baz.com - Brett Thomas' Blog

Socialism without the jobs...

I gave up, by conscious decision, being angry at the government about a decade ago. My liberal friends become outraged at the latest injustice (civil liberties, The Republican War on Science, crony capitalism), and my response is a yawn. Most of these things were either a direct problem a decade ago, or easily foreseeable as a logical consequence of government power. I got angry about it two decades ago, and realized there really isn't a lot of difference between the two parties. They have different rhetoric, but, at the end of the day, they both increase government power and help out their friends. Approximately ten years ago, I realized most people didn't care, and that things weren't going to change, so I decided that I could be really angry for the rest of my life, or just figure that things have been basically stumbling along in our modern system for about the last four score years, and hopefully they'd do so for the next.

And, probably, they will. But, the recent government response to the "economic crisis" has really raised my ire, again. To be clear: This bailout is no less the Republican party's fault than it is the Democrat's. It's Paulson's plan, but the Congressional Democrats think they're doing the Right Thing for the economy, and the country. Charles Schumer described Paulson's briefing as making him "gulp". Chris Dowd said this is "one of those rare moments [of] Democrats and Republicans deciding we need to work together quickly." My opinion has been for some time that "bipartisanship" is when both parties decide to work together to spend your money.

At best - if it does what the government plans - it will result in the government buying assets at more than anyone else is willing to pay for them. That's basically definitional - if someone else was willing to pay more, the companies involved would perform those transactions. The Treasury department is, of course, describing what they're willing to pay as "fair market prices", which Yves Smith very accurately describes as Orwellian double-speak for "above market prices".

As well, all the news stories desrcribing the "700 Billion Dollar Bailout" are wrong - we have no idea what this will cost. The Treasury Secretary and The Fed have the authority to purchase assets with up to $700 Billion. Imagine, though - as hard as this is to picture - that what they're talking about buying are banks with as-yet unknown liabilities. "Liabilities" here being accounting-speak for "money they are owed but may never get paid". The market says: "Firm X is owed $200B by borrowers of unknown quality. They also owe other firms $100B in other obligations. We have no idea what percentage of what they're owed they're going to get - so, we'll assume...say, 25%, and value the firm at -$50B, net of their obligations (i.e., they're bankrupt)." The government is going to say, "No, no, it must be worth more than that...we'll pay $50B." Then, it turns out that the market was right, and "asset" the government just paid $50B for is worth $50B in income, but owes $200B to others. If that "extra" $150B exceeds the $700B, do we have any reason to think that the Federal Government will simply default? Doubtless, if they did, the long-term cost to the credit of the nation would be higher than simply paying.

Of course, the old libertarian complaint that we're taxing "Grandma" to save the losses of a bunch of rich bankers is no longer true. In fact, progressives can't honestly make this complaint, anymore. The top earners underwrite most of the Federal budget. In effect, we're taxing rich non-bankers to pay rich bankers (and Grandma, via Social Security).

Perhaps, maybe, the silver lining is that leftish folks are starting to question whether giving government this kind of power is a good idea in the first place, since they always seem to need to use it. Matt Yglesias (a leftish blogger) notes:

It'd be one thing for a bunch of conservative politicians to ram a terrible policy through. Then we could say "well, if some progressives win the next election things will be different." But if this comes through an allegedly progressive congress then the whole enterprise starts looking pretty hollow.

Yeah, exactly, and that's why I've had a lot of trouble getting very exercised at the Bush administration: I've always known the Kerry administration would've been substantively just as bad. Tyler Cowen (a libertarianish economist) is even losing faith in the market:

[T]here are a number of enterprises -- not just Matt's -- which are looking pretty hollow these days. And I don't just mean banks. You can blame lots of the crisis on government -- more than most people think -- but at the end of the day it is hard to escape the conclusion that markets simply have performed horribly in a number of important regards.

I suppose that depends on what one wants of markets. Were the markets supposed to prevent bad outcomes? Or merely signal through prices that things were risky? It's very arguable that markets, in fact, priced the risk adequately. A handful of firms have had bad outcomes, but now the government is going to come in and buy the assets at their "fair market value".

