Good question. Here's a roundabout answer.
In some sense, all of history's progress from lives that were nasty, brutish and short to today's splendiferous buffet of iPhones, nine-month courses of physical therapy, and year-round fresh broccoli can be summed up in three words: gains from trade. We live better than a tribe of chimpanzees roaming through the primordial forest because we specialize and then exchange the fruits of our skills with each other. Trade, as the ecoomists say, increases the size of the economic pie to be divided between us.
But trade introduces an element of uncertainty into our lives above and beyond the possibility that we will be eaten by something bigger than ourselves, or starve to death when the rains fail. We still have to worry about those uncertainties, although the monsters now most likely to hasten our demise have four wheels and cost entirely too much to service. But now we also have to worry about our trading partners. In an advanced economy like the United States, that means millions of other people who are somehow involved in either making the things you buy, or buying the things you make. We spend more and more of our energy trying to guess what is going on in their pointy little heads. Since we haven't even met 99.9% of them, these guesses are necessarily somewhat imperfect.
Now, to finance. Finance is, in most essentially, the way that we distribute gains from trade across space and time. Money, by giving us a universal unit of account and medium of exchange permits us to make simple trades within large networks--it takes care of the tedious yet complicated business of swapping barter commodities around between myriad players until everyone has what they (think they) want. Money has somehow, mysteriously, become the world's most sophisticated swap-meeter.
Credit allows us to time-shift those trades. I give you something you want now in exchange for something I want later. These days, that thing I want later is almost always money.
In modern America, financial institutions stand between the players and most of these transactions.
But remember, we're now not only guessing about droughts and hurricanes and monster trucks; we're also guessing about the ever-shifting desires of all the people we trade with. If I lend you money to build widgets, I need to guess how great the demand for widgets will be, what other companies might try to beat you at your own game by making cheaper and better widgets, whether the government might decide it's in the public interest to outlaw widgets, whether you're likely to be the sort of fellow who runs his widget factory into the ground and runs off to Baja with his secretary, and so forth. I also have to make guesses about the future value of money. Will the government print to much of it? How much of the stuff I actually want will this money buy when I get it?
As you probably notice when you look at your TD Waterhouse statement, sometimes we get those guesses very wrong. When too many of us guess wrong at the same time, and it turns out that America doesn't actually need a Starbucks on every corner and seventeen varieties of social networking site, we get recessions. So add to the list of things you worry about the possibility that you, and everyone around you, have guessed wrong about your future desires.
If you have ever known someone who guessed drastically wrong about their desire to spend the rest of their life with their spouse, you know that when excessive optimisim crashes, it usually overshoots on the downside. And financial institutions, which are the collective repository of all of our guesses about the future, are often the locus of the economic equivalent of a nasty, nasty divorce. We are currently enduring the Alec Baldwin and Kim Basinger of economic corrections.
All this is very interesting, I hear you cry, but what does that mean for Citibank and Bank of America?
Well, when credit markets contract, the time horizon of our trading also shrinks. We start taking economic activity like Bill W. said--one day at a time. Credit markets are already contracting because people have realized that they are not nearly as good at predicting the future as they thought they were, and had therefore better neither a borrower nor a lender be.
A major bank failure accelerates this process. It's the difference between rolling slowly into your garage, and hurtling into it with the pedal to the metal.
First, their credit disappears from the market, which shrinks the economic pie by making it more difficult to trade goods and services between our current and future selves. The economic pie shrinks.
Second, the shrinkage of the current economic pie changes peoples' estimation of the future. Much of economic forecasting is, after all, trend extrapolation. To make matters worse, we are basically hard-wired to over-weight recent events when predicting what will happen next.
Third, the changed expectations shrink even further the amount of future trade that people are willing to do between current and future selves. No one wants to defer consumption now and lend some business the money on the wan hope that Snozzleberry soda is the Next Big Thing. The economic pie shrinks further.
This is all somewhat airy-fairy; perhaps you want to know exactly what will happen if Citibank and America will fail. Will CDS markets blow up? Insurance companies in receivership? Bank runs across the land?
But as the Lehman bankruptcy illustrates, we have no idea exactly what will happen. The Fed anticipated what might go wrong as best as it could, and actually did a pretty good job preventing those problems from getting out of hand. But they didn't foresee that the bankruptcy would cause the failure of a smallish money-market fund, or that this would, in turn, cause the entire commercial paper market to lock up. Where the credit contraction will occur is much harder to predict than the near-certainty that it will happen.
