The best case scenario: The bad banks continue to be bought up, there is no run on hedge funds next Tuesday, only mid-sized European banks fail, money market funds keep on buying commercial paper, and the Fed and Treasury continue to operate on a case-by-case basis. Since Congress doesn't have to vote for something called "a bailout," it can give Paulson and Bernanke more operational freedom than they would have otherwise had. The American economy is in recession for two years and unemployment does not rise above eight or nine percent.
The worst case scenario: Credit markets freeze up within the next week and many businesses cannot meet their payrolls. Margin calls cannot be met and the NYSE shuts down for a week. Hardly anyone can get a mortgage so most home prices end up undefined rather than low. There is an emergency de facto nationalization of banks to keep the payments system moving. The Paulson plan is seen as a lost paradise. There is no one to buy up the busted hedge funds, so government and the taxpayer end up holding the bag. The quasi-nationalized banks are asked to serve political ends and it proves hard to recapitalize them in private hands. In the very worst case scenario, the Chinese bubble bursts too.
Tyler notes "I still think some version of the best case scenario is more plausible, but I wish I could tell you I am sure."
I'm not sure I have a good p-value on the worst case scenario. More importantly, I'm not sure how to weight risks with small probabilities but catastrophic consequences--an issue we've been struggling with in assessing climate change action, among other economic policy questions of the day. If there's a 5% chance of the above scenario, how much should we be willing to pay to avoid that risk?
It is worth noting, in answer to the libertarians who are wary of government intervention in the economy, that if there is a serious crash, we will get even more government intervention in the economy--and intervention that is much less to our liking. That cost has to be weighed in your assessment. On the other side, to those who are averse to bailing out Wall Street rather than Main Street, it's worth noting that Main Street will suffer worse than Wall Street. Because of the way that their compensation is structured, Wall Street bankers tend to do things like buy their houses for cash.
Megan....
Wall Street IS Main Street.
You and Tyler talk like they are separable.
I don't think the question is how much one would pay to avoid a 5% risk of the worst case scenario. As I understand it, the question is how much one would pay to perhaps diminish that risk to some unquantified and unknowable degree. Possible diminution is certainly worth something, but it's not worth nearly as much as avoidance.
What's worse than giving near dictatorial economic powers to the executive branch? Really?
Q: when the credit system seizes up, how many companies can't meet their payrolls? I am ignorant of how most companies hold the cash they need to pay salaries.
But that particular threat might help make this situation more concrete to the average folks who've been opposing it.
I think the 'worst case scenario' is totally unrealistic and that it is getting fairly close to irresponsible to push this idea, there is a lot of concrete information about how psychology affects the markets...if you keep telling people that the global economy is going to crash, you increase the chances that it will.
As I write, the S&P is up 3.22%, the dow is up 2.5%.
Now, maybe there is a crash coming, but it will be really hard to pin on the rejection of the idiotic bailout. Why? Talk a look at the S&P charts for this and last year. We have been in a bear market since Nov 2007. No doubt pundits and historians will construct a narrative about how a short-sighted congress, yielding to public pressure, pursued a short sighted policy of not giving investment banks large wads of cash. Put it will be about as accurate as blaming the Great Depression on Smoot-Hawley.
"On the other side, to those who are averse to bailing out Wall Street rather than Main Street, it's worth noting that Main Street will suffer worse than Wall Street. Because of the way that their compensation is structured, Wall Street bankers tend to do things like buy their houses for cash."
So heads I win, tails you lose?
Short term or long term? A large number of companies finance their payrolls in lines of credit or short paper. The same companies often finance their receivables the same way. If those companies lose credit, they lay off and default on their payables. Then the people they owe money to suddenly have problems. Normally, those people would finance sudden unexpected defaults, but of course they can't, because people are shutting down new credit.
But If the markets go any further south, payroll problems will start hitting pretty soon.
Megan, your second point is too much overlooked. The "socialism" of the bailout opponents will look like a Hayek-ian paradise compared to what we'll get if the system crashes, the economy contracts, and unenmployment suddenly doubles. That's basically the scenario that wrought the New Deal in the first place.
Of course, the system may not crash; and if it does, the economy may not contract much. But lots of highly sophisticated economists and financiers are terrified that it might. Count me among those who don't want to take the risk.
Eddleman
Megan, thank you for posting this. Two questions:
1. The absolute worst-case scenario seems to have global consequences. Are any governments other than ours considering some sort of bailout?
2. Credit markets freeze up within the next week and many businesses cannot meet their payrolls.
If this is the main fear then wouldn't a far more direct (and thus, I claim, better) solution be an emergency bridge wherein some government agency issues very-short-term loans?
On further blog reading, Virginia Postrel posted the best (IMO) solution three days ago.
"Having helped create the problem, the Treasury could alleviate the credit crunch either by lending money directly or by guaranteeing loans--either of which should be done at some potential profit to the taxpayers. The goal is not to protect lemons but to give firms that know they'll be able to service their debts a chance."
Megan,
These bailouts will further the fundamental problem of too easy credit- a problem that will lead to the worst case scenario regardless, and from a starting position worse than the one we are in today. I would rather fight this problem now rather than later when we are much weaker and poorer.
Of course you don't have a good p-value, that's why it's called "uncertainty". Trying to put a value on it is a perversion of the concept.
Megan, great point re libertarian opposition. That's why I think the Republicans' vote against was super-risky, though now it appears thatDodd is considering a similar version of what they wanted all along (have FDIC provide insurance). But, it could have backfired with Pelosi giving them all the finger and getting all the Dems to vote for a bill that would have forced Goldman and Morgan to sell themselves to ACORN in exchange for a Che T-Shirt and bits of string.
