Last week I explained what a money market fund is. This week, I explain what they invest in. The money market is the market for short-term debt, which companies use to smooth out mismatches in their cash flows:
- Commercial paper: unsecured debt issued by corporations, with a duration of under 270 days, which avoids certain kinds of SEC paperwork.
- Repos: aka Repurchase agreements. Basically, the holder of a security sells that security to someone with an agreement to buy it back at a later date, usually measured in days rather than months.
- Banker's agreements: basically, a short-term financial instrument created by a non-financial firm, but guaranteed by a bank.
- CD's: You know what these are; you probably have one. CD's are what paleolibertarians would like the entire banking system to look like: you loan money at a guaranteed interest rate for a set period of time.
- Treasury bills: Government securities.
What happened last week is that one money market firm advertised its entire portfolio, including a large chunk of Lehman paper worth slightly less than 2% of the total fund assets. Spooked investors, who did not want to lose out if the fund "broke the buck" started withdrawing as fast as their little fingers could punch the buttons on their phones. Now, this money market fund had tens of billions worth of assets; if it started dumping them on the market, it would drive the price down, leaving them even less money to hand back to their shareholders. But there's a reason investors herd in a bank run: the first people out get all their money back. The rest get trampled in the stampede. The fund--incidentally, the same company that founded the money market industry--"broke the buck"; that is, its shares became worth less than a dollar. It's as if the value of your bank account suddenly dropped below the amount you'd put in.
This, by the way, is probably not the only fund this happened to, but it was the only fund that a) advertised its holdings and b) was not attached to an institution large enough to easily make good the loss.
Thus was touched off a general run on money market funds that held money for institutions--the kind that require buy ins of a couple million or more. Institutional managers have a strong incentive to do stupid, destructive things, as long as everyone else is doing them. It's the same reason that IT managers used to buy IBM--not because it was necessarily the best solution, but because as long as you did it, no one could blame you when things went south. "I bought IBM!" troubled CTOs would say when the server crashed. "The whole market is down!" cry money managers when the financial system crashes.
Investors were particularly worried about any exposure to financial paper. So, frankly, were the managers of money market funds. From Lehman, the worries spread to Wachovia, Washington Mutual, and beyond. Suddenly, said one source, no one could sell two-week Wachovia paper at 30% yield-to-maturity--which in layman's terms means they were offering a hell of a discount on a loan that was pretty likelyt o pay off. Some funds bragged they didn't have Wachovia, which only made the others seem ominously silent in comparison. The fund runs started to hit money markets that had no obvious problems (Putnam, BKNY/Mellon, American Beacon) causing them to shut down or redeem the shares in kind. Investors began worrying State Street's massive short-term investment fund complex was holding Lehman, which whipsawed its stock price 50% in one day.
Money market funds are generally designed to be the functional equivalent of a bank account: short-term vehicles where you park cash you aren't using at the moment. Investors are supposed to be able to pull their money out at any time. That meant that all the funds, sound or not, were vulnerable to a run. And virtually any fund that experienced a run would "break the buck" because while these funds are perfectly safe and liquid in normal circumstances, no one could dump a billion dollars worth of securities on the market without seeing the price of those securities plummet. Since funds definitionally try to hold their asset base near a dollar a share, and distribute the yield, there was no gigantic cushion to pad the sales.
The runs meant that all the money market funds were in the same boat: everyone wanted to sell and hoard cash in case of a run. No one wanted to buy. Once busted funds had gotten rid of their very short paper, they were stuck with the weeks/months maturities, which were virtually unsaleable. Unless the parent institutions make your investors whole the only thing you can do in that situation is distribute the assets in kind, to investors who can't sell them any more than you could.
Ultimately, despite last week's bailouts, no one wanted to hold financial company paper. Unfortunately, as I understand it that paper made up the bulk of the money markets, which is hardly surprising given the volume of trades they do (did) every day.
Banks have tens of billions of debt maturities to refinance in the coming months. The overwhelming majority of it will be good even under distressed circumstances--unless they can't roll any of it over. At that point, they experience the same problems you would if your credit card company pulled your credit line and demanded you pay back everything you owe them.
No doubt some of my readers are rubbing their hands and saying "Exactly what should happen to people who carry credit card balances!" And I'm sure that among you there are people who pay cash on the barrel for everything, having never taken out any loan for a house, an automobile, an education, a personal financial crisis. These people never even use an American Express Card, which is, of course, a short-term loan. They also do not work for companies that borrow money to buy capital equipment or finance expansion, and their firms do not experience any mismatch between their payables and their receivables. Those people should stop reading now, because I'm pretty sure the Amish aren't supposed to use the internet.
The rest of us live in a world that is created and run by institutions that amass capital from millions of people and concentrate it in areas where it (usually) makes people better off. I'm particularly confused by conservatives who claim to hate fractional reserve banking, duration mismatches in the financial system, and easy credit/bankruptcy. If you think more deeply about it, there are three reasons why this opposition is silly:
1) Outlawing it would require massive market interventions. The vast majority of people want to borrow long and lend short. Keeping them from doing so would mean not only outlawing the current banking industry, but giving the government sweeping powers and budget to make sure that no one synthetically recreates a duration mismatched position. Human ingenuity on this front is endless--witness the acrobatic contortions of Islamic finance to get around the bans on, yes, lending money with interest.
2) Credit and easy bankruptcy serve as a substitute for government intervention. In a developed society that will not (however you personally may feel) stand by and watch its members starve, income fluctuations have to be dealt with somehow. If people can't borrow money to smooth their consumption, they'll demand that the government provide that service instead.
3) No country in the world, except Britain, has managed to industrially develop on retained earnings. Which is why it took them twice as long as the rest of us.
Lefties overjoyed at the prospect of banks running out of cash should note that money markets also hold federal and local government securities. What happens when Maryland doesn't have the cash in its coffers to make payroll, and the money market no longer exists? What happens is they send the employees home and tell them to come back when they get more cash. To the extent that you think a large and well paid civil service is a good thing, this should distress you.
And if they simply carried big cash cushions to cover tax flow problems, that would mean either less spending, or more taxes. Conservatives and liberals alike can reflect on the likelihood of getting whichever of those options you don't want.
If the FDIC hadn't stepped in to backstop the runs on the money market funds, it's not crazy to think that we might have seen a massive liquidation of huge portions of the banking system at fire sale prices. That magnitude--one person I talked to before the bailout gave a wild-sounding estimate of $1 trillion worth of money market fund redemptions in the immediate offing. With the money market essentially destroyed, the resulting bank liquidations would have been even worse, beyond even the ability of the US Government's borrowing power to pull back. That would have touched the bank accounts, the investments, and the firms of even the hawkiest of credit hawks--unless you've actually got it buried in your back yard in tin cans, you'd lose something, and even then, who would buy whatever it is you sell to make a living?
Consider that the Great Depression came upon a society much less dependent on unsecured credit than we are. Then count your lucky stars that our financial officials are moderately competent.
How likely was this doomsday scenario? No way to know. But it was possible. That's quite scary enough.
Fear is the mind killer.
Excellent post.
How likely was this doomsday scenario?
I wouldn't say we're out of the woods yet...