Copyright © 2010 by The Atlantic Monthly Group. All rights reserved.
What does it mean if Citi and Bofa fail? My opinion is that it will become more expensive to the government and ultimately to the taxpayer to prop them up. Secondly, the current system is better at running those banks then a government implemented system. Finally if these banks fail (taken over) you are going to destroy private investors confidence. All these things taken together then say that these banks must taken government help, if necessary, for the time being.
Ted K.
Did the people running the banks really "guess" wrong? I mean they still get to keep their millions of dollars right? Also did the mortgage brokers "guess" wrong about people's ability to repay a 500K NINJA loans, or did they just not care?
We already have a depression/recession, let the banks fail, let the markets work. These weren't unlucky companies, they were poorly run. The sooner we get it over with the better.
Doing nothing = unknown what will happen
Prop them up = they will continue to make the same big bad bets
Is the devil you know the least worse of two evils?
Its not an either or situation. The government can let the banks "fail" as in bondholders take hits, and then "nationalize" while organizing a sell off of assets.
Or the government since it already owns Citi, could first split it into parts, then let the unhealthy parts fail.
Megan,
We all know the value of credit. But you are begging the question. Yes, we need credit. But where is the evidence that credit will disapear with Citi and BofA? Is it really the case that we no longer just need banks but we need these banks? Yes it sucks whent they fail and credit contracts. But new banks and new sources of credit will arise in their place. It is a simplistic view of finance markets to assume that the failure of any or one or two big banks will automatically spiral into a system wide failure. Further, even if the did, how is spending trillions and ruining the government's credit rating and risking inflation not worse than the disease.
By your logic is would seem that Citi and BofA have to as matter of economic security remain in business forever. That would seem to create one hell of a moral hazard. It would seem to me the only way to fix the credit markets is for Citi and BofA to die and for many of the people who worked for them to lose their jobs and never return to the industry at all. Let someone else have a go at it.
Since there is a lot less money to borrow because securitization has been decimated and there are far fewer borrowers through choice of worthiness we need far fewer banks.
As a general thing the gigantic supernational and multi national banks are Frankenstein monsters that serve no decent systematic purpose and have been shown lead to systematic risk. They will be downsized one way or another because they don't work.
The availability of sound systematic credit is not dependent upon these monstrosities. Since they were primarily responsible for the credit bubble they and their leaders should be purged, with prejudice. That is how the market is supposed to work.
Airy Fairy theory be damned.
As a side note the worlds treasuries are borrowing the the money that the private markets no longer do or can. For better or ill, probably ill. US Treasury and agencies borrowed $1.9 trillion in 08. Overall US credit market debt expanded at a 6% rate last year. That isn't enough as the GDP makes obvious. The worlds economic system is addicted to debt. Debt service continues to suck away our future. The credit system is broken.
As far as your friends in the finance industry Megan, all I can say is sometimes your entire purpose in life is to serve as a warning to others. There is no getting around the fact that a lot of the industry needs to fail and a lot of people need to look for a different line of work.
Rapier,
You mean bankers should be subject to supply and demand to? Wow. What a concept that in a recession we would have less need for credit and less need for multinational credit houses. But, that might mean that people in the industry might have to lose their jobs and ability to make obscene salaries and never be held responsible for their decisions. No one ever said anything about that at Wharton. The nerve of people like you.
By what definition of 'fail' do you make your projections? Is a Chapter 11 bankruptcy a 'failure'? Note: corporations continue to operate under chapter 11. The parts of their businesses which are healthy are preserved. Other parts, which turned out to have been bad bets, are wiped out, along with the common shareholders. Senior debt has a liquidation preference on any valuable assets.
I don't see why this sort of a 'failure' is not in our best interests. It has one huge advantage. It resolves the problems in a finite amount of time and allows the system to continue to funciton.
We already did this once with Seidman running the RTC. Interestingly, Volker and Seidman are still around to help us. It worked last time. Why don't we just do it again? Get rid of Geithner and appoint Volker at Treasury. Put Seidman in charge of RTC II. Follow the existing law instead of empowering the Congressional Cowboy Caucus.
and, let's not forget to trot this beauty out: "But as the Lehman bankruptcy illustrates, we have no idea exactly what will happen.."
MM,
why don't you, you know, for us young Grasshoppers who may be about, delineate for us, exactly, what LEH's BK did 'illustrate'?
or, was it, in fact, that that POS was allowed to implode, primarily, to give know-nothing twits something to point to in their fear-mongering screeds??