If the credit market seizes up, then take the $700 billion and loan it to banks interest free on the condition that they immediately loan it out in short term lending. The credit freezing up argument doesn't make a damn bit of sense. Credit froze up during the depression because we had sustained deflation. If you can make 5% by just keeping your money, why loan it out? Further, if you can make 5% by not spending, why spend, especially if you are uncertain of the future. None of those things are happening now nor will they happen any time soon. There are huge supply side injections into the economy like Social Security and government spending and such that will keep people spending and create demand to an extent that never happened during the Great Depression. Further, there is no danger of another Smoote Hawley. Markets are much more open than they were in 1930.
The bottom-line is that unless we have a major case of deflation, banks have to lend money to make money. The idea that these loses are going to cause them to stop doing that or that a federal injection of cash wouldn't solve the problem is ludicrous. This is not going to be 1933 all over again. Megan is quickly becoming like that passenger in airplane who freaks out and everyone stands in line to slap her and tell her to get a hold of herself.
I have turned against the "bailout." The very people who it is meant to protect are the ones most against it, mainly out of envy. They have no clue how bad this will hit them. And let's not forget that the "toxic" assets are toxic because they're backed by the creditworthiness of the American consumer. I'm glad I'm not retired or a baby boomer... prime working years reach into the 80s now.
BTW, McCardle revealed her true colors supporting the Pelosi/ACORN bill. Repeat after me -
"THERE is no coming depression if we don't do a bailout".
Repeat the mantra. Fight the fear-meme.
Michael - so it's the lowly American consumers' fault? Not the greedy bankers who leveraged themselves 80:1 in some instances on mortgage securities because 15% return wasn't enough. Why must we bailout greedy bankers and Wall St execs?
Megan, are you telling us that many companies do not keep enough liquid cash or securities to fund two weeks of payroll? That seems ludicrous. Companies that are borrowing money to meet payroll are already companies that are close to bankruptcy. And any bank that loans money to meet payroll without underlying assets, cash flow, contracts, etc deserves to go under.
But missing payroll is the last action of a desperate company. They will delay vendor payments, interest loan payments, stock dividends and any other corporate outgo before they miss payroll. All of the actions provide weeks and months to establish alternate credit sources. Maybe the new sources are a little more strict in their lending guidelines, but that's the point, isn't it?
For 8 years, people have stated that Bush & company are dumb. They didn't wake up smarter last week. Let the collective wisdom of 300 million plus people work this out.
Here's my worst case scenario:
Bailout happens. Inflation increases, but home values continue to decline and wages remain flat. Home owners, with budgets already crunched beyond expectations, are burdened with even higher costs of living and default risk increases greatly. Defaults increase and home prices fall more. The bailout causes the interest rate the government borrows at to go up, moving money away from businesses and causes banks to expect higher interest rates from home buyers, puting further downward pressure on home prices. Scared money also goes from home and business loan to continuously roled over long positions on commodities, which people expect production not to increase for but demand to remain. Prices go up relative to income, and default risk goes up.
Zoot,
She is telling you something even worse. Megan is trying to claim that a profitable company with good assets won't be able to find someone to loan them money at any reasonable interest rate. That is just crap.
Hello Megan, it is the Penn MBA Department calling, they want their degree back.
There's a very low probability that Canada will launch a sneak attack on us and take DC with their superiorly trained mounted police force. Therefore we should spend $700 billion to attack them first and hopefully we will regain the costs through appropriating whatever resources Canada has left after the invasion.
Ok, so that was a silly example to demonstrate what can happen if you take low probability events too seriously.
In reality, I the bailout is bad in the sense that the $700 billion can be used to inject cash into to financial markets if we need to in the future, but not if we blow it all now on worthless securities.
What I find so strange is that all of a sudden the Bush Administration has become a font of wisdom. Paulson says we gotta have $700 billion and the Democrats fall all over themselves to accomodate him? He's the same guy along with Benake who said that the sub prime mortgage crisis was no big deal and wouldn't 'bleed' into the rest of the economy.
I would think a smart person, based on the track record of the Bush Administration, would oppose anything Paulson initially says and assume its completely wrong.
Q: when the credit system seizes up, how many companies can't meet their payrolls? I am ignorant of how most companies hold the cash they need to pay salaries.
Companies small enough to rely on local and regional banks will have no problems, because the small-time credit system is working just fine. Banks throughout the country have adequate deposits and are making loans--including mortgage and car loans--at quite reasonable rates. The problems are all concentrated in the big guys who were heavily into securitization and derivatives. So the companies with problems will be the correspondingly large ones who either 1) require the kind of massive loans only big banks can provide or 2) are heavily into their own form of securitization, such as selling receivables on the commercial paper markets.
I'll readily admit that I don't really understand what's going on, but I don't trust the claims of crisis. I'm looking at buying a house right now, and 5.25% 5/1 conforming ARMs (or 5.75% conforming 30-year fixed) are widely available from sound local banks and brokers. None of them are at all worried, probably because they are all reasonably profitable and liquid. There are even non-conforming loans available, although not the crazy neg-am stuff Countrywide used to push.
This doesn't look much like a nationwide credit crisis to me; it looks like a few really big (and really stupid) banks who deserve to fail.
Do the numbers justify all this doomsday talk?
30 year mortgage rate as of this writing is 5.91% (Wall Street Journal Rate Center). That doesn't seem to indicate a credit crunch. What am I missing?
Worst case scenarios and acceptable risk give a veneer of rationality to what is still essentially ideological prejudice. Could we ever get a 700 billion dollar package to fight climate change?
Megan's argument is that we shouldn't be vindictive against the parasitical Wall Street institutions that lend us the money we need, because we won't be able to borrow money without them. Perhaps we should consider reorganizing our lifestyles in such a way that we aren't beholden to them to begin with.
There's a class war element to this. I don't yet own a home. I make decent money, but don't want to accumulate a lot of debt. Tightening credit and falling house prices are, frankly, completely in my interest - and in the interests of a lot of people who aren't yet homeowners. There could be other benefits to moving to a cash-centered economy in which over half our income goes to housing, particularly for the lower-middle classes and below: it could increase their discretionary income. But these sorts of possibilities are off the radar of those afflicted with the Ricardian vice.
