It Doesn’t Give People Confidence (II)
The Fed, the Treasury and the SEC appear to be in a state of panic. A crisis mentality led the custodians of the U.S. capital markets publicly to jettison their lifelong commitments to the capital markets in favor of a series of short-term regulatory quick fixes. Even more troubling, for the past several months the doyens of U.S. fiscal and monetary policy have ignored the most fundamental principle of central banking, which is that the primary responsibility of central bankers is to promote stability and to maintain confidence in the capital markets. Our central bankers appear to have suddenly lost confidence both in their own abilities and in the standard tools of fiscal and monetary policy. ~Jonathan Macey
I agree entirely, and I have been saying much the same thing for the last three weeks:
The role the government and bailout supporters have played in exacerbating the real problems in credit markets and sapping market confidence with apocalyptic warnings will, I suspect, go down as one of the most dangerous episodes of hysterical overreaction in recent history.
A bit earlier, I had said:
I wonder why confidence might wane when all of the people who claim to know the most about what’s going on are declaring that the end is nigh. Bailout supporters are doing their best to instill unreasoning fear in the minds of the public and their representatives to stampede them in the direction of taking action, but I would bet that this political panic is contributing directly to the general loss of confidence. As the loss of confidence spreads because of alarmism, I can imagine that the political panic could lead to a worse financial panic than might otherwise be the case.
It is difficult to understand the mad sell-off of the last week except as a general panic stoked by those in positions of authority. Many will point to the credit markets, but even here the tightening of credit has been at least partly a response to government promises of intervention. Macey does not limit his criticisms to the actions of the last few months, but includes the mistakes of the Fed, Treasury and SEC dating back to the start of the year and earlier. It is worth reading Macey’s entire article to understand how rushing on several occasions to do something in very ad hoc, arbitrary ways, which was supposed to be imperative for restoring confidence, has been undermining confidence by sending clear signals that the authorities believe the markets to be broken.
Macey concludes:
Most of all, if the markets are to get back on track our regulators must put an immediate stop to their current practice of publicly demonizing the markets and work to restore confidence in the system.
19 Responses to “It Doesn’t Give People Confidence (II)”
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Are you arguing that the government is partially responsible for freezing the credit markets by either promising an intervention or by creating panic through its dire forecasts of doom?
If so, can you please quantify that using empirical data?
The reason I ask is that I haven’t read anything credible that argues the government’s response to this crisis is in anyway responsible for it. Everything I have read on the credit crisis indicates that the cause is market conditions.
Now its probably true that the government helped cause these market conditions through poor regulations and regulatory oversight, but that doesn’t prove that the government’s panicked response is exacerbating or causing those market conditions.
For example, what do you make of this?
Disagree that people would not have reason to panic if it were not for government intervention, that it’s a “hysterical overreaction.”
For example: yesterday the founder of a company I know well had to sell $400 million in shares to pay debts owed by one wing of the firm. This after the stock sunk nearly 70% this year. Obviously this is a desperation measure, probably caused by an inability to raise capital by borrowing or issuing corporate paper. This is sure to cause the stock to sink even further, and may well result in lay-offs. This has absolutely nothing to do with the government, and it’s the sort of problem that Paulson is trying (so far, with little success) to solve.
Plenty of blame to go around, but blaming the government for a market meltdown is like blaming the fire department for trying to prevent a forest fire from spreading. Maybe it will succeed, maybe it won’t, but showing up to try to avert disaster is not the problem.
I refer you to Daniel Mitchell once again:
Markets crave certainty, and these interventions, along with the promise of future interventions, have helped to create nothing but uncertainty. What all of the bailouts and especially TARP have done is to delay deleveraging and avoid some bank failures. Citing evidence that people are having difficulty raising capital, which I don’t doubt, confirms what Macey and Mitchell are talking about. Almost everything the relevant authorities have done over the last year and a half, and many of the things they did before that period, exacerbated the crisis and has been delaying recovery. If the government is the fire department in this story, it is the fire department depicted in Backdraft.