I was going to add some criticism / analysis, but fortunately John's first post saved me the time and effort; well done!
With that said, Megan's post reads like a hypertrophied example of her literary idiosyncrasies. I'm a fan of these in small doses, but she really lays it on thick here, to the point of being somewhat grating.
Legally, banks can't reorganize, they have to liquidate.
As to my "friends in finance" . . . sigh. The belief that everyone who writes anything except "first let's string up all the bankers" must simply be protecting their trust fund/rich friends/shadowy conspiracy employers is inutterably ridiculous. I have more friends in liberal academia and the liberal wonkosphere than I do currently turning the wheels of commerce on Wall Street.
Megan, you're tone has gotten weirder and weirder. Now you sound like Mr. Rogers in drag: "Hello children, today I'm going to talk about trade. Yes, if it wasn't for trade, you wouldn't have that wonderful Fisher-Price toy set, or this TV. Yes, kids, trade is what allows mommie and daddy to go to work in a car, and to buy you Gerber's." Sad, what's happened to the Atlantic. Scary, what's happened to Megan. Some kind of a meltdown over this whole Santelli/CNBC scandal.
We also know what happens when insolvent banks are kept alive.
The best solution would be to try to put off the liquidation until the other institutions that are dependent in some way to the two banks are able to stand without them. I suppose that is the real issue. Would anyone else be left standing if these two fell.
If others would survive, let them go. If they would bring the whole thing down, prop them up until they don't. Strongly encourage everyone else to decouple.
If they are gone, they are gone.
Derek
"Now you sound like Mr. Rogers in drag"
Heh, I had similar thoughts when reading the post.
I disagree with you that's its somehow a bad thing for the Atlantic (this post notwithstanding). Megan has a very unique writing style, and I find that refreshing. It's weirdly fascinating in the same way that gory photographs of automobile accidents are.
... and, speaking of writing, rapier may want to look up the definition of 'decimated'. I made the same usage mistake for the vast majority of my adult life, and now it's become one of my pet peeves.
Staash,
to your point, here's a link:
http://www.thefreedictionary.com/decimated
you know, you could have offered him a pointer..
MM,
btw, thanks for the incisive commentary on LEH. now, everyone understands that it's a mere prop..
or, are you, still, waiting for the answers to be funneled to you?
Now, to finance. Finance is, in most essentially, the way that we distribute gains from trade across space and time. Money, by giving us a universal unit of account and medium of exchange permits us to make simple trades within large networks--it takes care of the tedious yet complicated business of swapping barter commodities around between myriad players until everyone has what they (think they) want. Money has somehow, mysteriously, become the world's most sophisticated swap-meeter.
This paragraph says more than I think you meant to say.
Money is in fact a medium of exchange - invented to make it easier to trade without having to carry around cages full of chickens or buckets full of eggs or boxes full of shoes or whatever. Credit is nothing more than the farmer telling the cobbler that he'll give him two bushels of wheat in three months for a pair of shoes today. If the cobbler gives him the shoes, he's making a bet that the farmer will be able to give him the required amount of wheat in three months.
Having gold, paper money, buttons, shells, or electronic ones and zeros in the equation doesn't change any of this.
Given that -
Please explain how - if there was no money of any kind paper or otherwise - any government anywhere could "stimulate" the economy. How could they cause shoes, or wheat, or eggs, or chickens to materialize and be traded? Magic?
Please explain how - given paper money - the government can simply print more and expect there to any kind of "multiplier" on that money if the requisite goods and/or services are not there to back it up. If you just print ass-loads of money, but still have the same number of shoes, or wheat, or eggs, or chicken, then what happens?
Please explain how - given any kind of money - the government could take a bunch of it from some of the citizens, and gain any kind of "multiplier" when they spend it with other citizens. If they take from Peter and spend with Paul, then Paul may very well get more shoes, or wheat, or eggs, or chickens. But at what expense to Peter? What will Peter and his family have to do without?
Col Sanders
Nice post. A bit oversimplified, since AIG is an insurance company. But management of risk has very a similar analogy to your story about credit, and they were kind of doing banking stuff anyway, so that's fine.
I wish you had elaborated a bit more on the pros and cons of the various solutions being considered, though. Obviously, the choice isn't just between either bail this institutions for all time or let them fail, as some posters suggested.