I think a large part of the problem with the bailout is that (AIUI) it's trying to avert not just the worst-case scenario but also the coming recession. It seems to me that a recession is necessary. The financial system has become over-leveraged. That needs to work it's way out and bad debts need to be realized. It will be painful, but it becomes more painful as we keep postponing the day of reckoning.
Which is not to say that no intervention is necessary, but it should be focused on easing the failure, not simply avoiding it. The AIG intervention seemed a reasonable model. I don't see the need for the Fed to become the general buyer of last resort, and that strikes me as a plan that can have a much greater downside. I've heard numbers in the $10's of trillions on outstanding debt. If the Fed is a no-questions buyer of last resort, what happens when the Fed becomes illiquid? Given the magnitudes involved, it could happen.
Have you given any thought to the worst-case scenario of the bailout? It's not just a matter of avoiding the worst-case scenario; it substitutes a different one. The bailout plan was financial shock-and-awe. What happens if it didn't work?
One thing that just hit me at lunchtime: Where is the government going to get this magical $700 billion? The Treasury doesn't have it laying around in a sack under Mr. Paulson's office. The government only has 2 ways to get that $700b:
* Sell Treasury paper on the open market (or more likely straight to sovereign funds and central banks). M2 right now is around 7.7 trillion dollars (US style). 700B is around 9% of that. If you believe Shadow Stats, M3 is around 14 trillion. $700b is 5% of that. How are the money markets supposed to react to 5% of the total supply of dollars suddenly being pulled into Treasuries?
* Have the Fed "buy" the Treasury paper with new money. How exactly is inflation supposed to react if we magically increase M2 by 9%? Fed-printed money is supposedly M3 (i.e. doesn't really count), so the whole justification in inflating the crap out of M3 was that it didn't leak into M2. Making M2 jump 10% in a matter of days just can't be healthy. Sounds a lot like Weimar Germany to this Packrat.
Neither option makes a lot of sense to me, and the latter sounds downright painful. I'm almost suspecting that a natural deflationary recession would be better for us all.
There's a class war element to this. I don't yet own a home
I don't own one anymore, but I did make good money off the bubble and now I'm sitting on a nice nest egg and waiting for the market to hit bottom before I buy again.
I would feel like a Snidely Whiplash housing profiteer taking advantage of orphans in rags except that the damn prices in Portland are refusing to drop enough to enable me to live my dream of buying up a whole cul-de-sac and establishing a compound*
*(Defined by the media as any single-family home on more than 1/2 acre containing at least one conservative and one firearm)
Rob,
You evil bastard. Haven't you listened to Megan, that lifestyle is just unsustainable. You need to be an adult and move into an efficiency, buy a bike and go vegan.
The prices in DC won't fall either outside the real outer burbs. It is killing me. I don't have your nestegg so my chances of having a compound are going down. Fortuntely I have already bought my firearms though.
I think the 'worst case scenario' is totally unrealistic and that it is getting fairly close to irresponsible to push this idea,
Libertarian, are you arguing that the worst case scenario cannot happen, and that it might happen if we even discuss it?
How about this idea? Before bloggers start throwing around words like "Depression", they have to crack a book and make at least a post or two on the actual depression and the causes of it.
You need to be an adult and move into an efficiency, buy a bike and go vegan.
How will I sustainably raise hemp-weaving chickens and grow organic vegetables with their manure in an efficiency?
Here's my best case: Nothing is done. Banks, afraid to lend to eachother and faced with watching their assets depreciate, loan to good borrowers with higher down payments or collateral and lower interest rates. Portions of loans with 6% or higher interest rates are refinanced at a lower rate, probably around 4%, on the existing value of the house or other collateral, the owner must pay the portion of the principal not covered by the current value of the house at existing terms, but the current rate is locked in. Owners deemed too risky at the new low rates default. Some banks holding mortgage backed securities that are dependant on the cash flows on the portion of the loan refinanced and on defaulted loans go bust. The assets of failed banks are sold off and the debts are nationalized. Inflation is kept in check, so costs of living do not increase relative to income, so default risk goes down. Commodity production increases to take advantage of recent rises in prices, continuously rolled over long positions on commodities are seen as untenable long term investments. Money is moved away from commodities, and prices of consumables fall. Default risk further decreases and some risky assets become valuable again.
"How will I sustainably raise hemp-weaving chickens and grow organic vegetables with their manure in an efficiency?"
That is what rooftop victory gardens are for and since the chickens must be free range, it will be up to your neighbors to let them roam the halls and their appartments.
You know I would love to move next door to Megan with a bunch of chickens and plant some rediculous container garden on my deck. She is such a prissy snob, she would have a heart attack, but be too PC to ever say anything to you about it.
Rob, what do you think of this post?
It should be noted that Fannie and Freddie are still operating as wholesale consolidators and providing, along with the Home Loan Bank system, very much as much housing credit as the market seems to need. The problem in housing is in part that the lending standards by the originators have tightened,appropriately, and the no-down programs, public and private,have vanished.
Farm lending is equally protected by the existing agricultural lending programs.
And, as your writers point out, businesses that are financing payrolls on short term lending are already in trouble. These firms are probably also not making their tax payments and will soon be in the hands of the IRS
What we haven't heard about is the status of the credit card issuers and their ability to finance their flows of funds. As long as they can continue to fund their needs, and their lending margins on balances should allow them to do so, the system should continue to work for most individuals.
The key is going to be in industrial and commercial lending, by firms such as CIT and GE.
Let us not forget that many of the people who are predicting this disaster told us that Saddam Hussein had WMDs. They had more evidence of that than they have this time around, though. And they've admitted that Paulson pulled the $700 billion figure out of the air.
Tell me again, please, why we should believe either in the crisis or in the Treasury's secret plan to resolve it.
Nothing justifies the doomsday talk, but McArdle continues with it. I guess it generates more hits. Very cynical ploy if you ask me.
"Nothing justifies the doomsday talk, but McArdle continues with it. I guess it generates more hits. Very cynical ploy if you ask me."