Banks are awash with liquidity, but there is great reluctance to take risk and make loans until either the government program gets up and running (which will be weeks or months from now, as Kling warned), and so long as the government keeps floating additional proposals of support for financial institutions there is going to be no risk-taking (i.e., lending) if all one needs to do is wait for a better government deal. That is why the perverse incentives of the bailout are so damaging. The other problem with bailing out excessive risk-takers is that it discourages responsible lenders from taking risks until they also receive some kind of assistance or support. While everyone waits on the government to “avert disaster,” uncertainty reigns and credit markets tighten. The government is right now *delaying* price discovery of the toxic assets, which is contributing to the paralysis, and it has thrown so many lifelines to so many collapsing institutions that there are no incentives for solvent institutions to put themselves at risk by lending to institutions that may not be until they get some additional guarantees. The trouble with bailing out virtually everyone is that everyone begins to expect a bailout and acts accordingly, which distorts economic behavior and prolongs the time it takes to recover. The reason people keep warning about a repeat of Japan in the ’90s is that their mistakes are more or less what the government seems to be making. Add to this the doom-laden prophecies that we have been hearing from the people who should be boosting confidence and reassuring investors and lenders, and you have quite the mess.
Even the hated WSJ editors, who supported the bailout, sees how the government has sapped confidence with the way that it has intervened:
These are the same people who caused the problem in the first place, and got huge bonuses for their pains. Chutzpah without limits.
It’s something like taking your car back to the same mechanic even though it breaks down every time you leave the place.
Time for truisms:
Askari and Krichene in Asia Times have some worthwhile things to say about all this:
The banking crisis might have happened no matter what- but the stock market is based on psychology as well as economic fundamentals. So it seems to me that the Fed’s alarmism probably caused stocks to go down faster than they otherwise would.
Basically, this is because the government didn’t bail out Lehman. The message they intended to send was that they aren’t going to be there all the time, and now the skittish banks so took that to heart to the point that they are destroying the economy out of fear despite the amount of liquidity abounding. Which will eventually lead to further nationalization.
Daniel, I’m a little shocked by your ignorance of economics, though maybe I shouldn’t be. The idea that markets “crave stability”, rather than money, is simply infantile. The notion that all the markets need is stable messages, rather than cash, is simply ridiculous. No evidence that the credit markets are suffering? Have you examined the spread lately? It should be in the range of 50 basis points, and now its about 350. Do you really think the major movers and shakers of the markets are simply panicked by government rhetoric? Panic is never good, but there’s a difference between panic that has a basis, and panic without a basis. If the house is on fire, you better do something. The notion that the credit markets are not on fire is simply head-in-the-sands Hooverism. One can certainly argue about what is the best way to resolve the situation, but the notion that it is going to resolve itself happily without some kind of serious action on someone’s part is simply delusional. The idea that government action cannot do any good, and only harm, is also delusional, with an ideological cherry on top.
The biggest problem with the market right now is that no one knows how to price anything, because no one knows how bad the effects will be of this credit crunch. But even if that were resolved, the markets will remain down due to lower profits and a recessionary climate. Bailout measures can’t change that much, they can only halt the slide into a full scale disaster. And Japan is a bad example: they wound up in a long term economic stagnation precisely because they didn’t do anything quickly enough or strongly enough to reverse their slide.
I didn’t say that we should do nothing, or that there would be no problem in the credit markets had the government done nothing. I know full well how bad things are in the credit markets now, and I understand that things have been growing worse in those markets since last year. I am saying that the government has contributed to the panic and has created additional uncertainty above and beyond what existed, which I think describes at least the last three weeks pretty well. Markets need cash most of all, but they also need certainty; markets are made up of human agents and can respond irrationally based on fear. That’s hardly the observation of someone with an ideological faith in the reliability of markets.
Also, there are competent ways to intervene and restore confidence and then there is the politically incompetent, rushed-out, dreadful plan that we saw from the government early on. Today we are seeing a more credible plan to take equity stakes in major banks, which might have done a lot more to restore confidence last week had they focused on that in the first place.
“Basically, this is because the government didn’t bail out Lehman.”
Yes and no. This is because they didn’t bail out Lehman after already having bailed out Bear Sterns. That is the erratic and arbitrary kind of intervention I was talking about above.
Yes, that is what I meant.
