Lawson for Congress

The proposed $700 million bailout is unlikely to increase trust between banks, will threaten our sovereign credit rating, and may even collapse our currency.

It only attempts to protect favored banks, and ignores the reality that trillions of dollars in bad debt must be liquidated before we can recover from this crisis. For every lender there is a borrower, and our borrowers have simply assumed too much debt relative to their income.

Objections from a variety of perspectives are expressed by others:

• Dallas Federal Reserve Governor Richard Fisher - Bank Rescue Plan Would Worsen Fiscal Chasm
• Former Treasury Secretary Paul O’Neill - Bush Doesn’t Get Financial Crisis
• Former FDIC Chair William Isaac - A Better Way to Aid Banks
• BB&T CEO John Allison - Paulson Plan Aimed at Helping “Poorly Run” Banks
• NYU economist Nouriel Roubini - Why the Treasury TARP Bailout is flawed
• New IMF Study Contradicts Bailout Bill Premise and Details
• Over 150 economists - Hundreds of Economists Urge Congress Not to Rush on Rescue Plan

Of particular interest are comments in the last article about the game theory implications of vastly increased central bank lending as well as expectations of a bailout. In short, we’re making the problem worse:

Advocates for a rescue plan this week point to a seizing up of credit markets, reflected in elevated inter-bank lending rates, as reason for action. Some economists are unconvinced.

“I suspect that part of what we’re seeing in the freezing up of lending markets is strategic behavior on the part of big financial players who stand to benefit from the bailout,” said David K. Levine, an economist at Washington University in St. Louis, who studies liquidity constraints and game theory.

Makes sense, doesn’t it? As also stated by Yves Smith:

Now consider the bailout version of this problem. Yes, the market for bad bank assets wasn’t so hot, but the big reason is not lack of buyers, but unwillingness of banks to accept the lousy realistic prices on offer.

But the government is now moving towards a plan to buy that paper for something closer, maybe a heck of a lot closer, to your price. You now have no incentive to try to unload those assets, so what little trading there was in them has probably gone into a deep freeze.

In other words, “We need a bailout, or else lending is going to freeze up and the financial system is going to collapse” becomes “We expect a bailout, so we’re going to just sit here until we get one.” It’s a self-fulfilling prophecy. Depending on your level of cynicism, one might also consider it a hostage crisis with our economy as the hostage.

Most importantly, also at stake is trust in our nation’s financial system and capital markets. Karl Denninger eloquently makes that point here:

The government cannot simply keep changing the rules to benefit a privileged few.

Focusing on the banks, the current crisis has four related ingredients: liquidity, solvency, capital, and trust. There is plenty of central bank liquidity available for threatened institutions, and due to lack of trust and transparency, banks will not lend to each other — each prefers to go to the central bank for relief. This tendency to look to the central bank for relief appears to be finally threatening the balance sheet at the Fed itself, according to Brad Setser:

In the last two weeks — if I am reading the Federal Reserves’ balance sheet data correctly — the Fed has:

Increased “other loans” to the financial system by around $230 billion (from $23.56b to $262.34b);

Increased its “other assets” by about $80b (from $98.67b to $183.89b);

Increased the securities it lends out to dealers by $60b (from $117.3b to $190.5b);

That works out to the provision of something like $370b of credit to the financial system in a two week period. That may be a bit too high: the outstanding stock of repos felll by $40b (from $126b to $ 86b), leaving a $330b net change in these line items. But that is still enormous.

The most that the IMF ever lent out to cash strapped emerging economies in a year?

$30b, in the four quarters through September 1998 (i.e. the peak of the 97-98 crisis).

The most the IMF ever lend out over two years?

$40b, in the eight quarters through June 2003 (this covered crises in Argentina, Brazil, Uruguay and Turkey)

This is a very real crisis. The Fed’s balance tells a story of extraordinary stress. I never would have expected to see the Fed lend out these kinds of sums over such a short-period.

For another look at the Fed’s balance sheet, see this visual map provided by Cumberland Advisers.