I don't think she is cynical. I think she is stupid. I don't think she really knows very much about what actually caused the great depression so she falls into whatever is the media conventional wisdom. For while she was making some sense. But lately she has just been sock puppeting whatever she hears from other media outlets and not really thinking too much. I think doing so might make her head hurt.
What I find somewhat surprising is that so many politicians don't seem to have recognized this little detail: Most people's pensions (or IRAs and 401(k)s or whatever) are invested in the stock markets. And there are a whole lot of Baby Boomers who are getting right close to retiring currently.
So suppose the fiscal crisis results in a lot of companies going down because they can't get the short term financing to pay their bills. (A scenario mentioned above.) Then a lot of people, in the biggest demographic of voters, are going to suddenly find their retirement plans will have to be massively revised. And at the last minute, too. This is not going to make for happy campers.
If I were a politician, the last thing I would do is fight any possible bailout. Propose alternatives? Sure. But demand things that simply won't happen? Not a good way to get reelected -- not to mention what you do to your party and your governing philosophy. Just because you get a government pension doesn't mean your constituents are similarly safe.
The problem with Tyler's worst-case is that the Chinese bubble is deflating with or without the help of the US crisis. Real estate prices in secondary cities have been declining since January. Meanwhile, in Shanghai and Beijing, real estate transactions - not prices - have dropped by more than 50% over the last couple of months, but without a simultaneous decline in prices. Not good.
The Chinese government has injected more than US$300 billion into its corruption-ridden banking system since 2002. In fact, it happens on a fairly regular basis. The only difference between, say, 2002 and 2008, is that foreign banks have exposure to the declining Chinese market. HSBC and Citi come to mind. And let me tell you, some of the real estate loans that have been made by those organizations make US sub-primes look like AAA. Brace yourselves.
I've been thinking the same thing as Kentucky Packrat - to get the $700b to buy the assets up, the government is either going to need to sell t-bills or make the money out of thin air. The former seems like trying to fill up the shallow end of a pool by pumping from the deep end as far as worries about money being available for bonds goes and the later will cause inflation. A major increase in inflation expectations could end up being very bad news if it causes a collapse in foreign investment in dollar-denominated assets. If that happens, we'd have to raise rates to bring down inflation expectations at the same time the credit markets are locked up from the withdrawl of foreign investment. It seems like there is a very serious risk in overreacting.
Kentucky Packrat:
I had the same thought.
Option 3 is a direct swap of bad MBS for T-Bills. It's the only politically viable way it can be done in the short term. Of course, that really is just a drawn out version of Option 2....letting the Fed print the money.
John, a) I have never urged everyone to move to Manhattan and b) I come from a family of farmers and love chickens; Great-Grandpa Taylor was a chicken farmer. Just properly dispose of your waste and don't invite me over to clean the coop, and I'll be more than happy to have you and your chickens next door. Though to be honest, I prefer cows, into which the Taylor family has since diversified.
"John, a) I have never urged everyone to move to Manhattan and b) I come from a family of farmers and love chickens; Great-Grandpa Taylor was a chicken farmer. Just properly dispose of your waste and don't invite me over to clean the coop, and I'll be more than happy to have you and your chickens next door. Though to be honest, I prefer cows, into which the Taylor family has since diversified."
My family are cattle ranchers and I wouldn't have chickens for love nor money. But if I did, my chickens have to be free range. No coops here, except for them to roost in at night and I will clean those. So they will have to range all over your building. No, you haven't urged everyone to move to Manhattan, but you certainly had that awful post about how we all had to be "grown ups" and stop our unsustainable ways of life. All the while world tempatures dropped 0.7 degrees in 07.
What about the odds for the scenario where we pass the bailout, the government drops the money, and it still isn't enough? What makes 700 billion a magic number?
Or do we want to test that theory about how long markets can remain irrational using the entire US treasury?
I've been thinking the same thing as Kentucky Packrat - to get the $700b to buy the assets up, the government is either going to need to sell t-bills or make the money out of thin air.
My God, someone actually gets it! This is all smoke and mirrors. What did you think? The Treasury is going to tax every household $5000 to pay for the 'bailout' as we are going to a recession? That Uncle Sam would take money from the hoard he has accumulated over the last 8 years? Oops, there is none -- quite the bloody opposite.
No, this was about the Fed pressing a button, 'creating' assets, and then funneling them to connected clients to 'clear' balance sheets. As it is, the Fed and other central banks (if only we had a responsible central bank!) 'pumping money' into the system. I.e. creating reserves out of thin air and distributing them. The difference is, Paulsen needs authorization to distribute money --maybe that should be 'money' --targeted at connected firms.
But if I did, my chickens have to be free range. No coops here, except for them to roost in at night and I will clean those. So they will have to range all over your building.
By the looks of things around these parts, you've already gotten started. I see John-monogrammed chicken offal all over the prissy Mlle. McArdle's hallways, and hear petulant cackling to match. Fortunately, we mice are okay with that. In addition to their less-pleasant habits, chickens tend to scatter a lot of mouse-compatible food around.
Better watch your claws, though. I hear that if she gets overly provoked, she sweeps away noisy, filthy chickens with a broom-by-four.
"I'm not sure I have a good p-value on the worst case scenario."
Ironically, neither did the banks making many home loans, or purchasing MBSes. 'Tis a hard problem.
There's no such thing as an atheist in a fox hole a free marketeer in an economic crisis.
Excuse me, that should have read:
There's no such thing as an atheist in a fox hole a free marketeer in an economic crisis.
Dang html.
Industrial Companies Can Thank Banks for Lower Rates
This isn't just a default risk issue. These idiots were probably also betting that they'd barely ever see any balloon payment from subprimes, or certain levels of interest from variable rates.