I'm confused. You've claimed in the past that American-style bankruptcy is a good thing because it allows people to get out from under unsustainable debts with a minimum of fuss and muss. I tend to agree.
So what would have been so bad about allowing more banks to go bankrupt? Bankruptcy isn't always a death sentence; it's often a time-out in which entities write off unsustainable debt and emerge later without it. Lots of airlines went bankrupt post 9/11 and people were still able to fly. So what if a few more banks get knocked down for their profligacy, and then get up again?
And thanks to these enormous interventions, coupled with inflation, the dollar is circling the drain. The Fed is going to have to do something in the near future, probably before the end of the year, to prop up the dollar. That means a pretty hefty interest rate increase. We may have pulled back from the abyss of a total collapse, but it's going to be rough sailing for the forseeable future.
I am now in agreement with another poster a few days ago, who hinted that Megan McArdle was behind the meltdown in order to have a basis for a series of truly excellent economics and business posts.
Unfortunately, market power of this magnitude means that my plans for mouse world domination apparently have some unwelcome competition. I must have my minions, ehm, "look into this".
It's still possible. You did see how the major indices (and oil futures) closed today, no?
So in the future, what's to prevent a run on money markets in good economic times, spurred by a bad rumor or a large embezzlement at some fund outfit? If they're that close to catatastrophe at all times shouldn't they be regulated and insured just like bank deposits? Why not an FMMIC?
Joe Magarac--
I believe that financial institutions aren't allowed to file bankrupcy and be restructured; they must have their assets liquidated. Which is why Lehman can't be restructured, but must be sold off in little chunks. So the typical rules of bankrupcy where a company declares bankrupcy, equity holders get wiped out, debt holders become equity holders don't apply since the firm must be liquidated. Liquidating financial institutions all at once would be a mess given all the assets they hold (which is why everyone was so worried about AIG, that if they start unloading their stash of MBS', the value of those would plummet, killing off a couple investment banks).
"... Suddenly, said one source, no one could sell two-week Wachovia paper at 30% yield-to-maturity--which in layman's terms means they were offering a hell of a discount on a loan that was pretty likelyt o pay off. ..."
If that 30% is an APR then the discount is only about 1% which doesn't seem that big to this layman.
"... The vast majority of people want to borrow long and lend short. ..."
The vast majority of people also want to borrow at low interest rates and lend at high interest rates. That doesn't mean they are entitled to do so.
From Doug Noland:
MEGAN: My opposition to fractional reserve banking is not silly. We had this discussion before, when you claimed that fractional reserve banking had nothing to do with this crises. But I take it that your thinking on that point, at least, has changed.
You raise three points, and each seems to be based on the belief that, without fractional reserve banking, no one can borrow or lend. This is simply not true, the only requirement is that the duration of the loan be matched to the duration of the deposit:
--
1) Outlawing it would require massive market interventions. The vast majority of people want to borrow long and lend short. Keeping them from doing so would mean not only outlawing the current banking industry, but giving the government sweeping powers and budget to make sure that no one synthetically recreates a duration mismatched position. Human ingenuity on this front is endless--witness the acrobatic contortions of Islamic finance to get around the bans on, yes, lending money with interest.
--
We are already in the middle of massive market injections, and there is a good likelihood of massive market injections to come.
The end of fractional reserve banking does not mean the end of long term lending -- it just means the end of long term lending buttressed by short term deposits. You can still make a 30 year old loan -- it just needs to be tied to a 30 year old deposit. This will make long term lending more expensive, but I think it's clear that long term lending is currently far too cheap as, for it to be viable, it needs extraordinary government insurance of the sort we've been seeing for the past 6 months.
If your point is that changing to a non-fractional reserve system will involve account changes, and then enforcement (which will not be complete) then you are quite right, but that is where we are today. There is no GAAP compliant book on the planet that values securities in the midst of a bank run, and clearly that is an important (in a "totally dominates the performance of the firm") element of what investors should expect a firm to return.
--
2) Credit and easy bankruptcy serve as a substitute for government intervention. In a developed society that will not (however you personally may feel) stand by and watch its members starve, income fluctuations have to be dealt with somehow. If people can't borrow money to smooth their consumption, they'll demand that the government provide that service instead.
--
You're still not getting it. Fractional reserve banking enables systematic bank runs, and credit and easy bankruptcy are *NOT* substitutes for government intervention in bank runs. The end of fractional reserve banking does not mean the end of banking, or the end of lending or borrowing. It just means that if you want to borrow for 2 years, you need to find someone willing to lend for 2 years. That is all.
--
3) No country in the world, except Britain, has managed to industrially develop on retained earnings. Which is why it took them twice as long as the rest of us.
--
*Sigh*. You can borrow and lend in a world without fractional reserve banking, and even have growth. The VC industry, for example, operates in a duration matched sense, and the technology industry that it funds grows fine.
-winterspeak
Those people should stop reading now, because I'm pretty sure the Amish aren't supposed to use the internet.
Meh, I hardly use credit and if the credit markets seized up for a month or so it wouldn't matter all that much. The company I work for has zero debt and pays for capital equipment through saving some of the profit. I know, crazy in these times.
I use credit when it's in my advantage to do so, i.e. low interest loans with rates less then inflation and reward credit cards that I never carry a balance on. If push came to shove, I doubt many people really need to use credit except for just a few things. From looking at the state of mortgage loans, it's not like qualified individuals with down payments are having no trouble receiving a home loan.
A question that others, if they are like me, are asking...is the worst over? Are we going to start recovering now? If so, what is the long-term prognosis? If not, then what could happen?
What worries me (as someone who knows little about this stuff) is that I can't tell if anyone knows where rock bottom is...is it possible things will deteriorate more? It wouldn't seem like it to me, except that I thought we had hit rock bottom back when Fannie and Freddie were first in the news...
Lefties overjoyed at the prospect of banks running out of cash...
And who, exactly, would these people be? Can you please cite to them, because I read A LOT of liberal and lefty blogs and articles and I recall most of them peeing on themselves in fear. They certainly blame those on the right and are pleased the it looks as if certain individuals might be screwed out of a lot of money, but I ask you to please point me in the direction of a "lefty" who is "overjoyed" at a severe and frightning financial crisis.
Anyone totally disconnected from the financial system will not be affected(Amish, goat herders, etc..) The rest of us are royally humped.
btw, Megan, many money funds publish weekly position files. All do it at least quarterly.
I suspect, Kate, that any such lefties are of the chortling-while-capitalism-falls variety, and are thus well to the left of all mainstream political thought and power in the US. Such people are assuredly not Democrats, for instance; that entire party would be far too rightist for them.
In other words, a lunatic fringe.
Matthew - they are all to be found on the Daily Kos.
we obviously dodged a bullet. and now that the dust has cleared and the bad stuff is about to be nationalized, i think the government is bad people have to be quiet for awhile.
government is very good. face it. when the shit hits the fan, competent government is the only thing between you and a world of hurt, be it a hurricane, financial or otherwise.
and guess what? the health care system we have is in a crisis just as bad as the financial system. there are some problems the market cannot fix, or rather there are some problems the market cannot fix the way we'd like it to.
no one wants to be at the mercy of the free market. anyone who says they do is lying. period.