Daniel,
Thanks for walking things back a bit. Yes, the markets need stable access to cash. I’m glad you are not opposing government intervention in the market, only what kind. And yes, the government could have done better, faster, and more directly addressing the credit problem, which the recent pivot to cash injection to major banks seems to be aiming at. Clearly both a cash/credit injection and buying up unmarketable securities is needed. But I don’t think the government’s handling of the situation actually made it worse than doing nothing would have. The original plan sucked, of course, but the compromise at least in made possible the kind of pivot the treasury is now doing. It’s way socialistic, but apparently capitalism can’t survive it’s own dark side without some socialism thrown in.
Also, not bailing out Lehman was not considered “erratic”. It was considered, at the time, drawing a line in the sand and saying we’re not bailing everyone out, we’re not going to massively intervene. This was because many in the government didn’t like the idea of intervening in the markets, since the government is in the hands of, you know, conservatives. That sent a signal to the market that the government wasn’t going to massively intervene, and that meant the market was playing without a safety net, and thus everyone panicked. This turns out to have been a huge mistake, but it’s not as if there was large public support for massive intervention and bailouts until the markets started tanking and talk of another great depression began circulating among serious people. As I recall, you have been very much opposed to massive government intervention until now, based on conservative principles. Glad to see you tossing those out the window, but shouldn’t you at least admit your error?
I don’t think I’m necessarily tossing anything out. What the original Paulson plan proposed to do was outrageous and also unlikely to work. The measures announced today are better in that they seem to stand a better chance of spurring on lending and not bilking the taxpayer. Possibly some other recapitalization measures carried out through existing institutional mechanisms that had been floated by various critics of the bailout would have been better, and I am not pleased that the government is even partially, temporarily nationalizing anything, but I would still maintain that the bailout that was proposed and passed was as bad as I said it was.
I remember that not bailing out Lehman was an attempt to say, “No more,” but they had already crossed that bridge with Bear and were scarcely in a position to draw the line where they did. Having allowed such major institutions to become so overleveraged, the government probably could not have avoided these bailouts without causing a major shock, but there definitely was a lack of predictability and arbitrariness in what they were choosing to save and not save. There are legitimate questions why the government opted to save AIG, in which Goldman had a significant stake, and not Lehman, and I’m not entirely convinced that “drawing a line in the sand” was the whole reason for the latter. Among other things, this made it even crazier to invest the Treasury Secretary with more of the same power to choose winners and losers when that power could be used to aid certain firms over others.
Instead of simply taking on additional debt to purchase what are probably mostly worthless assets, the government is at least getting an equity stake in the banks, which likely reduces the debt that the public would be taking on. That addresses part of what I considered the fiscal irresponsibility of the original measure. Rather than leaving things in the hands of a veritable financial dictator, purchasing shares in the banks, while still far from ideal, does not represent quite the same concentrated power that I found so appalling about the bailout. For the record, I never said that recapitalizing banks was in itself a terrible violation of principle. I still think an argument can be made that the original way that the government proposed to do this was deeply wrong.
Daniel,
Everyone is in agreement that the original plan was not specific enough, but the bill that passed wasn’t really much different except that it included oversight. However, saying that was a bad bill and the new plan is a good one misses the point that the new plan is being enacted under the provisions of the old bill, which means that it wasn’t a bad bill to begin with, in that it gave the Treasury secretary the discretion to do precisely what he is doing now with all that money. Which is why even the original bill wasn’t all that bad, except for it’s lack of oversight, in that it allowed for all kinds of uses of the money, including the injection of cash into banks in exchange for equity stakes as we are now doing. It’s just that the public emphasis was on the unmarketable securities purchses, which was only one of the potential uses of the money allocated in the bill. And it is also completely inaccurate to call those securities worthless. They are far from worthless. Most of the mortgages in these securities are quite valid and being paid on, and will continue to be so unless the entire economy utterly collapses. It’s a relatively small minority of bad mortgages mixed in that ruins the packages, and introduces so much uncertainty that the market doesn’t know how to price them, and thus they are unmarketable at present. They are certainly not worth their face value, but it is also utterly certain that they are worth far more than zero. In fact, from a pure investor point of view, this is probably a good time to buy them, as long as we pay discounted rates for them rather than book value, as that utter idiot McCain wants to do (is he still running for something?). We may lose money on some securities, but make money on others, and in the end, even come out ahead. Why? Well, if the economy ever recovers, and only the most deranged think we are literally coming to the end of the world, then jobs will return, growth will return, housing prices become supportable, foreclosed houses can be sold, and these securities will recover value, even possibly returning to something closer to book value. If not, we’re all fucked anyone, so it hardly matters.