Dude, if you're this ignorant of chicken behavior, you shouldn't accuse me of out-of-touch elitism. A) I live in a third floor walkup, and chickens are not known for their fondness for aerobic excercise on food-free surfaces. And B) If you let your chickens range free in the street, I won't need to worry about their mess, because you'll lose the entire flock to cars within 18 hours. Chickens are not known for their cleverness at avoiding cars. Or were you planning to tunnel through my walls? Careful, as the relevant walls are structural for the houses on either side of me as well as my own. They're good old-fashioned brick victorian rowhouses. Also, my dog will kill your chickens. But otherwise, go ahead.
Nelson, very nice. Gives me hope for my best case scenario. Maybe interest rates will fall low enough that solid companies will borrow to buy stocks people cut and run on.
Or lend to them.
Them being the companies of the stocks.
Nice. I have been called lazy and dumb by the hostess, and threatened with death by dog drool.
"Dude, if you're this ignorant of chicken behavior, you shouldn't accuse me of out-of-touch elitism. A) I live in a third floor walkup, and chickens are not known for their fondness for aerobic excercise on food-free surfaces. And B) If you let your chickens range free in the street, I won't need to worry about their mess, because you'll lose the entire flock to cars within 18 hours. Chickens are not known for their cleverness at avoiding cars. Or were you planning to tunnel through my walls?"
I am not ignorant at all of chicken behavior. It was a joke. I fully realize they don't roam where there is no food. As far dodging cars, I have never seen a chicken hit by a car and they are everywhere in Key West. As thickly populated as Key West is, there wouldn't be a chicken left, if they couldn't dodge cars. Further, my grandparents had a real chicken coop, as opposed to a chick farm and their chickens roamed and never seemed to get in the road or get hit in the yard by cars or pickups. I suspect if you let a flock of chickens lose in DC, they would scatter and probably do okay, sans a few that were hit in the road.
Yes, Megan you are totally out of touch elitist. The fact that you once went to a farm, is the equivilent of saying "some of my best friends are black".
arron, you're brilliant! We can turn MSFT into the world's biggest ABCP conduit with four day paper!
Also, my dog will kill your chickens
Careful there, I wouldn't be surprised if there was a law in your area that says if a dog kills livestock it can be put to sleep. I know it was that way where I used to live, but I could see a city not having a law like that on the books.
Who Pays?
The credit market has already frozen up. The stock market is a side show. Soon after the bailout passes, which has to be rated as a 75% possibility and a sad sad day for whats left of the tattered remains of the Republic, the stock market and the Treasury market will crash.
The US Treasury market is the last bubble.
This is hard to sort through but listen to the Treasury guys Sunday night talking to the Securities Industry and Financial Markets Association on a conference call. The public, congress and the press not invited.
They happily explain away every limit built into the compromise bill. Saying the law will be ignored. High fives all around.
http://www.nakedcapitalism.com/2008/09/mussolini-style-corporatism-in-action.html
What would happen if China begin to sell U.S. treasure bonds? I think that would be a K.O.
The Chinese Central Bank cannot sell their Treasury holdings. All foreign central bank holdings are in fact held in accounts at the Fed and are officially called Custody Holdings. It's a fact, never tested but a fact, that the Fed would not allow these holdings to be sold at the market in any significant amount.
The FCB's do not have to sell their holdings in order for the market to implode. All that is necessary for a dislocation in the Treasury market is for the FCB's to stop buying.
The US Treasury market is the last bubble. Like all bubbles the timing of its demise is impossible to predict. However like all bubbles its demise is an absolute certainty.
The worst case scenario above is laughable to the point of inanity. Of course it was written this morning. A few things have changed:
1) The SEC has clarified the mark-to-market rule, allowing companies to value their securities as level 3 assets, instead of $0. This should increase liquidity
2)The FDIC is increasing the insurance limit, which will cause fewer people to pull their money
3) the 'bailout' will pass with added tax cuts and other incentives.
4) Even if the credit market is frozen, there will always be a market for lending money to someone willing to pay interest. just ask the mafia.
However, this was written tonight: "The credit market has already frozen up. The stock market is a side show. Soon after the bailout passes, which has to be rated as a 75% possibility and a sad sad day for whats left of the tattered remains of the Republic, the stock market and the Treasury market will crash."
Chicken little, don't you know that's just an acorn? Or have you been reading too much "clusterfuck nation"? James Howard Kunstler can go kill himself.
NYT reports this morning credit woes are already getting close to threatening the pocketbooks of people who work for (or do contract work for) for state and city governments.
“We really are in terra incognita here,” said Robert O. Lenna, executive director of the Maine Municipal Bond Bank, which helps that state’s towns and school districts raise money. He said he had worked in public finance for 34 years and had never seen credit evaporate so completely. Maine had already begun some of its road work when the bond markets stopped functioning, so now it is scrambling for bank loans to keep the dump trucks rolling. If money does not start flowing soon, Mr. Lenna said, Maine will have to cancel some of its road and bridge projects.
IIRC two of Maine's House reps voted against the "rescue" bill. I imagine news like this might start to change their minds. How many regular Joes work road construction in Maine? How do they vote?
Chickens are not known for their cleverness at avoiding cars. -- MM
I have never seen a chicken hit by a car and they are everywhere in Key West. -- John
I believe we may be talking about different kinds of chickens here. Both in West Africa and Hanoi, as John says, chickens are everywhere, and are rarely or never hit by cars. But these are what the West Africans call "poulet-bicyclette" and the Vietnamese call "ga huong": free-range, muscular, independent chickens, used to pecking for themselves in the streets. I imagine that the overstuffed, genetically obese poultry usually raised in the mainland US might be less capable of figuring out how to get out of the way of motor traffic.
-- Your Bipartisan Conciliator, Brooksfoe
IMO, a big question is whether or not the credit markets are frozen, and if so, whether the Paulson plan (or some new derivative thereof) will actually accomplish anything.
It seems that government meddling in the housing market is largely, but not wholly, responsible for the housing bubble and it's eventual popping. Why should we have faith in a massive government bailout plan?
Why not repeal the mark-to-market accounting requirements and the entire SOX under-the-table corporate tax and see if that frees up the capital markets before committing $700B in taxpayer dollars to a questionable bailout plan (order before midnight tonight and get a free set of Ginsu Steak Knives).