Not a single thing has changed except vague guarantees worth a trillion and a half or so. The credit system continues to deteriorate, deflate. The trillion and a half will be borrowed so where ever it goes it will not increase systematic liquidity. It will just go into badly, and rightly, deflated assets which might keep them from overshooting to the downside but that's all just water under the bridge. Old news. It won't bring on new lending, except in a very tangential way which I'm sure someone can expound upon with theory.
US assets will continue to deflate for a lot longer. They have to. The entire system since the mid 90s was devoted to inflating those assets, mostly with borrowed money. That's over. When prices get low enough many will be bought by foreigners who built up such gigantic dollar reserves from our gigantic trade deficit, which every warm body on Wall Street and K street didn't matter.
They will be the ones arranging the sales now, but I digress.
Maybe the worst panic moment is over, maybe not. What is sure is that Americans will be depressed for years and years to come over things economic. Last week was just one week. Put away the party hats.
the health care system we have is in a crisis just as bad as the financial system.
false
there are some problems the market cannot fix, or rather there are some problems the market cannot fix the way we'd like it to.
you're right, thank god the government is there to fix all our problems just the way we'd like them to be fixed.
Megan writes Institutional managers have a strong incentive to do stupid, destructive things, as long as everyone else is doing them
How does this sqaure with her assertion last week about the impossibility of shorts driving down the price of a stock? Why wouldn't the same herd mentality apply?
If we bail out money market funds, then why not bail out stock mutual funds? Some people reached for extra yield and those people are being bailed out by the people who played it safe.
If money market funds are going to be bailed out, they must pay a fee to some organization like the FDIC. Otherwise we just have endless episodes of socialized risk and privatized profit.
Kate, one example is Rosa Brooks (daughter of Barbara Ehrenreich) in the LA Times. "Overjoyed" would be a strong word, but her "Welcome to the 3rd World" column was dripping with schadenfreude.
...and the Amish and goat herders aren't totally divorced from the system either. Eventually some of the production gets sold to people who are more intimately involved in the system. Both use kerosene for lighting for instance. If they can't sell their goods there won't be any kerosene....
Meh, I hardly use credit and if the credit markets seized up for a month or so it wouldn't matter all that much. The company I work for has zero debt and pays for capital equipment through saving some of the profit. I know, crazy in these times.
Is your company the world's only source of clean drinking water, and guarded by the world's largest guns? If not, then the kind of economic crash associated with "the credit markets seiz[ing] up for a month or so" might mean that there is no longer a viable market for the products and services your company sells, and may not be for some years. The business assets might even be valueless in a sale, since nobody needs them and nobody has money to buy them anyway. Shutter the windows, lock the door, and hope there's still a building standing and a job for you to work when things finally pick up again.
Personal or even business responsibility is a fine virtue, but you still operate in a larger ecosystem.
What are the chances that the EU would allow us to get on the EurO?
We can't punish the people that got us into this mess economically, so why not punish them corporally? Will moral hazard still exist if we make it a policy to execute all workers from bailed out firms/companies who make over one million a year in net annual compensation? The Japanese would take it upon themselves to do the honorable thing, but given that we're Americans, I think a massive human sacrifice would be just the thing to restore investor confidence.
the health care system we have is in a crisis just as bad as the financial system
That's a load of nonsense. Healthcare providers aren't going belly-up. Neither are insurers. The cost of the latest and greatest healthcare is going up, that's all. That's not a crisis; that's supply and demand. Putting the government in charge would simply get us shittier care at higher cost.
Karl Popper's corpse is clawing at his coffin in an attempt to rise from the grave for an "I told you so."
Putting the government in charge would simply get us shittier care at higher cost.
Just like all those other rich countries who get shitter care at higher cost. Oh, wait a minute, they tend to get better care at lower cost.
I think Megan you have acquainted us with the problems the Fed faced and helped us to a more comfortable level of humility in the face of our outrage that Bernanke or Paulson didn't do what we, as amateur Fed governors, could have accomplished easily. I go back however then to your criticism of McCain for saying Chris Cox, head of SEC, should be fired. A general expects his officers to acquaint him with problems. One of the issues here clealry has been the new 'mark to market' rule. Cox should have been seeking to have that rule changed in light of the enormous implications of this thin market. This has greatly increased the instability of the banks. It certainly has taken them out of the market for mortgage assets.
Your analogy of the monster under the bed is interesting. In psychoanalytic theory, the infant of about a year old has experienced fulfillment of his or her needs and also frustration at needs not being met. The infant perceives it has 2 mothers as it were, one in whom there is complete satsifaction and one which wants to destroy him or her. Maturation leads to a trust that there is one mother. You are saying that we were to a point of loss of trust in our social economic relationships such that the bad mother was back, only that which would destroy us was extant.
Depends on how you define "better care." If you think that waiting 6-12 months for elective surgery is better care than waiting only 1-2 months, then you are correct.
And I won't even start to begin the discussion on how the U.S. healthcare system is paying for the majority of the new drugs on the market. If drug discounts weren't offered to other countries (such as Canada), you'd see a huge increase in the costs of their healthcare.
Melting down?
One day of the money markets seizing up and the financial world is "melting"?
Oh, pshaw! True or false: Americans just don't like "stress".
Those with long memories will remember when European Central Banks used to fling their overnight rates up 50% and more to "protect" their currencies, etc.
The idea that many or most consumers were ready to pull their money markets is a Red Herring (I think). Of course, it was reported as "millions of dollars in losses" and "breaking the buck" at the time. Few bothered to say, as does Meagan above, that is was 2-3%. ... some people are willing to pay that much in advisory fees, alone (gulp!).
Truly, most people don't even know what the interest rate they are getting on the money market accounts is.
And today, you saw the fatal flaw of the bailout plan- the dollar was crushed. There are no free lunches.
Depends on how you define "better care." If you think that waiting 6-12 months for elective surgery is better care than waiting only 1-2 months, then you are correct.
I think waiting times are a non-trivial factor to consider (although they're hardly the whole picture), but I've seen no evidence that Americans typically have shorter waiting times than the citizens of other OECD members. Do you have any? This is especially true given the fact that a sixth of the US population must wait forever for elective surgery, or at least until they're in their sixties, and are covered by evil government social insurance.
And I won't even start to begin the discussion on how the U.S. healthcare system is paying for the majority of the new drugs on the market.
And I'm supposed to accept this as an argument in favor of the US status quo (the fact that Americans enjoy the privilege of subsidizing the drugstore bills of rich foreigners)?
Lefties overjoyed at the prospect of banks running out of cash - MM
Yeah, you want to stay away from saying that. It's the equivalent of questioning leftists' patriotism, but in the economic realm. What's happening here is that leftists who have an automatic pro-regulation, pro-enforcement, anti-laissez-faire bias are seeing their basic worldview confirmed by an event which, in and of itself, is obviously a catastrophe. "See? I told you so!" is not the same as "Oh good, I'm glad we're all screwed." Similarly, leftists who felt Katrina vindicated their condemnation of Republican laissez-faire governance were not actually overjoyed that New Orleans was destroyed.
But more to the point of your post: wasn't the money market backstop just the $50 billion guarantee Paulson instituted on Sept. 19? Nobody I've seen has questioned that move. What relationship does this bear to the Big Bailout?