This naturally leads us to "moral hazard" - that bankers make risky bets, knowing they get to keep the profits and government gets to keep the losses. The markets, I think, will accurately (over) value firms that have a now explicit government guarantee. The bankers, of course, are now incented to hold out for a better price from the government. That's their job. In theory, the government's job is to watch out for us. We all know that isn't going to happen, though. Since we know (from places like the USSR) that trying to make the bankers act in our interest doesn't work, the only alternative I see is to stop trusting the regulators.

But, we all know that isn't going to happen, either.

Over at the Volokh Conspiracy, Ilya Somin and Eric Posner have been having a spirited debate about the recent failure of the "Paulson Plan" to pass Congress. Prof. Somin is of the opinion that yesterday's drop in the markets provides no information about the intrinsic value of such a bailout - Paulson proposed to transfer lots of money from taxpayers to shareholders: that failed; shareholders were disappointed.

Prof. Posner believes, instead, that the markets fell because the plan was good for everyone (taxpayers and shareholders) and that, consequently, when it failed, the markets were signaling their overall fear of the future, not their specific fear that they'll be unable to rob taxpayers.

David Post weighs in with his opinion that the information in the market is not sufficient to tell the two apart:

I don't see any way to distinguish between those two hypotheses without asking a (large) number of yesterday's traders what they had in their heads, and why they made the trades they made (and even that, of course, is deeply problematical, given the enormous difficulties of getting any reliable information from surveys of that kind).

His point here, of course, is good. In the best of circumstances, it's impossible to tell what the market "means" by its movement - if such a question has any validity, at all. But, I think, there are at least two other hypotheses that can't be ruled out with this data.

First, it's quite possible that these movements are largely random. People are making individual decisions not based entirely upon news, but more upon other conditions in their portfolios, expectations of what everyone else is going to do, raw emotions. If these are the causes, no conclusion may be drawn, in any case.

Second, investors abhor risk that they know that they don't understand. When a company announces that it's going to restate previous earnings, it often causes a drop in the stock well out of proportion to the eventual restatement. It reminds investors that they really have no idea of the actual underlying information about this security, and causes them to sell.

A similar problem is the event that started this whole mess - it turned out that subprime mortgages that were thought to have a pretty low default rate (say, 4%) will have a larger default rate. How much larger? No one knows. It's hard to imagine that, even in a Great Depression scenario, it'll be more than 20% (and that is really in an unmitigated and highly unlikely disaster). When investors realized they had no idea what the underlying risk of default was, they fled these investments, causing a precipitous drop in price, far beyond even the worst estimates of the actual losses.

It is not unheard of for companies to rise on bad news - because the uncertainty about their fate has been eliminated. It is quite possible that the market had been expecting that the Paulson Plan would pass for the past week. It's also possible that the consensus was that it was worth than nothing - but, that consensus was priced into the securities, already. When Congress failed to pass the Paulson Plan, it raised the specter that something even worse would happen, and this possibility is what the markets were responding to.

As Prof. Post notes, we have no way to distinguish between any of these hypotheses. I thought it was worth noting, though, that there is even an argument that the market went down because it thinks the Paulson Plan that didn't pass is worse than doing nothing.

Of course, the market went up, today: What does that tell us of the market consensus of what we should do?

I loved Eric Posner's comment on the bailout process:

Here's a recap. Paulson sought to give Treasury the power to buy mortgage-related assets. A power grab!, said the critics. So congressional Democrats sought to give Treasury the power to buy mortgage-related assets, non-mortgage-related assets, and equity interests, and to regulate executive pay. Socialism!, said the congressional Republicans. So the final bill gives Treasury the power to buy mortgage-related assets, non-mortgage-related assets, and equity interests, and to regulate executive pay, and to issue insurance to distressed institutions. Madisonian deliberation at its finest!

As Neal Stephenson notes in his most recent book, "it happened all the time that the compromise between two perfectly rational alternatives was something that made no sense at all."