Ok.
MV = PQ
M = the money supply
V = the velocity of money or how much that money changes hands
P = the price of all goods and services in the economy
Q = the quantity of all good and services in the economy
When there's a panic, V goes toward Zero as everyone reduces spending, as banks stop lending, as companies can't borrow commercial paper to pay payroll, as less goods are sold, as wages go down . . .
I guess I'm one of the libertarians that you're talking to. 1) I don't think there is an economic crisis -- there might be a financial crisis, but that's not the same thing. 2) I'll be damned if I'm going to be railroaded into supporting the massive government intervention that has (of course) been proposed. Wake me up when there is a real crisis. 3) The long-term trend in this country (and elsewhere) is in the libertarian direction.
Tell me again why I should run around like a chicken with its head cut off. I must have missed the point the first time.
The credit market has already frozen up. The stock market is a side show. Soon after the bailout passes, which has to be rated as a 75% possibility and a sad sad day for whats left of the tattered remains of the Republic, the stock market and the Treasury market will crash.
The US Treasury market is the last bubble.
This is hard to sort through but listen to the Treasury guys Sunday night talking to the Securities Industry and Financial Markets Association on a conference call. The public, congress and the press not invited.
They happily explain away every limit built into the compromise bill. Saying the law will be ignored. High fives all around.
http://www.nakedcapitalism.com/2008/09/mussolini-style-corporatism-in-action.html
Posted by rapier | September 30, 2008 8:47 PM
Are the credit markets frozen?
From Bloomberg.com
The London interbank offered rate, or Libor, that banks charge each other for such loans climbed 431 basis points to an all-time high of 6.88 percent today.
The Libor-OIS spread, a gauge of the scarcity of cash, also increased to an all-time high.
The seizure in the credit markets is tipping lenders toward insolvency, forcing governments to rescue five banks in the past two days, including Dexia SA, the world's biggest provider of loans to local governments, and Wachovia Corp.
V is going toward Zero. Now, let's think about what to do.
Note to Joe: V (the "velocity" of money, i.e. the rate at which money changes hands) never goes to zero or anything like it. 99% of the economy is cash-based, and totally immune to the nightmare scenario that you'd like us to believe. I could personally survive quite well without credit, as could the vast majority of Americans, who would be at worst slightly inconvenienced. I doubt the validity of your silly "equation", too.
Another note to Joe: Wachovia was bought out by Citigroup, which is not (as far as I can tell) an arm of any government. If you're going to scare people with terms like LIBOR, perhaps you should first explain that the L in LIBOR stands for London. The LIBOR fixing is an agreement among a dozen or so London banks to establish a fixing (break-even) price for Eurodollars, which are not U.S. dollars. It is relevant to the interest rate swaps market, but little else, and even that is just an informal agreement, not a rule. The fact is that no bank, not even the contributors who help to establish LIBOR, are bound in any way by the LIBOR fixing.
Eurodollars have existed for about 40 years now -- they are essentially a way for foreign banks to get around the requirement of the U.S. market that dollar-denominated transactions be backed up by actual sovereign U.S. dollars. Oil worldwide is priced in Eurodollars. It allows foreign countries to pretend that their dollar-based transactions have some basis in reality, which they only do through the courtesy of the United States. This courtesy could of course be withdrawn at any time, which is what really scares foreign financial institutions.
Pink Pig:
You say: "99% of the economy is cash based."
But you must have heard that people have mortgages and credit cards. Personally, I almost never use cash, and though I pay my credit card balance in full every month, many people don't. These people are living on credit, not cash.
And MV = PQ isn't "my" equation. It's one of the basic equations of macroeconomics, and if you think about it, you'll see that the equation is necessarily true.
Anyway, I sincerely wish you good luck.
But, honestly, do you know the extent to which you understand what's happening?
Pink Pig:
You think the problems at Wachovia and Washington Mutual aren't a sign of any problem? How about National City Bank? Sovreign Bancorp?
What about what happened to Lehman Brothers? Bear Stearns?
How many banks should fail before it becomes a problem that concerns you?
What if all of the banks made bad subprime mortgage bets?
I suppose it would be "fair" for those "stupid" banks to fail.
I don't personally know many people who have money in banks. But the federal government "insures" those deposits, right?
But you must have heard that people have mortgages and credit cards.
Last I heard mortgages were fairly easy to come by and at low interest rates by historical standards. Of course, you need more than a pulse to qualify but that's what got us into this mess in the first place. I'm still flooded by credit card offers, so it seems like there isn't a lack of money to be lent to qualified borrowers.
What we are seeing is a contraction of credit, but credit was so heavily extended in the last few years I don't see any other way it could go. Unless you want us to start lending to unqualified borrowers again who will never pay back the money.
JordanT: "What we are seeing is a contraction of credit."
Yes.
Some people assume that the market always functions well if left alone. Of course, the market in the United States has not been left alone. Government incentives to give subprime loans is one example.
I think the question is: Is the market 1) functioning or 2) are we in a panic situation where supply and demand are not determining choices and everyone is looking around and doing what everyone else is doing (example: I pull my money out of the bank because my friend did ... etc ... until collapse). Or: pension funds pull money out of the Money Market Funds because other pension funds are doing so.
If we're in #2, and the market isn't functioning, then government intervention would be called for.
On the other hand, if this is a normal market correction, as you suggest, then nothing should be done.
I note only that we don't have a true market, because the government has always been and continues to interfere with it. Does that justify further interference when there's a collapse? Maybe it does.
On the other hand, if this is a normal market correction, as you suggest, then nothing should be done.
If the government wants to reduce panic, then going on TV repeatedly and telling us that the financial system is about to collapse is hardly the way to go about it. Unless they want to scare us into giving $700B to banks when they really don't need it. We've been far too quick to be scared and pass hasty legislation to our ruin over the past 8 years.
