can be effective and, in fact, very successful.

This necessitates that the legislation be simple with a simple mandate.

As the scope of the legislation grows and individual members tack on additional spending initiatives, simple and targeted becomes complex and scattered. It is this type of scenario that will bring the type of unintended consequences to which I have referred in the past.


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Bret Baer: History Of A Crisis

(h/t Greg Mankiw)


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Stop The Bailout

The more I read the more I'm persuaded against the bailout--in pretty much any form. Greg Mankiw posted a letter from an economist who is opposed to the bailout. The entire letter bears reading because its author, Robert Shimer, does an excellent job explaining the economic ins & outs of the current crisis.

But to my mind, the most compelling graph was the last one. It reads:

In closing, let me mention one other issue that I take very seriously. I recognize that this might not matter much to my Congressman, but in my view it may be the most important issue for global welfare. The U.S. has long been a beacon of free markets. When economic conditions turn sour in Argentina or Indonesia, we give very clear instructions on what to do: balance the budget, cut government employment, maintain free trade and the rule of law, and do not prop up failing enterprises. Opponents of free markets argue that this advice benefits international financiers, not the domestic market. I have always believed (at least since I began to understand economics) that the U.S. approach was correct. But when the U.S. ignores its own advice in this situation, it reduces the credibility of this stance. Rewriting the rules of the game at this stage will therefore have serious ramifications not only for people in this country but for the future of global capitalism. The social cost of that is far, far greater than $700 billion.

I'm a free market/free trade true believer. As such, I cannot support an anti-market solution to a problem that is, to my mind, a government-caused problem. In my opinion, such action will have lasting negative consequences.


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Alternative To The Bailout: Fiscal Darwinism

From a historical perspective, here is the doubt I have about today's economic crisis:

I do not believe that policy makers understand the current economic crisis any better than policy makers did before & during the Great Depression.

All I'm saying is that our increasingly complex understanding of the economy is matched by an equally complex economy. If we truly understood our current economy better than policy makers in the past understood theirs, then we would never have market failures, because smarter policy makers would have averted them.

The corollary that flows from this theory is that I do not trust policy makers to do anything that will actually improve the situation or cause the economy to recover better or faster than a natural market correction.

University of Chicago economist Casey B. Mulligan makes sense to me:

In the somewhat more recent past, economists thought that the non-financial sector in a modern economy revolved around financial markets, despite the facts that only 4 percent of the workforce was employed in the financial sector (including insurance and real estate), and even today that sector employs only 6 percent of the total. President Bush and supporters of the recent massive Wall Street bailout plan still believe Wall Street to be the center of the entire economy.

Economic research over the last couple of decades rejects this belief. It has shown that the financial and non-financial sectors experience quite independent changes, especially over the short and medium term. Take for example the promised yield on the best commercial paper. Fluctuations in this yield are critically important to persons in the financial sector (such as money market traders), but have hardly anything to do with activity outside of that sector. Since World War II, the correlation between the inflation-adjusted commercial paper yield and subsequent inflation-adjusted growth of GDP per capita is zero. That is, GDP growth has been high following high yields just as often as it has been low. It is equally hard to detect a correlation between stock returns, long term bond returns, or commodity returns and subsequent GDP growth. Quite simply, history has shown that the non-financial sector can do well when the financial sector does poorly, and vice versa.

In order to find good predictors of non-financial sector performance, and GDP growth generally, we look to the non-financial sector itself. One of those predictors is the profitability of non-financial capital, or the “marginal product of capital” as we economists call it. The marginal product of capital after-tax is a measure of how much profit (revenue net of variable costs and taxes) that each unit of capital is producing during, say, the last year. When the marginal product of capital after-tax is above average, subsequent rates of economic growth (and subsequent marginal products of capital) also tend to be above average.

Since World War II, the marginal product of capital after-tax averaged between 7 and 8 percent per year. During 2007 and the first half of 2008 – exactly the time when financial markets had been spooked by oil price spikes and housing price crashes – the marginal product had been over 10 percent per year: far above the historical average. Compare this to the marginal product of capital in 1930-33 (the years of Depression-era bank panics): 0.5 percentage points per year less than the postwar years and significantly less than in 1929. The marginal product of capital was also below average prior to the 1982 recession (in this case, far below average) and prior to the 2001 recession. Thus, the surprise was not that GDP continued to grow 2007-8 despite the bleak outlook from Wall Street’s corner of the world, but that GDP growth failed to be significantly above the average. More important from today’s perspective is that much capital in America continues to be productive, and that this will likely permit Americans to advance their living standards as they have in years past. The non-financial sector today looks nothing like it did in 1930.