I read Megan's post with admiration both for her clarity and her prose. Then I read the Winterspeak comment, again with admiration. Oops, I seem to have ingested some 'cognitive dissidence' :-) My formal economics background is limited: one course in college (using Samuelson :-() and a recent read of David Friedman's "Price Theory" -- neither of which helps me with the practicalities of fractional reserve banking. I understand the concept but not the practicalities. Megan, could you perhaps address Winterspeak's remark
in a future entry? Is "far too cheap" long-term lending a bug or a feature?Speaking for myself, I was about 1 day away from trying to move significant (to me and better half) money market assets to something insured. It only takes a little bit to start an avalanche, or a cascade.
Interesting play-by-play, Megan.
Yet the fatalist in me says that things will either get worse in a slow-moving fashion with official steps to tamp out spot fires interminably, or there will be an abrupt crash that inspires some sort of general rethinking.
I've certainly welcomed growth in our nation's economy over the years, but have also had the sense that it wasn't very palpable. Yes, the largest investors made money hand over fist. But the amount of consumer and public debt continued to rise.
As one market bubble burst, the next began inflating. At some point, I think we're better off allowing things to reset naturally and pick up the pieces from there.
I disagree with the anti-traders, the collective-action goobers, the watermelon socialists, etc. But it always seemed rather obvious that our economy would need to grow to invest in energy efficiency and new technologies, that it should produce more things rather than just consuming materials processed abroad. All of the speculative binging encouraged none of that.
Nevertheless, our foreign friends and adversaries -- not to mention their domestic wannabe counterparts -- are more than glad to blame our national preference (so far) for market solutions for the disaster. But let's not forget that we made multiple attempts over several administrations to reflate the economy (while inflating bubbles) to draw in foreign capital that had nowhere else to go in the hope of growth: Euroland lagged, the West wallowed, the East Asians dumped cash on us to keep their exports humming, and most continued their different socialist experiments.
I say let some significant pyramid operators fail so the external cynics are seriously burnt. We'll clean up while taking care of our own.
Of course, if the current Dems take over government, all bets are off. They want to emulate all the smiley-faced socialism that has failed for decades now in Europe. And they'll reap the well-earned love of the outside world for completing their long-term project to see all of America in ruin.
Far too cheap is a bug. Far too cheap credit is the foundation of this crisis. Too cheap credit does many bad things. The worst is that it causes mal investment, think residential real estate. It causes over consumption,think residential real estate. It causes increased speculation, of the highly leveraged kind, think residential real estate.
It discourages savings. Nobody has any. Instead we are told the latest bubble is where we save. Remember when we all were going to retire fat and happy on our IRA? Remember when we were all going to be rich on our houses inflating? Oooops, I mean increasing in value.
A great moral/ethical case can be made that the cheap credit system is a bad thing. It's always good to recall that for it's first 1400 years Christianity forbade, or strongly discouraged any money lending for profit.
Moral absolutes are all well and good but they go against human nature. People want growth and wealth. They will always opt for a system which promises it. The best we can hope for is that the excesses will be moderated most of the time. We went off the rails and now are paying the price.
This episode was typical bank run behavior.
What's wrong with simply requiring money market funds to operate under the same rules as normal mutual funds? If you own x% of a mutual fund and you want to cash out, the fund gives you what x% fund is worth at the end of the day prices on the day you sell. This is basically the same as the fund actually selling x% of its assets and handing you the proceeds. So even if you think everyone else is going to cash out, there is no reason for you to beat them to it.
Money market funds don't operate this way, but more like a bank. If you own x% of the fund and cash out, they give you x% of the face value of the fund, not the market value, even though they have to sell underlying assets to pay you. Thus if the market value of the assets is only $.97 per share, if you cash out, you get $1 per share. If half the shares are cashed, the remaining half now only have $.94 of assets per share. Thus it's best to cash out whenever the market value of assets fall below $1.
This is just bad practice. Requiring money market funds to use the same cash-out rules as mutual funds would not cause them to go away. There would still be funds committed to buying only short term commercial paper, but they wouldn't be subject to bank runs.
My opposition to fractional reserve banking is not silly
Actually, you're probably right. It doesn't make enough sense to actually be merely silly.
Megan, being a city girl and a finance type, has understated some of the issues.
Grocery stores sell groceries they purchase not with cash, but with very short term loans. No commercial credit, no food on the shelves; lines to buy bread and meat when there is any.
Farmers should be planting winter wheat right about now; most of them use seed loans. No credit, no seed. Next summer, you won't have to stand in line for bread: no bread.
Of course, it wouldn't go that far: the government would do ... something.
Think Weimar Republic. Think Zimbabwe.
Megan was pretty close to what happened but she downplays the risk. This would have made the depression seem like a good ol' time worldwide. The fact that it is not resolved is even more scary. What prevented a total meltdown was simple. The Sec of Treasury and the Chair of the Fed took the pressure off by announcing the plan. If the plan (aka money) does not come fast then we are right back where we were last week but this time nobody is going to believe them. With the way congress has been going over the last 48 hours this deal may not happen and if that is the case, it has been nice owning my house, I did like my job, at least I do know how to hunt and fish. If you think that I am overstating the impact, just look back to the 30s and multiply to the tune of 50 trillion in lost asset's.
Sleep well,
Mark
Fractional-reserve *is* fraud - and if it was treated as so by the powers that be, it wouldn't matter if people tried to get around it, their attempts would make them guilty of fraud.
You can't create money from debt. And you can't loan money you don't have. Or you can, but it creates a house of cards that one day will blow down, once people stop pretending all the paper and IOUs they are holding mean something tangible. If that means it takes twice as long to get to point X, that means you got to point X when you were able to, and you didn't have to steal to get there. This is why moral libertarians can't stand the consequentialist neolibertarians - anything that keeps the trains running on time is ok in their book (but gosh, wouldn't it be nice if taxes were lower?).
And who, exactly, would these people be? Can you please cite to them, because I read A LOT of liberal and lefty blogs and articles and I recall most of them peeing on themselves in fear. They certainly blame those on the right and are pleased the it looks as if certain individuals might be screwed out of a lot of money, but I ask you to please point me in the direction of a "lefty" who is "overjoyed" at a severe and frightning financial crisis.
Michael Moore was crowing that "Communism won!" the other day at the premier of his latest film.
Similarly, leftists who felt Katrina vindicated their condemnation of Republican laissez-faire governance were not actually overjoyed that New Orleans was destroyed.
The fact that those leftists were essentially demanding a clairvoyant action by FEMA outside of its scope in order to prop up a state and a city that owed the worst aspects of their aftermath effects to corrupt state and local governments run by incompetent Democrats was, of course, conveniently forgotten.
Say, did you hear the one about how there were over 3,000 Ike deaths along the Texas coast with preliminary reports in the tens of thousands? Me neither.
Smarminess aside, I really wish Megan would make a concerted effort to lay off all references to "left" and "right" in general, since she has an odd way of introducing such references at a point where it will serve no aid to the argument, but you're not doing a splendid job of refuting her if that's your approach.
"Consider that the Great Depression came upon a society much less dependent on unsecured credit than we are."
{blink}
Are you seriously not aware that the crash of '29 and the Great Depression are two different things?