Solvency is a problem as threatened institutions are finding it difficult to access additional financing and service their debt. Capital is a problem because creative accounting and assets of unknown value have led to balance sheets (and off-balance-sheet vehicles) that encouraged wishful thinking and reduced trust.

The administration’s proposal to buy toxic assets doesn’t address all of these problems, may make solvency issues worse, and most importantly, it does not address the lack of trust between market participants:

Non-financial private debt is $32.4 trillion dollars as of 2Q 2008. Household debt is $14.0 trillion. Households lost 400 billion dollars last quarter. You wish to add $700 billion more in losses (via government obligations that taxpayers must cover) this quarter; this package is insignificant against the total bad credit outstanding. Federal capacity to “bail the system out” is insufficient.

It will not and cannot work because the issue is trust, not money. There is lots of money (and credit) but it is being hoarded throughout the system. Consumer savings have gone from nothing to the highest rate ever in American history – in the space of a few months. Money is flying into Treasuries because of lack of trust, not lack of money. You must fix the cause of the problem, not apply band-aids.

Despite all this evidence to the contrary, this evening’s New York Times article shows to what lengths our elected representatives will go to do the wrong thing. Allow me to translate:

Officials said there were still more than a dozen points of disagreement, though the centerpiece of the rescue effort remained intact: a plan for the government to purchase up to $700 billion in troubled assets from financial firms as a way to free their balance sheets of bad debts and to help restore a healthy flow of credit through the economy. It could become the largest government bailout in the nation’s history.

We’ve been pretending to object to the administration’s plan, and we’re making a lot of noise, but we’re not really changing anything. We’re still going to pistol-whip the American taxpayer to bail out poorly-run banks, and we hope credit starts flowing again even though this bailout does nothing to support property markets, improve the ability of borrowers to service their debt, or increase trust in the integrity of the capital markets. But hey, we’re all about hope.

Republicans, under pressure from Democrats to deliver 70 to 100 votes from their side, were scouring the ranks and focusing on the two dozen Republicans who were retiring this year.

Both parties were also scouring the political map to identify lawmakers who face little or no opposition for re-election in November, knowing they would be more willing to vote yes.

We’re looking for representatives who can afford to blow off their constituents.

Democratic officials said that despite having control of both chambers in Congress, they were far from having a majority sufficient to pass the measure just from their ranks. And they also warned that Democrats in potentially tough races could not be counted on to provide the votes to put the package over the top when, and if, it reaches the floor.

If David Price ends up voting against this bailout, it will be because he’s getting the message that 4th District voters are ready for principled representation that serves the people instead of corporate interests.

The ultimate cost of the rescue plan to taxpayers is virtually impossible to know. Because the government would be buying assets of value — potentially worth much more than the government will pay for them — there is even a chance the rescue effort would eventually return a profit.

We’re calling it a “rescue plan” because folks don’t like the word “bailout”. There’s no chance this rescue will return a profit, since banks are only going to dump the most toxic of their assets — they’ll hold on to the good stuff. Furthermore, if there was a reasonable chance of a profitable investment, Warren Buffett would be all over the deal himself.

The administration had initially requested nearly unfettered authority to run the rescue program. But in negotiations over the last week, the White House agreed to accept strict oversight of the program by an independent board, as well as a requirement that the government increase its efforts to prevent home foreclosures.

We’ll give the impression of resisting tyranny with empty gestures of “oversight” and some empty pandering about bailing out borrowers. But we allocated the big money to bail out lenders.

I should mention that I tried to visit David Price’s Chapel Hill office on Thursday to express my sentiments as a constituent, not even as a candidate. But when I arrived, the office was closed:

I received word from folks calling his Durham office that there was no one available to answer the phone, and no way to leave a message.

The behavior of so-called Congressional leaders, our deeply-conflicted administration, and my opponent demonstrate supreme arrogance and disrespect for the rule of law.

Washington, you’re fired.

This entry was posted on Saturday, September 27th, 2008 at 10:35 pm and is filed under banking, campaign, corporate welfare, debt. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.