The weak correlation between asset prices and non-financial sector performance and the strong profitability of today’s non-financial capital are two good reasons to scoff at the idea that the non-financial sector will collapse because of the recent events on Wall Street, and even better reasons to scoff at the Bernanke-Paulson-Bush idea that a massive bailout of financial firms is the key to avoiding a non-financial collapse. Wall Street’s woes are and will be largely limited to Wall Street. The Bush administration should not use the power of the IRS to force the rest of us to board Wall Street’s sinking ship.

Of course, six percent of the workforce is bigger than zero, so a Wall Street mess has indirect effects on the non-financial sector as it absorbs former Wall Street employees and finds alternatives to the financial services Wall Street once provided. But, as long as the government does not get in the way, the marketplace will quickly react to provide the non-financial sector with financial services, even if the main players in that marketplace are no longer named Lehman, Merrill, or Goldman. There are two basic obstacles that Washington might create in this process, both of which are included in the Bernanke-Paulson-Bush proposal. One is to pile on regulation and further impede entry by new firms that might provide financial services to the non-financial sector in the years ahead. The second is to impose a heavy tax burden on the non-financial sector to pay for Wall Street subsidies. The Treasury and the Fed should let Wall Street drown alone, to be replaced by new financial service providers who can swim as robustly as are non-financial American businesses.

(emphasis added)

This feels right--it appeals to the fiscal libertarian in me.

We may yet look back on this "bailout" and conclude, as we have in so many other instances, that the prescription was worse than the disease.


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Economic Crisis Video Primer

(h/t Power Line & Ace)


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Political Diary Quote Of The Day

Donald Luskin, Chief Investment Officer of the consulting firm TrendMacro, in a note today to clients:

Only a fool would say that there is no risk to the banking system here. But given the apparent lack of any idea at Treasury or the Fed of how the bail-out would actually work, the terrible track record of those same authorities whose bungling of the Fannie Mae, Freddie Mac and American International Group situations only accelerated the crisis, and the onerous capital-punishing provisions being forced into the plan by Congress, at this point we are tempted to think that the world might be a better place without this particular bail-out. . . . The climate of fear in Washington could easily still force a deal in very short order. No deal would be a shock to markets at first, and it would be a shame to lose what was good about the proposed program. But if it's loaded up with mortgage forbearance mandates and punitive equity grabs, then markets will be far worse with a deal than without one.

(emphasis added)


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Iowahawk!

Back in the day I used to read 2 columnists every week--Daniel Henninger & Mark Steyn (now I pretty much read everything). Since the Canadians sued Steyn for writing about Muslim demographics, he hasn't written much. Which is a shame, because Steyn is awesome.

So now I get my weekly comedic fix from Iowahawk. To really get a sense of who Iowahawk is, let me quote from one of his many admirers:

Iowahawk might get up tomorrow, get [redacted], grab his beautiful wife and ride his moped backwards to a Hells Angel rally, then drink himself into oblivion and fight about 7 crank dealers from the Racine chapter of the Death Jokers all by himself. Then maybe he'd go home, romance the beautiful wife, build a perfect retro treehouse for his perfect kids, drink a bottle of tequila, prepare a 3-course meal while beating away a push-in home invader and sacrificing him on a makeshift, though historically accurate, Inca altar he built in the woods behind the railroad tracks. Then he'd sit down and knock out a tremedously insulting Leftist parody that pissed off thread after thread of Kos and DU lunatics, romance the bride once again and fall asleep chuckling. It's like he's Paul Bunyan and Mark Twain rolled up into one hipster.

I'm sure the guy doesn't mean that Iowahawk is a hipster in the same sense as all the too-cool-for-school twentysomething hipsters who form Obama's core supporters.

Anywho, read the latest. A sampling:

The subprime mortgage crisis rocked Wall Street again last week, spurring federal bailouts and takeovers of several large financial institutions - including Fannie Mae, Freddie Mac, AIG Insurance, Lehman Brothers and Bear Stearns. Americans are asking the tough questions -- how will this effect me? and, where do I get my bailout check? To help understand the issues Dave travels to TGIFriday's Happy Hour for a spirited roundtable debate with guest financial expert Linda Mustaine from First Coralville Mortgage, and next-door neighbor Craig Evers.

If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

The Crisis: A Primer

Courtesy of Big Lizards, an instructive discussion on the how, why, where, what and all the other interrogatives we learned back in 3rd grade.

Excerpt:

Republicans see the collapse of the mortgage market as a potential catastrophe that requires emergency measures... but an aberration caused by government intrusion into the market, not an indictment of capitalism and free markets.

Democrats see it as proof positive that capitalism has been proven to be a fad that will soon pass away, like pet rocks... and a golden opportunity to reintroduce failed liberal fascist economic policies straight out of the platforms of Woodrow Wilson, Franklin Roosevelt, and Jimmy Carter.