Fractional-reserve *is* fraud - and if it was treated as so by the powers that be, it wouldn't matter if people tried to get around it, their attempts would make them guilty of fraud.
No, it's not fraud. It is a way of increasing both risks and returns in a fashion that has largely proven successful and is therefore accepted by many as a legitimate way of doing business. If you don't like it and want it to change, that's a fair cop and there are good arguments to be had, but boilerplate rants about fraud will see you and yours rapidly consigned to the looney bin.
The people running this madhouse are not 'moderately competent.'
If they were even minimally competent, none of this would be going on.
There's a reason there were no panics between 1929 and no, and it was called New Deal regulation.
The whole miserable crew have no coherent economic theory, except that taxes can always be lower than they are.
aMouse, while you are completely wrong in everything you write here about Katrina, you're also completely off point. The point is that, regardless of your personal idiosyncratic views, the federal response to Katrina was generally viewed as an indictment of the incompetence of the Bush administration, and many on the left were glad to see such recognition gaining a foothold. But they were obviously not glad that New Orleans was destroyed; they were furious. Similarly, leftists now are glad that the anti-regulatory mania of self-serving Wall Streeters is coming in for contempt. But they are not glad that banks are failing and average people are getting poorer.
I note for example that back in May, a Merrill Lynch analyst based in Hong Kong nearly kicked off a run on the Vietnamese dong with an analysis that the currency might collapse by the end of the year. The paper dripped with contempt for Vietnam's overly managed economy. Less ideological analysts felt Vietnam had some serious problems but would likely muddle through okay. Well, Vietnam is muddling through, the currency is back to normal, and Merrill Lynch no longer exists. That's schadenfreude. It doesn't mean I'm happy that Merrill Lynch collapsed, since that happened as part of a financial crisis that's costing me a lot of money too.
Nonsense. They were thrilled; they had a club to beat Bush with. Nagin and Blanco got a complete pass on what was, by any rational standard, their job first and foremost, to deal with, and on which they failed, abysmally. Leftists don't give a rat's ass about the poor, or blacks, or what have you. They're a means to an end. Period.
More utter nonsense. Leftists - or, let's call them what they are, communists - typically believe that the worse things get, the better for them, because it increases their chances of inflicting their malignancy on society.
I remember all too well passing by a "church" on my way in to the lab one night in Berkeley, right after the fall of Saigon. Communist scum (pardon the pleonasm) were visible toasting the event. Fifty thousand dead Americans, and soon to be many thousands of dead Vietnamese, and they were pleased.
So please don't maintain that leftists aren't pleased, because if you do, you're either disingenous or extraordinarily obtuse.
Fractional-reserve banking is a non-issue in this case because it was the money-market mutual funds that were attacked. They are not banks and no fractional-reserves are involved. If the money-market mutual funds can have a run, with their short-term liabilities matched by short-term assets, than any financial intermediary can have a run. Do we really want to eliminate financial intermediaries from the financial markets?
Watching what is happening to the Fed's balance sheet is interesting. Reserve balances held at the Federal Reserve exploded from $7.978 billion for the week ending on September 10th to $46.996 for the week ending on September 17. I do not know exactly why, but the story that Megan McArdle is telling above is clearly most of the reason. In times of crisis, cash is king.
There is a lot of money being made and lost in the financial markets. If you bet right, you make a lot, but if you bet wrong, you can lose a lot.
Grocery stores sell groceries they purchase not with cash, but with very short term loans.
Many business "purchase and sell with credit" but there is no bank or interest involved at all. You have a decent relationship with suppliers, they give you the goods and you pay with cash on Net 30, 60 or 90 days depending. Do grocery stores purchase with credit given to them by banks, or by their suppliers?
Good description of the trees, now for the forrest. George bush financed the war on terror with deficits. He simultaneously kept everyone fat, happy, and apparently, stupid with borrowed money. Now we desperately need to inflate as our civilized way of repudiating that debt. The danger is that the elderly voters will prohibit the Fed from doing so, causing a liquidity trap. This happened in Japan ten years ago. They had a ten year recession.
If you think more deeply about it, there are three reasons why this opposition is silly:
It's pretty clear from a reading of economic history that almost every single panic, crash, recession, and depression has had maturity mismatching at its heart.
From Wikipedia on the Panic of 1873: "Years of government-promoted speculative credit created vast overexpansion of the nation’s railroad network. The failure of the Jay Cooke bank set off a chain reaction of bank failures and temporarily closed the stock market. Factories began to lay off workers as the nation slipped into depression."
Sound familiar?
Or how about 1907: "The panic's primary cause was a retraction of loans by a number of banks in New York City, and the sentiment quickly spread across the nation leading to the closures of both state and local banks and businesses."
And then we all know about 1929, another inverted pyramid of debt and cheap credit, with over leveraged, maturity mismatched banks imploding everywhere.
More recently we have the S&L crisis and the early 1990's recession. And finally, we come to our our current little situation.
Given that every one of these panics and depressions has had maturity mismatching at its heart, why is it silly to talk about actually fixing this root problem?
Furthermore, why is it so hard for you to understand that ending fractional reserve does not mean getting rid of loans? Winterspeak has been over this a dozen times. Borrowers would simply have to match maturities with lenders. There are plenty of people who want to save for 15 or 30 years. Much of our savings is long term - for houses, college educations, and retirement. And as should be clear from this bailout, artificially cheap credit always has a price. The low interest rates of today result in the bailouts tomorrow. It only makes sense that instead of the tax payer footing the bill, those doing the borrowing should pay in the form of higher interest rates.
As for your argument that banning fractional reserve is anti-libertarian, you are mostly correct. The real libertarian argument is to allow totally free banking and free currency, and let those using shoddy banking practices fail early and fail often. That's the argument that Ron Paul was making. Unfortunately, the prospect of allowing free currency is even more remote than getting rid of fractional reserve.
But at the moment this crisis is a monetary crisis. And the money involved is Federal Reserve Notes. Gold is doing fine. There is nothing free market about Federal Reserve Notes - they are entirely the creation of the U.S. Government. Note that there about 800 billion federal reserve notes circulating around. Yet the national debt is $9 trillion. The entire U.S. monetary base is - well - no one really knows for sure. M3 is at something like $10 trillion. So we have 800 billion of actual currency, but a money supply of $9 trillion. That means that 90% of the money supply is informally defined. It all comes from leveraged credit structures. When those credit structures look like they might implode, the government must step in and formalize them, buying them out and converting them into actual money. Otherwise, the entire thing collapses, and you get a catastrophic 90% money supply contraction.
The solution is simply good accounting. Formalize the existing money base, creating a "broad money" note that would represent the broad, M3 money supply. Attach each dollar with a serial number. In essence, we have converted informal credit structures acting as money into formal money. This will allow trading to resume, and the threat of credit collapse will be over. Then fix the total money supply quantity, never creating anymore serial numbers. The Fed must then Inform Wall St. that there will never, ever be another bailout. If the government notices leveraged credit structures, where dollars are not being backed with "broad money" serial numbers, it should poke the structure with a stick. Short it, do bear runs, make speculative attacks, send a few black swans its way. If it's stable, then great. If not, it should fail early and often. The government should watch the price of gold and oil along with nominal GDP to make sure their is no monetary inflation. Monetary inflation is a sign of a growing credit pyramid that will eventually either collapse or need to be bailed out.