What we are seeing is a fairly normal market contraction, call me when lending is starting to become more difficult than it was 10 years ago and I'll agree banks are panicking. However, when we're just rolling back the lending insanities of the last few years I'm not going to panic.
As a libertarian i'm conflicted as well. But then again, its a bit late in the day to debate seatbelt laws when you are hurtling towards the windshield.
Thing is, we all know Washington (right and left generally) THRIVES on 'crisis' to expand their powers. Its a boy who cried wolf syndrome. But in this particular case, the wolf may actually be here, and we're talking Carcharoth (for Tolkien utlra-nerds).
Its our own fault in a lot of ways, and particularly so-called small government conservatives over the last 30 years that have been anything but. Essentially it seems way too late to take a Pompey-like stand. What good is staking principle as suicide? This battle was lost years ago. There are times when too late is worse than never.
According to the article I linked above, the credit markets still work, and better than ever for manufacturing and retail companies.
The only problem is lenders in the financial sector don't really trust borrowers in the financial sector to pay them back. So they lend to manufacturers at lower than normal rates and wall street firms at higher than normal rates. This is just the market at work. It also means some wall street firms will fail, which is why they are screaming for a bail out as if the world will end. For them it will. For the rest of us, life will be just fine.
Save the $700 billion, and see how things unfold. If the only harm is losing a few wall street firms while real economy firms can still get credit the government should do nothing. And if things for some reason do turn south for the real economy firms, help them out directly and ignore the financial firms who made unwise decisions.
The claim that companies do a lot of short term borrowing is complete and utter lie. Most banks run on a cash basis. In 28 years of my adult life, I've never worked for a company that didn't meet payroll out of their bank account. I've never worked for a company that ever got a short term loan--hell most couldn't even get long term loans. This is yet another lie the socialists are telling to scare us.
Congress can do dozens of things without causing hyperinflation by dumping $2 trillion into the economy (if you think this will end at $700 billion--a totally made up number by the way with ZERO basis in facts--you are just plain dumb.)
I think part of a worst case scenario is that we don't fix problems with overextension of credit and the whole mess happens again in a few years.
I have a friend arguing against for the notion that the CRA from the Clinton Admin caused most of the problems. Presumably that means any 'best case scenario' would require the repeal of that act. I'd be interested to hear countervailing opinions.
tim.2wgroup.com/blog/archives/001911.html
tim.2wgroup.com/blog/archives/001909.html
He also argues that the Republicans were pro regulation and the Democrats opposed to regulation, outside of Clinton's version of the CRA which wasn't exactly free market.
tim.2wgroup.com/blog/archives/001908.html
In any case, I don't see why Americans couldn't borrow from other countries. What barriers prevent foreign firms from stepping in if there's a meltdown of US firms. Or is the US engine just so huge that that isn't possible.
Correction: "Most companies run on a cash basis."
(Though most banks are healthy and are loaning money at very good interest rates. A friend of mine is getting a house loan right now. A neighbor just got one. Yeah, real crisis.)
From one Joe to another Joe:
You say, "Most companies run on a cash basis."
But lots of companies, such as McDonalds and other healthy enterprises, borrow money to smooth out the cash flow valleys month to month and use this borrowed money (commercial paper) to fund operations, including payroll.
Even if "most" run on a cash basis. The portion that uses commercial paper is a significant part of the economy.
Commercial paper used to be seen as just like cash. Then the asset backed commercial paper market imploded. Many of the 'assets' held by the issuers were fictitious capital. Over the last year it has shrunk 60% and much of the remaining 40% is there because they are trapped. The issuers won't redeem for cash. They are forced to accept long term promises of workouts.
Money markets used to be seen as the same as cash. As the funds assets deteriorated more money kept flowing into them, masking the problems. Now the Fed has stepped in to back them with %50B but that's just the tip of the iceberg. People will be withdrawing not because of fear of loss but because they need the cash. Another huge source of short term credit for the system will start shrinking.
Every flavor of CDO was so liquid that they seemed almost the same as money. They had a quality that has been called moneyness, a close cousin of truthyness.
The forces of deflation have now ravaged the world of paper assets,and will continue to. That deflation really took hold at the exact moment that commodity inflation had a big pop. The competing forces in the mostly separate worlds, Wall Street vs Main Street have confused things mightily in peoples minds.
"if there is a serious crash, we will get even more government intervention in the economy--and intervention that is much less to our liking"
The essence of modern governance: do what I want you to do voluntarily, and if you don't, then I'll force you.
Bad faith everywhere, and no respect for individual rights.
If you are woried about the comercial paper market or the money market, take some steps to fix that.
Temporarily guarantee Money Markets subject to certain regulations, which I think is what we have done.
From Nelson's quote it appears comercial paper markets are NOT drying up.
The worst case scenarios all involve specific fears, lets try to combat those fears instead of trying to bail out the entire finacial industry.
What barriers prevent foreign firms from stepping in if there's a meltdown of US firms
The simple fact that foreign financials face just as many balance sheet problems as their U.S. counterparts. In many cases (England, Belgium, Ireland...probably China) the problems are even worse.
In finance, the libertarians have won the argument. It is generally recognised that government actions in the financial markets can be expected to be clumsy and costly, and are best minimised.
In finance, the libertarians have lost the battle. The markets have proved capable of follow-my-leader behaviour of such collective idiocy (not least in their recent panics) that large scale governement action is judged by almost all informed people to be likely to be less costly than the result of such market behaviour.
Any scenario (Tyler's are better judged than most on offer)is a guess. There is not evidence to attach a p-value to any of them. But we have to call the odds (choose our Bayseian priors if we are conscientious academics)as best we can.
In looking for a least cost (including minimum government intervention) route, I favour passing some version of the Paulson plan now; and spending a month of the technican's time coming up with an improved plan to be considered after the elections.
On a slightly longer horizon, I note that Warren Buffet and his partner Charlie have selected six candidates as successors. I suugest that for the future health of the US financial system, any of the six that Berkshire Hathaway eventually rejects should be offered any vacant jobs atg the head of major banks or major financial regulation agencies. They have been selected by experts as very good people who are likely "to behave like owners".
