A partially correct analysis, and a fatal flaw
Here’s what business columnist Joe Nocera gets right. NYT:
“We need to stop committing economic arson,” Bert Ely, a banking consultant, said to me this week. That is what Congress committed: economic arson. How is the political reaction to the crisis making it worse? Let us count the ways.
IT IS DESTROYING VALUE During his testimony on Wednesday, Mr. Liddy pointed out that much of the money the government turned over to A.I.G. was a loan, not a gift. The company’s goal, he kept saying, was to pay that money back. But how? Mr. Liddy’s plan is to sell off the healthy insurance units…In other words, it is in the taxpayers’ best interest to position A.I.G. as a company with many profitable units, worth potentially billions, and one bad unit that needs to be unwound. Which, by the way, is the truth. But as Mr. Ely puts it, “the indiscriminate pounding that A.I.G. is taking is destroying the value of the company.” Potential buyers are wary. Customers are going elsewhere. Employees are looking to leave. Treating all of A.I.G. like Public Enemy No. 1 is a pretty dumb way for a majority shareholder to act when he hopes to sell the company for top dollar…
IT IS DESTABILIZING How can you run a company when the rules keep changing, when you have to worry about being second-guessed by Congress? Who can do business under those circumstances?…I have been an advocate of nationalizing big banks like Citigroup. But after watching Congress this week, I’m having second thoughts. If this is how Congress treats A.I.G., what would it do if it had a bank in its paws?
Here’s what he gets wrong:
there is a much bigger issue that has barely been touched upon by Congress: the way tens of billions of dollars of taxpayers’ money has been funneled to A.I.G.’s counterparties — at 100 cents on the dollar. How can it possibly make sense that Goldman Sachs, Bank of America, Citigroup and every other company that bought credit-default swaps from A.I.G. should be made whole by the government? Why isn’t it forcing them to take a haircut? What’s worse, some of those companies are foreign banks that used credit-default swaps to exploit a regulatory loophole. Should the United States taxpayer really be responsible for ensuring the safety of European banks that were taking advantage of European regulations?
Sigh. Has no one learned the lesson of Lehman Brothers, even at this late date? We don’t give a fig about AIG, Citibank, or any of the others as individual institutions. The entire point of this cavalcade of government investments called “bailouts” is to keep the international payment and credit system functioning. As soon as the value of AIG-backed credit default swaps becomes a matter of uncertainty and negotiation, the fire will spread to every other large institution and the global banking system will melt down again. The results would be catastrophic for almost everyone in the world — except for those few whose fortunes are made by bets that the financial world is reduced to rubble.
Whether the global amount of credit default swap risk is $1.14 quadrillion, or a mere $60 trillion, the world cannot afford the results of the cascading failures that would eventuate were Mr. Nocera’s advice taken. Mr. Nocera seems to have the same blind spot about CDS’s that he does with the equally toxic consequences of nationalization. How is it possible that intelligent, informed individuals cannot see the obvious and profound second-order effects of their policy prescriptions?
March 22nd, 2009 at 12:17 pm
All these ties, not supported by any measure by the people at large, yet they drag the masses in. Like the tens of millions that were killed in the mud of WWI France, for obscure elderly and past time royalty and states.
Now we have antique institutions that lived and thought of themselves as royalty, and we are told the mass must pay, except instead of being blow apart, they must be bleed, and their children bleed for decades.
CDS, central banks, bailouts, fiat currency. All like royalty, all looked at by the elites as critical, all in truth burdens.
As once said, a specter haunts the halls. Everywhere in positions of power, I see midgets, polished and eloquent, but small never the less.
March 23rd, 2009 at 2:04 am
So what happens if the Government shoots off all their bullets and the collapse comes anyway? Then what? Obviously I am missing something. If the losses amount to 60 trillion or more it looks to me like the bailouts are just urinating in the wind. Postponing the inevitable if you will. One thing I have not yet seen but would very much like to see is an outline of the putative collapse. An outline that shows every domino in the collapse and describes why it will fail. So far, all I have seen is: If the big banks and AIG fail, it is financial Armageddon. End of story. I would like a little better explanation than that. My apologies if this makes me sound snarky or troll like. That is not my intention.
March 23rd, 2009 at 7:14 am
feeblemind, I suspect that some of Jack’s posts address your issues but the locations don’t come to mind. There is Steve Hsu’s discussion (including his subsequent posts and his links (especially this one (in particular the discussion of the three-contract network))).
March 25th, 2009 at 5:16 am
…those few whose fortunes are made by bets that the financial world is reduced to rubble.
At first blush, the recently proposed triggered uptick rule would retard feedback mechanisms that enhance the instability of plunging markets, and it would impede alleged malicious collusive short selling–and it would preserve the contributions of short sellers to normal markets: provision of spread-reducing liquidity, and improved price discovery which reduces volatility.
To suppress market bubbles, I’d still like to see an offsetting downtick rule on margin purchases of stocks that have risen sharply…but a stock market bubble shouldn’t be a pressing worry any time soon.