If you keep track of the fundamentals - account for every Federal Reserve Note the same way a company would account for its shares of stock, and never, ever bail out any financial institution - then you actually need much less regulation. Companies will always get around regulations. But as long as there are no bailouts, bad banks will disappear from the market before long. And as long as you account for every dollar, it becomes easy to publicize which banks are engaging in risky, high leverage activities.
Outlawing it would require massive market interventions.
Megan-
If there was no FDIC, what reserve ratio would you require from a bank for you to put your savings into an account paying .2% annual interest? 10% reserves? 0%? 50%? 100%?
If your answer is anything other than 0% ( which is effectively what it is now), the question is not "should the government intervene to stop fractional reserve". The question is, "Why on earth are we actively subsidizing a practice which has been at the heart of every single financial crisis?".
Depends on how you define "better care." If you think that waiting 6-12 months for elective surgery is better care than waiting only 1-2 months, then you are correct.
Posted by Rex | September 22, 2008 8:16 PM
A 6-12 month wait for elective surgery is a problem for you? What is your definition of "elective surgery?" To me "elective surgery" is just that, surgery that you have a choice whether to have it or not. Surgery that is required for you to continue to live and be productive is not "elective" in my book; and I have not heard of a single confirmed instance of necessary surgery being postponed to the detriment of a patient. Get a new argument against universal health coverage.
Michael Moore was crowing that "Communism won!" the other day at the premier of his latest film.
Posted by Larry | September 22, 2008 11:30 PM
Michael Moore Derangement Syndrome rears its ugly head. You forgot to point out how fat he is.
So please don't maintain that leftists aren't pleased, because if you do, you're either disingenous or extraordinarily obtuse.
Posted by Occam's Beard | September 23, 2008 12:10 AM
Good grief. There's no way to have a reasonable discussion with you people. It's all black and white in your world; the only way to resolve our differences would be pistols at dawn. Talk about extraordinarily obtuse. If a leftist told you the sky was blue you'd deny it.
Virtually all leftists aren't pleased that there is a financial crisis. Only the utter loonies want to see an economic collapse. Just like loonies on the right said Katrina was God's wrath for New Orleans hosting a gay rights parade.
I'm a finance lawyer in NY and have been pretty close to what has been going on. Megan's post is spot on but I'd concur with earlier posters that said she may have underestimated how close we came and how bad it was, and also with those who say we aren't out of the woods yet.
One thing that deserves mentioning is that the media is not so good at capturing the reality of people working on Wall Street. Its a very, very ruthless place and adjusts pretty fast. There are legitimate cases for and against the "bailout" but understand regardless of whether it happens or not (and I'd argue it has to, but I dread the unforseen consequences) this won't be a bailout for the old Wall Street where [insert your mental image of a disagreeable banker or lawyer here] goes back to business as usual. A huge swathe of the mortgage specialists (on Wall Street and in the Main Street mortgage industry) are long gone. Thousands more are going to go at Lehman and Merrill and others, and then there will be a delayed reaction at hedge funds, law firms, possibly accounting firms. Hell, Wall Street may in the end relocate to Charlotte. We'll see, but its going to be bloody now, regardless of how much taxpayer money is spent.
Nobody working on a public sector salary or at a steel mill will be expected to cry into their beers for all these people (although they probably should for the support staff, which is getting decimated as well and had pretty ordinary American jobs). They knew, or should have known, the risks. But bear in mind that most of those who are going to get tossed made alot less money then the Wall Street image suggests (the millions generally come later, if you survived) and to the extent the bankers made "obscene wealth" alot of it was (especially recently) in restricted stock so that Lehman folks "worth" $3 million went to $5,000 without any ability to sell (at the top, see also Fuld and Cayne's sales). And for the most part they worked brutally, insanely hard. I have friends who are not in the industry, and one of the difficult things for them to grasp is how demanding these jobs are. If someone thinks that you can help them move X million, they don't care if your kids need to be picked up, that you have a date, that you have tickets to Y -- you do whatever they want. People are (were) blackberrying in the delivery room, flying home to Australia to give a best man's speech and then getting on the first plane to London, forgetting the names of their kids. These stories are true. Again, I don't expect anyone to be wearing black armbands and people knew the risks, but it should be taken into account.
Conservative commentators are idiots to shift the entirety of the blame to the Community Reinvestment Act, Fannie and Freddie's politicized mission and the governmental endorsement of the rating agencies (although all three had an effect). Libertarian ideologues are off base because (a) as Megan does a good job of explaining, some form of the current banking system is essential and (b) there is no way in hell to address the informational disparities and allow true free-market, assumption of institutional risk banking. The market, at least in this arena, tends to get it catastrophically wrong every generation or so and global turbo financial laissez-faire just doesn't work the way I, and many others, thought. Barring a U of C platonic world of the forms, we need regulations.
But Lefties are insane for thinking that "predatory lending" was at the heart of the crisis -- abusive lending practices as far as I can tell were vanishingly rare, although collusive fraud of borrowers and brokers was all too common. The left is also worryingly clueless about the basics of the industry and while it may be understandable on an emotional level their bashing of their cartoon wall street hate figures is going to produce some horrible, counterproductive results. To begin with, if you cap salaries at $400K for the still large number of people who can make $35 million a year with a phone and a Bloomberg or $5 million with a suit and a powerpoint for their employers, they will decamp en masse to Dubai, Frankfurt and London.
You know who won out of all of this? A chunk of the Wall Streeters who got out at the right time so they had enough money to live well if they are never employed again, yes. But also millions of Americans who benefited from catastrophic mispricing of risks by Wall Street and European financial institutions. The majority of people who got mortgages in the last ten years won't default, and they got terms that they never would have had in the past and nobody will again, at least in my lifetime. It wasn't a wealth transfer from Main Street to Wall Street -- it was a wealth transfer from the taxpayers and Wall Street shareholders to a select group of both Wall Street and Main Street. This will, of course, not be recognized in the partisan point scoring.
Good post Megan.
Monsters in the closet? I guess I am not the only one going with a kid-friendly theme for understanding the credit crisis. Here is my take, playing on Everything I Needed to Know I Learned in Kindergarten--and using Second Life as an object lesson.
http://www.metanomics.net/23-sep-2008/everything-i-needed-know-about-credit-crisis-i-learned-second-life
Fwiw, in my day job I am a Professor of Accounting at Cornell's Johnson School, specializing in financial market regulation. But by night I am the host of a Second Life interview show, Metanomics: Business and Policy in Virtual Worlds.
Enjoy!
"... The vast majority of people want to borrow long and lend short. ..."
The vast majority of people also want to borrow at low interest rates and lend at high interest rates. That doesn't mean they are entitled to do so.
Posted by James B. Shearer | September 22, 2008 5:23 PM
You want a mortgage on your house buddy?
You know who won out of all of this? A chunk of the Wall Streeters who got out at the right time so they had enough money to live well if they are never employed again, yes. But also millions of Americans who benefited from catastrophic mispricing of risks by Wall Street and European financial institutions. The majority of people who got mortgages in the last ten years won't default, and they got terms that they never would have had in the past and nobody will again, at least in my lifetime.