The more personal point I was trying to make is that since this crisis began, you have been fairly steadily suggesting that it’s not serious, that nothing needs to be done, that it’s all smoke and mirrors, a scam, etc. Somewhere along the line you seem to have changed your mind and decided that this massive intervention is a good thing, particularly the latest use of the bailout bill, which you opposed, and which you still seem to be in denial of, even while praising. So, really, don’t you think you need to plead a few mea culpas here? Admitting you were wrong shouldn’t be too hard, even if there are some rather deep-rooted policy questions you have to concede in the process, such as the notion that government regulation is sometimes a very good thing.
For example, you say:
“Having allowed such major institutions to become so overleveraged, the government probably could not have avoided these bailouts without causing a major shock…”
As if the government could have prevented major institutions from becoming overleveraged without some kind of regulatory authority to prevent overleveraging! The basic theory of economic conservatism in our time is precisely the opposite, that government regulation of such things as “leverage” simply obstructs the market and inhibits economic activity. And, in fact, the government doesn’t have any authority over leverage in the credit default swap markets, or the derivatives market, which is where all the leveraging of mortgage securities occurs. The only power the government actually has is to step in after the damage is done and try to bailout the idiots who got overleveraged. So if you think it’s the government’s job to stop this, you must think it’s right for the government to expand its role and regulate leverage in all these markets. That is not just an admission that you were wrong about the bailout, or that a crisis exists, it is an admission that the whole conservative movement was wrong about markets themsevles, and the need to keep the government out of them. Again, this needs to be addressed on many levels, and merely saying that you’d rather the government didn’t assume these kinds of powers has to be squared with your criticism of the government for not assuming these kinds of powers.
I still oppose the powers given to the Treasury Secretary, because I don’t think that much power should be concentrated in anyone’s hands. He has so far used it in better ways than I expected, but that doesn’t change my view, and I don’t know what would change my view. What they announced yesterday is aimed at recapitalizing banks, which they did not have to do this way and conceivably could have done without granting vast new powers to the government. Now that they have those powers in spite of what I think were sound objections, I am trying to judge their proposals as much as I can on the merits, and taking equity stakes in large banks seems, from what I understand, to be more likely to achieve what they’re setting out to do. That government officials are using vast new powers in ways that aren’t entirely absurd does not change that they shouldn’t have those powers. I would stand by the arguments that there were other ways to spur more or less normal lending, which means my original skepticism about the necessity of the bailout has not changed.
It’s as if someone who opposed the invasion of Iraq could have nothing to say about the relative merits of our actions once we had invaded without being accused of abandoning his antiwar views. Nothing changes that the invasion was a terrible and unjustified action and that there were other ways to address any threat from Iraq, but there are then better or worse ways to handle the situation once that bridge has been crossed. So I don’t see how I contradict my opposition to an outrageous power grab by acknowledging that the government could and should have done something with the powers already at its command or by recognizing that the latest proposal is more credible than earlier proposals. I still think that the government exaggerated the danger, and of course all of my points about the sheer incompetence of their presentation of all of this stand. That doesn’t mean that I think the danger was not real and significant. None of this should obscure, either, the more basic argument that the government had a large role in precipitating the crisis.
I don’t assume every commenter has read every word I’ve written on this subject, so I’m going to take it for granted that you don’t know that I found fault with the SEC for allowing these banks to take on much greater levels of debt, and I said this some weeks ago. There was a rule in place, it was relaxed in 2004 and we are paying for it now. In a modern financial system, something like the SEC probably has to exist. Don’t assume that I am someone who thinks there should be no regulation of this sector.
What you call conservatism is some sort of blind worship of market forces, which isn’t my conservatism or any kind of traditional conservatism. I often see people refer to me as some kind of libertarian because I oppose many aspects of the central government just as libertarians do, I agree with Ron Paul about most things, and I happen to find libertarian arguments against the bailout to be very reasonable, but this misses almost everything I have ever said on this subject in the past. I doubt most people who have been reading me for a few years would think that I sing the praises of an unfettered market or the cult of growth.