I know this is a bailout string, but Megan makes a misleading tossaway comment on climate change that I'd like to address.There's virtually no scientific question that receives greater consensus among working scientists than the reality of climate change caused by human activity. And many of these are highly skeptical, conservative people. Unfortunately, the preponderance of the evidence indicates that dramatic climate instability is very likely to become the norm by the second half of this century. (I find brealclimate.org a good place for somewhat detailed discussions of current research.)
Well here we are again with another nightmare scenario that may or may not happen. The comparison with climate change warnings was apt. Once again the elites want to throw large sums of money at something to do exactly.....what? Solve it? Diminish it? Make it go away? Stop hollering about it?
How do we know the things they'll do with our money won't make things worse or that we're addressing the cause and not a symptom? The only thing we know for sure is that, as with climate, the elite's will be in control of the process...and once they've got the money, we'll have no say whatsoever.
It's always tempting to throw money at uncertainties for uncertain results when
a) there's lots of money around
b) the money's not yours
I predict that every bump, shift and realignment of anything that could affect western society will be magnified and/or turned into a crisis until they finally get their hands on our money and blow it. Once everyone's broke the incentive for crises will be gone and we'll get back to solving & preventing these things using reason.
Just checked my Home Equity line of Credit.
I can borrow up to 60k at 5% from my regional bank.
Credit card also does not seem to be a problem, still getting bombarded with applications at reasonable rates. (it doesn't matter to me I never carry a balance anyway).
Where is this credit crisis? I can borrow more cheaply today than I could a year ago. Was about 7.75% on home equity loc then.
Looks like the banks view me as a better credit risk than LIBOR which hit 6.88%. The regional banks still have deposits that they are paying like 2% on and they need to put them to work and they would rather lend to me at 5% than a big bank. I am not sure why that is a problem.
Seems like this is more of a credit crunch for big banks than main st. Maybe folks with bad credit or little or no assets are having a tough time borrowing, but isn't that how it should be? Wasn't that the problem.
This crisis does increasingly seem to be a case of "If you don't give me all of your money, I will shoot myself".
Could you comment on Soros's proposal in today's Financial Times as an alternative to the Paulson plan?
In addition, could you comment on two aspects of the various alternative plans:
1. What is the effect on governance of corporations, their growth and efficiency, if the government, in pursuit of its upside possibilities to recoup losses, takes equity? Is it such a good idea to have the government having an ownership stake in such a large part of the economy? Even for the purpose of recouping taxpayer losses?
2. The assumptions of the various bailout proposals seem to be that the bottom-level assets - the actual mortgages - have value that is not now reflected in asset prices. But what is the effect on value of those mortgages and the underlying property (which is, finally, the only engine of actual value in the chain of succeeding paper assets, people paying their mortgages) if a political actor, government, owns them? Is there likely to be a tendency of the actual value of the assets to decline in the hands of government, simply because political actors will not be willing to do what must happen to get value out of them - force people to pay their mortgages or foreclose? Won't the pressure be to keep people in their homes, with the effect that the assets themselves are less valuable in the managerial hands of government? How is this political discount figured into the valuation of these assets? Is it?
"more government intervention" if there's a crisis?
Certainly fundamentalist collectivists will always argue in favour of global catastrophe, whatever the weather, and market failure, whatever the state of the market.
Your reasoning that we might therefore consider the nationalization of the financial services industry, rewarding incompetent businesspersons and giving politicians more earmarks to dole out as an appeasement option is strange.
A bit like shooting ourselves to avoid a fight.
And I note that the US public is overwhelmingly on the side of saying No to Bush and Pelosi. So what possible political benefit is there?
If something is morally, logically and pragmatically wrong (even on a Machiavellian scale), IT'S WRONG! DON'T DO IT!
Is that a complicated message? The policy wonks are wrong (as usual). The public is right (for once).
"...if there is a serious crash, we will get even more government intervention in the economy--and intervention that is much less to our liking."
What is the p-value for this claim, stated as if it is a certainty?
This has got to be the worst argument yet for the bailout, and it's reminiscent of the conservative arguments for the prescription drug bill (a.k.a. the greatest expansion of the welfare state since the 1960s). "If we don't accept a big bunch of socialism now, we'll get an even bigger bunch later."
This is a terrible argument. It has been used before and will be used again. We have to do what is right even if there is short term economic harm, because in the long term it will result in good. In the words of in the words of Ronald Regan, "if not now then when, if not us then who?"
What about the odds for the scenario where we pass the bailout, the government drops the money, and it still isn't enough? What makes 700 billion a magic number?
alexsim | September 30, 2008 5:13 PM
It's magic because its a really large number.
Congress has been stuffing this bill with Pork. Business as usual.
As Glenn Reynolds says, "I'll believe it's a crisis, when the poeple who tell me it's a crisis, start ACTING like it's a crisis."
When have the Democrats ever NOT accommodated him, on any major issue you care to name?
-Iraq AUMF: passed
-NSA secret wiretapping: FISA revised and retroactive immunity granted
-Iraq supplementals: every last one passed as requested, pre and post 2006 election
-Military Commissions Act: passed
-"60 votes" never an issue prior to 2006, now suddenly any Democratic initiative requires 60 votes in the Senate or it's simply not attempted.
Just go ahead and add the "revised, sweetened" Paulson plan to the list. What the Kingfish wants, the Kingfish gets, yassa yassa! It's pathetic.
When have the Democrats ever NOT accommodated him, on any major issue you care to name?
Social Security privatization. And hell, judges, until the "nuclear option" was invoked and the Gang of 14 and whatnot.
Re: Social Security privatization. And hell, judges, until the "nuclear option" was invoked and the Gang of 14 and whatnot.
And does anyone doubt that the Bush administration would have seriously proposed a good deal more extreme legislation if the GOP had held a filibuster-proof majority in the Senate?