I don't really understand what you're saying here. I thought I did, but then realized I didn't. The misprision of risk wasn't that Wall Street gave solvent people mortgages at rates that were too generous. Those mortgages pay what they pay -- there's no surprises there. The misprision was that they gave mortgages to people who couldn't pay. In other words, they set the rates too high, not too low. No?
Or are you saying that the inclusion of bad financial risks (who were thought to be better risks than they actually were) in pools with good financial risks lowered the cost of borrowing for both, so that now the ones who haven't defaulted are enjoying better terms than they otherwise would have?
"... The vast majority of people want to borrow long and lend short. ..."
Indeed they do.
One of the "complicated financial structures" now blamed for the crisis is one I worked on for many years. Industrial companies have always wanted long term finance, for which the banks charged accordingly. Wall Street figured out a way to offer long term financing to industrial companies at short term rates, with the banks getting compensated for the marginal risk that short term funding (provided by the money market funds which are the subject of the post) would dry up and they would have to step up. Eventually, the short term funding dried up in the chaos of the last year. The banks took a hit to their balance sheet and the companies paid a higher interest rate (but not as high as if they had matched their durations from the start). Cue pain from the banks, cue bitching from the companies involved. But at the end of the day the companies benefited tremendously -- without the complexity of modern finance, they would have been stuck paying the banks cost of financing from day one. And the banks paid a cost for mispricing risk. The underlying credit risk for these transactions, is still solid by the way and they continue to pay, its just that the complicated machinations to avoid the disconnect between the reality of borrowers wanting commitment and stability and banks with short assets and long liabilities broke down.
Matching asset and liabilities would be wonderful. So would a perpetual motion machine.
Brooksfoe -- Neither scenario exactly (and sorry for another long post). As I understood/relied on, the mortgage industry was relying on historical data on historical data for modeling. Fine, but the models depended on historical data that (a) was based on a different era where property owners viewed default as a communal shame, rather than a financial option to be weighed alongside others, (b) was based largely on fixed rate mortgages and (c) to the extent it included ARMs, was based on limited data and a very stable rate environment. Then, you had a complacency across the board in the credit markets (sovereign debt and leveraged loans were also priced at insane levels in retrospect) after years of stability--above my pay grade as to whether this was a harmful byproduct of central banker's wise stewardship or a natural result of wicked central bankers flooding the market with liquidty.
The result, in the mortgage market, was that lots and lots of lenders convinced themselves that they had a foolproof system and environment to charge less to traditional mortgage customers and still make money, and build pools of concedely awful credits that would also make them money if charged a higher rate. The point is the people who would have gotten mortgages in the 1970s got a much cheaper rate, or more house for their deposit. And hundreds of thousands of subprime borrowers who would have been thrown out of the bank by an S&L on their backside got mortgages too.
Enough of these assumptions went pear shaped to throw thousands of bankers on the street. But the default rate on even the crappiest vintage of subprime is 16%ish. That means 80% of borrowers in subprime have a house, are building equity, etc.--exactly what FDR and Barney Frank wanted. And their friends in the prime bucket got either a lower rate or a McMansion for a downpayment that would have gotten them a Cape Cod fifteen years ago. If you got into it, you had access to credit, or cheaper credit, that wasn't there before or since. And they guys who paid for it were first the shareholders of Lehman and Bear and Merrill (including their employees) and only then the taxpayers.
Apart from the math, there was admittedly a set of perverse incentives in the nexus between appraisers, mortgage brokers and borrowers once the lenders started focusing on selling things on and servicing rather than taking on the risk to term. But I am absolutely convinced that "predatory lending" is a myth in this instance -- abusive lending happens and should be punished, but the people being foreclosed on are in the overwhelming majority being foreclosed on because of interest payments that were absolutely clear in the disclosure documents. My cousin got foreclosed on years ago off a non-option ARM, and I didn't feel particular sympathy for him. Don't feel sympathy either for a Bear guy who bought a house in Greenwich assuming he wouldn't get fired and doesn't pay. Its a mortgage -- if you have one, they're not complicated.
"leftists who felt Katrina vindicated their condemnation of Republican laissez-faire governance were not actually overjoyed that New Orleans was destroyed."
Maybe not. But they weren't very bright either. What did Katrina have to do with laissez-faire? Did laissez-faire bring the hurricane upon us? Did it make the local and federal governments the wonders of efficiency that so impressed us all? Is the corruption, misuse and mismanagement of public funds, so typical of our politicians, really the way forward?
The system you described is not the system we have. The system we have now is burdensome condescending bankruptcy for the poor and middle class and easy screw-ups with million dollar rewards for millionaire and billionaire incompetent jackasses like Paulson and his friends.
humm....it's not whether to mismatch. The question is *how much* to mismatch, right?
In the end, it's doubtful that a "meltdown" was in progress. Still, we can judge that the Fed may have done the right thing, because the only time to stop a "run mentality", really, is before it begins. All the same, I'd bet that the largest chunks of "retail" money, namely 401(k) et. al., do not even have a "cash" option in their plan. Where would people have "run", then?
All the same, what about those financial advisers who have been putting their clients into insured money markets, precisely because they knew the risks and planned for them? That has cost their clients (at lot, actually), over the years. Now, it turns out "everything and the lamp post" was "guaranteed" all along? It stinks.
(Loved "second life". Looking forward to a Michael Lewis type memoir, "Living Large, My Life Off Balance Sheet".)
Wall Street figured out a way to offer long term financing to industrial companies at short term rates, with the banks getting compensated for the marginal risk that short term funding (provided by the money market funds which are the subject of the post) would dry up and they would have to step up. Eventually, the short term funding dried up in the chaos of the last year.
======
So we can add basis swaps (or others?) to the list of 'things gone wrong'?
The yield-curve is not a money pump. The yield-curve is not a money pump. The yield-curve is not ...
This is actually misleading. Since I'm not at work, I don't have defaults in front of me, but I could show you quite a few pools of RMBS, only partially subprime, with 60+ (day) delinquencies over 50%. What is your roll-to-default assumption for 60+ delinquencies?
Also, the world is too focused on subprime. Residential mortgages in general are, cumulatively, over 9% delinquent or worse. This is a record.
This article has useful summary stats. But remember, the stats are averages, and there are far worse pool and geography-specific results.
Money market inflows have stopped. The commercial paper market is shrinking, huge. The asset backed commercial paper market has shrunk 40% in two years and much of the money left there is frozen. It can't be withdrawn because it's backing is fictitious capital. People don't trust banks. So all the money being withdrawn and new money is flooding into T bills. This has been a great thing for the Treasury and taxpayers but what's good for Uncle Sam isn't good for anyone else wanting to borrow money.
The amount of credit is shrinking. Systematically we have been operating a giant Ponzi scheme as new credit was necessary to pay off old. Since Uncle Sam is the only one left who can borrow cheap now it follows that he's been tapped to supply all the new credit to the financial system now.
This week the Treasury is going to borrow 98 billion in new money. Last week it was $78 billion. That's all before the bailout comes to pass. How the markets can swallow $700 billion in new paper escapes me. The rush to safety in Treasury paper noted above has kept T bill rates scraping the ground despite the flood of supply. This cannot go on forever. Then too the long end has suddenly taken flight. While I think rates will rise even if they don't someone tell me how the economy can grow if most of the credit is going to Uncle Sam, much of it to prop up old credit.