What offended me and still offends me about this entire project is that it is a power grab designed primarily to the serve the interests of concentrated wealth. I think government has a regulatory role in a world where such concentrated wealth exists, so I don’t accept the anarcho-capitalist caricature of my position that you keep trying to pin on me. Does that square things enough?
Daniel,
I’m glad you’re at least engaging the subject. I like the fact that you try to think a little deeper about these things than the average analyst of the latest news cycle. I admit I don’t know all of your ideological views, but I do not both your libertarianism and your call for the government to regulate markets, which seems more than a little contradictory.
For example, calling on the SEC to regulate these matters better doesn’t take into account that the SEC has very little authority to regulate these matters, precisely because of the governing philosophy of market-based conservatism/liberterianism. The credit swap markets (why does that sound like a back alley flea market?) and the derivatives markets have no regulatory oversight at all, and that is perfectly legal due to the Phil Gramm laws that created them in the first place (and which were, shame on all, voted for overwhelmingly by both dems and GOP back in the late 90s). I assume that over the next year some kind of regulatory body will be created to make sure that leverage stays within reasonable values, and credit ratings aren’t handed out like free popcorn at the hardware store, and maybe it will just be an expansion of the SEC, but one can hardly blame the SEC for not doing what the law says they are not allowed to do.
The point here is that if you approve and even demand government regulation of every facet of the market economy, there’s not much room for libertarianism. If you think the government should use existing laws to regulate these markets, you simply don’t believe in regulating them, because existing laws don’t allow for that. If you think the bailout bill was bad, but think the government should have acted using existing laws, what laws are you talking about? Letting the Fed just do whatever it likes with all that money? I find it difficult to beleive that a Ron Paul Libertarian wants the Fed to become even more powerful.
So yes, I understand you have some fundamental problems with the bailout, and the unprecedented power it gives the treasury secretary. It’s hard to imagine how it could have been done otherwise. For example, this latest switch in policy can at least, under the bailout bill, be done fast, rather than have another endless bullshit ride through congress with endless riders attached and hopeless delays. At least there is openness and oversight, and we can see what is going on and raise objections if it looks bad.
Now, you are of course right that the objectives of this whole intervention is to save huge private institutions and their concentrated centers of wealth. But that is what the entire conservative approach created in the first place – massive concentrated wealth. Everyone in this country is dependent upon those massive concentrated centers of wealth functioning smoothly. The simple fact of modern life is that if they do not, everyone will suffer. They have of course very smartly made themselves not only very rich, but indispensible. That age of gentleman farmers has long since passed.
The question is, since the bailout bill is solely directed at these huge concentrated centers of power, what is to be done for everyone else? Nothing? A stimulus package of increased spending, personalized bailouts/welfare, and tax cuts? These bailout measures seem to be cauterizing the bleeding, such that there’s less fear of a great depression, but there remains the fact that we are falling headlong into a bad recession. Part of the problem now is that not only do banks not want to lend, but business and consumers don’t even want to borrow. There’s no reason to, since demand all over is soft, inventories are high, and people are scared, and not spending, and this looks to be spiralling into a bad downward business cycle.This doesn’t make the market very happy. Yes, the patient is no longer on his deathbed perhaps, but he’s in for a very long recovery period. So, is government supposed to stand by and do nothing, or should it intervene? And even, in this unhealthy condition, can it do much without making the patient sicker?
One argument that I’m probably most sympathetic to due to my liberal leanings is that of some massive government spending to gets us at least back into a functional economy. Everyone seems to want to buy treasury bills at bargain prices to the gov, so why not put that money to good use? It’s generally acknowledged that what got us out of the Great Depression wasn’t the war itself, but the truly massive spending by the government, which dwarfed anything FDR had tried to do during peacetime. Isn’t it obvious, however, that this will also lead to an increased role for the federal government in our economy, such as national health care and so forth? Probably. The question is, are their really any viable alternatives to this “socialization” of the economy? When even you seem to be called for an increased role for the federal government, despite your not liking it, where’s the actual, practical opposition that can offer a real alternative that is something more than ideological crack for depressed conservatives?