(emphasis in original)

This is pretty much the same line I have repeated from day one: This is not a market failure. This is a cautionary tale for the central-planning-inclined, government-market-interventionists, public-policy-do-gooders; this is a lesson in unintended consequences. As though we needed another one after the ethanol/starvation debacle. Of course, this one has been stewing for a little bit longer.

Sure, giving loans to more minorities and poor people sounds good (and gets lots of Democrats elected), but when you give mortgages to people who can't afford them, well, economic crises happen.


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Economists Respond To Paulson's Bailout

A lot of people, for whom I have a lot of respect, insist on the internet and TV that if something isn't done soon, we could have an "economic Pearl Harbor." It's tough for me to say if this is just alarmism or a sincere assessment of the current economic crisis.

Meanwhile, economists from around the country have weighed in on the plan as proposed by Hank Paulson and backed by the Bush administration:

As economists, we want to express to Congress our great concern for the plan proposed by Treasury Secretary Paulson to deal with the financial crisis. We are well aware of the difficulty of the current financial situation and we agree with the need for bold action to ensure that the financial system continues to function. We see three fatal pitfalls in the currently proposed plan:

1) Its fairness. The plan is a subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.

2) Its ambiguity. Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards.

3) Its long-term effects. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America's dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.

For these reasons we ask Congress not to rush, to hold appropriate hearings, and to carefully consider the right course of action, and to wisely determine the future of the financial industry and the U.S. economy for years to come.

(h/t Greg Mankiw)

If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

McCain Suspends Campaign To Resolve Economic Crisis (UPDATED)

If ever there were a candidate who had the credibility to do something like this, it's John McCain. This is the man who supported The Surge when it was eminently unpopular to do so, because he felt he was putting his Country First.

Whether you agree wholeheartedly with the bailout or, like me, have doubts, you must believe that John McCain is suspending his campaign because he believes it is best for America.

UPDATE 4:31pm MDT: Barack Obama's response to John McCain was to say, essentially, 'I wanted to issue a joint statement with John McCain and he unilaterally decided to suspend his campaign and go back to DC to resolve the crisis. Presidents have to be able to chew gum & walk; I'm going to carry on campaigning and prepping for the debate.'

Of course Presidents have to be able to muti-task. But you better believe that if Pres. Bush were abroad, talking foreign policy, pundits would be calling for him to return and focus on the economic crisis. And they would be right. Whether he, personally, actually did anything about it, his attention to the crisis lends efforts to resolve it increased legitimacy and calms market and public fears.

UPDATE 4:55pm MDT: Yesterday, Harry Reid said that John McCain's support was the key to passing bailout legislation. Now, Reid says he doesn't need McCain's help. What's going on here?

In the first instance, Reid was trying to get political cover for legislation that may or may not work out. If it failed, disastrously, he could pin some or all of the blame on Republicans & John McCain.

Now that McCain has called his bluff and is going to get to work, Reid says, "stay away." Why? Pure politics. He's sticking up for his man Obama.

That's leadership, Democrat-style.

UPDATE 7:00pm MDT: Looks like Mr. Obama is going to Washington after all--at the invitation of President Bush.

I know how political junkies on both sides--McCain & Obama--view today's developments. What I don't know is how will the casual observer look at things? Events like these tend to break down into simple sentences in the larger election narrative--McCain went to Washington to fix the problem, Obama followed his lead OR McCain tried to play politics with the economic crisis.

How will today's page of the 2008 election picture-book read?

UPDATE 9:31pm MDT: McCain & Obama finally released that joint statement Obama was crying about in his press conference earlier in the day.


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.

Barack Obama: Stonewalling Important Change

Fannie and Freddy didn't get to where they are without a little help from enablers in Congress--especially in the Senate. And these enablers didn't go un-rewarded. Greg Mankiw outs the biggest recipients of donations from Fannie & Freddy. The biggest beneficiaries might surprise you. Or maybe not.

Top Recipients of Fannie Mae and Freddie Mac Campaign Contributions, 1989-2008

1. Dodd, Christopher J, D-CT
2. Kerry, John, D-MA
3. Obama, Barack, D-IL
4. Clinton, Hillary, D-NY

This is exactly the type of political corruption Obama rails against time and again. But when it came to actually doing something, he looked the other way in favor of campaign donations. This is the politics he learned in Chicago.

Senator Obama reaped the rewards of stonewalling reform that would have averted the bailout, will he now reap the political punishment? Obama's co-conspiracy to look the other way helped cause the housing crisis he now blames on President Bush.

Talk about lipstick on a pig; in Barack Obama, the old, corrupt politics are made new. Or, at least, given a fresh coat of paint.

(h/t RD @ Pendulum Politics)


If you have tips, questions, comments or suggestions, email me at lybberty@gmail.com.