It can't. Credit is the foundation of the economic system. The Fed and the Masters of the Universe screwed and screwed and screwed with and distorted the most important market in the world. Manipulated it and gamed it. Along the way adopting the most absurd idea that one man, The Maestro, controlled the market. An idea that is absolutely antithetical to the very concept of free markets.
What we have is debt deflation and nothing is going to stop it. What the system demands is capital, not credit. Things will shrink. The capital will come from overseas where that gigantic pool of dollars has accumulated and buy up US assets when they have deflated enough to be rational.
GirondistNYC,
You make it sound as though homeowners were the ones that benefitted most from this. Meanwhile cheap credit drove prices up and we're now seeing the "real value" of real estate. Somehow I don't think Joe Blow who purchased a house at 120% of its current value with an ARM is thinking, "Lucky me!"
The Joe Blows that bemefited are no different from the bankers that benefited: the ones that liquidated their portfolios at the right time and didn't get stuck with the hot potato.
"No, it's not fraud. It is a way of increasing both risks and returns in a fashion that has largely proven successful and is therefore accepted by many as a legitimate way of doing business. If you don't like it and want it to change, that's a fair cop and there are good arguments to be had, but boilerplate rants about fraud will see you and yours rapidly consigned to the looney bin."
Consign me to whatever delusional category you'd like, the bare facts show otherwise.
Money is a hell of a lot easier than direct barter of skills and products, but it's foolish to forget that in the end money represents that labor value.
At first banks were used to securely hold people's money, since it wasn't practical to carry around your life savings in gold everywhere. Then the bank deposit slips were traded *as if they were money*, since it saved time going to the bank for every transaction. In addition, the banks started to loan out their own money (which they received as payment for holding everyone else's money). This was so profitable some decided to loan their *customer's money* (or rather bank slips representing that money) - with the sanction of the government. Even more profitable. But it didn't stop there, and - again with government sanction - they decided to loan money they did not have (considering the money loaned out and the interest promised, as existing assets) - so that magically the *bank slips* out in circulation exceeded the actual money in those banks. People make loans, the "assets" of the bank increase, the amount of paper slips in circulation increases well beyond the natural increase in money through applying labor in the marketplace. Rinse and repeat, wait some time, and you have a mountain of worthless IOUs. When such a scheme is done without the sanction of government, it's known as fraud. When those in charge and their special interests who benefit (bankers) claim it's business as usual, the way things are done, how else can civilization advance, without fractional-reserve we'd all be living in trees, etc etc - it's legal fraud.
And the killer is people rail against capitalism and the free market for causing the problem, and they look to government to save them.
OK Megan, you convinced me. The government really is controlled by Big Business. Big Finance is wholly underwritten by me and every other taxpayer, but we don't get a share of the profits. It all goes to Wall St.
Let's see. Transfer of wealth. From one group of citizens to another group of citizens. One group benefits at the expense of another. Edumacated people tell us it's for our own good. Depression was coming. Wow. Identity politics for bankers.
Neo-libertarianism is the new socialism. Well it's not really socialism, it's just corporatism because the big government programs are benefiting Big Business not individuals in society. It's not multiculturalism, it's just rich people maintaining the their wealth at the expense of poor and middle class people. Next thing you know, libertarians will be selling indulgences.
I've been a Republican for twenty plus years. I really believed that stuff about free-markets. That stuff about "churn" and how "failure is normal in a free market." I don't believe in free markets anymore.
Oh, not in the sense that I think free markets are bad. I mean that free markets do not exist. Lets' stop pretending. Now, the central question of citizenship is how to get your slice of the socialist pie.
Megan, your argument was utterly convincing. Libertarians are liars and hypocrites. Come to think of it, so are Republicans. Nice job.
Megan,
Part of being grown up is having the measure of the monster in the closet. Yes, things were scary during Thursday; but by the end of the day the only real frightener was the state of the money market funds. That had to be sorted quickly, but I did not expect it to be a great problem.
Once money market funds were regulated and had started being used like higher-yield bank accounts, the question of what would happen if there was a run on them had to be addressed. I had rather expected the contingency plan to be that one or other Government agency would buy money market assets at a discount in unlimited quantities; so facing depositors with the option of taking less now or waiting sensibly for the funds to be come more liquid. Still the action taken should serve for now.
What did not need to be done then, and which has disoriented the markets, was go firm on an un-thought-through monster rescue for mortgage securities.
"1) Outlawing it would require massive market interventions. The vast majority of people want to borrow long and lend short."
Get it right. No one objects to that. It's borrowing short and lending long that makes the system unstable. That's because peoples plans are not coordinated.
One could set up non-fraudulent accounts for the banking system. The rules would have to be such that withdrawing your money would be a long process, which involved someone else depositing money in order for you to get yours out if you try to withdraw more than the reserve percentage. If you want to tap the part not held in reserve then you have to wait for the underlying assets to be sold to a new depositor.
Of course, doing so would require banks to charge slightly higher interest rates, and that savers be given higher rates. That's all.
It's certainly fraudulent to pay back one customer his full cash while not giving the next guy his. They have equivalent contracts and the banks shouldn't be using one guys reserves to pay out to another.
Brian Macker wrote, "It's certainly fraudulent to pay back one customer his full cash while not giving the next guy his. They have equivalent contracts and the banks shouldn't be using one guys reserves to pay out to another."
Exactly right.
But let's get real. The government WILL use one guy's reserves to pay out another. This is how it works in America today. There are no free markets. We must cease using free market analysis methods. Modern America is all about the political force one can bring to bear on one's interests.
With coercion in the picture, free market economics isn't a legitimate method of analysis.
Regarding the myth of waiting times in socialized medicine systems, cf. Germany, Switzerland and France in the OECD study:
http://www.oecd.org/dataoecd/31/10/17256025.pdf
Lefties overjoyed at the prospect of banks running out of cash...
Mmmm...delicious straw...
Seriously, what planet are you on?
But let's get real. The government WILL use one guy's reserves to pay out another. This is how it works in America today. There are no free markets. We must cease using free market analysis methods. Modern America is all about the political force one can bring to bear on one's interests.
Posted by: Jeff | September 23, 2008 9:06 AM
I'm glad you have come to understand this (if you're being serious). Free market analysis and theories may work well in an academic, theoretical vacuum, or where the political forces are aligned behind them; but when subjected to the real world of individual interest and contrary political goals, they are all too easily subverted. And there are areas such as health care where the self-correcting mechanisms that are a highly-touted feature of free markets have such unacceptably harsh effects that they really ought never to be put into a free market environment.
If you're just snarking, well, never mind.
Why is the answer to our current credit problems always to increase the amount of credit? Isn't that how we got here in the first place?
We need less credit not more!
Heh...well let's see...I've never bought a house, and my last car loan was about fifteen years ago. I didn't get student loans, because I got scholarships and went to state schools. I use a credit card for convenience but my balance is always far less than the money I have in the bank, so I wouldn't be the least bothered if the bank called it in. I work for a software company, and we make enough money that we don't need to take out loans to buy more servers or whatever.
Does this mean I'm Amish?