I've been living in the U.S. for a year and a half now, and I keep hearing that nationalization, the new N-word, is:
a) Culturally unpalatable, because Americans are instilled with a repugnance of state owning things like banks.
b) A one-way street - Once you do it, you can never go back.
I have nothing to say about a), which I think it's generally a healthy principle to have. But I'm confident that b) is not true. There are lots of examples throughout the world of companies that have been nationalized and reprivatized. Given a), it's fair to assume that the reprivatization process would be much faster here than in pretty much any other country.
So, I guess the 2 questions that cry for a response right now are:
1. Is nationalization of AIG and BoA the best decision to make right now? There are certainly fine economists, like Stiglitz and Krugman, who think it's at least an option to consider.
2. If nationalization turns out to be the best option, is it politically feasible? Many, MANY people in this country seem to believe in "You shall not nationalize" as an economic equivalent of a dogma of faith.
I saw that woman in charge of the FDIC on the news tonight, taking calmly about how solvent the reserve fund is. That should make us all nervous.
The solvency of the FDIC should not be a newsworthy issue. Why was such an appearance deemed necessary?
It reminds me of that calm Soviet apparatchik who reassuringly told the press that everything was fine at the Chernobyl Nuclear power plant.
A failure of Citi and BOA would be unimaginably horrible in the short term, but ultimately a good thing. The FDIC would fail, the markets would tank and ultimately the dollar collapse. Then we could reboot the system. Anything less would mean permanently impaired performance.
Bearded,
By Alison Vekshin and Margaret Chadbourn
March 6 (Bloomberg) -- The Federal Deposit Insurance Corp. may reduce an emergency fee on banks to bolster reserves if Congress expands the agency’s borrowing authority with the Treasury Department to $100 billion, Chairman Sheila Bair said.
The existing $30 billion credit line “provides a thin margin of error” to cover losses from bank failures, Bair wrote yesterday in a letter to U.S. Senate Banking Committee Chairman Christopher Dodd. Dodd, a Connecticut Democrat, plans to introduce legislation to raise the borrowing authority to a permanent level of $100 billion and temporarily increase it to $500 billion through Dec. 31, 2010...
http://www.bloomberg.com/apps/news?pid=20601087&sid=aB5N5zb7pY58&refer=home
is, probably, as good a reason as any..
Saying we need more credit is just another way of saying we need more debt.
Debt is not only what got us into this mess, it is what is keeping us there. We can't spend much more without spooking the ChiComs who are propping up the market for U.S. Treasuries. We can't lower rates below zero and we can't raise them without send the whole economy into another tailspin. The only option left is to increase the money supply with no rate-hike option to put on the brake if we overshoot.
If no one is buying houses or toxic assets, then that just means that nobody is selling them at a market clearing price. A recovery without real price discovery is not a bottom. It's just another bear market rally.
What a difference a few months can make. Yes it's bad if credit contracts. There are a lot of businesses that run on credit. For example, not too long ago there was a story about a family run construction company that suddenly got many of its loans called in. Even though they said they had good finances and had a good credit history the contraction of the credit market took down that one business that depended on credit.
But we've had nearly 4+ months now of 'credit freeze'. Many businesses that depend on credit have either been killed or have found ways to work without credit. As this keeps going, more and more of the businesses left will be ones that find ways to run with little or no credit. Likewise the opportunities to extend credit profitably expand since so many of the big players are down for the count. As Megan pointed out earlier, personal savings has ballooned. That money must find a home somewhere.
So I'm starting to suspect that the failure of Citi and BoA might be better now than it would have been back in Jan or Dec. The situation has been a bit confusing for me since Citi has been claiming that they are now profitable and are able to run without any more gov't money. If that's the case let them run and if they end up failing let them fail and be nationalized by a beefed up FDIC.
I think we should keep in mind the fallacy of sunk costs. Yes if you blew a Trillion dollars on bad loans that's a bad thing. Nonetheless, if you are presented with a person applying for a loan, willing to pay 10% and the person is an excellent credit risk it makes sense to make the loan regardless of past losses. Since monetary policy is stimulative and fiscal policy is likewise stimulative....it seems to me that somehow loans will find their way to that type of person. Banks will either recover or a new set of banks will rise up.
Shorter Megan .. I don't really know but probably the shit hits the fan.
If Citi and BoA fail, there would be financial Armageddon. The great depression might look cheerful by comparison.
Why? Assume the Fed is aggressive with monetary stimulus and Obama is aggressive with fiscal stimulus. Why should the failure of Citi & BoA together be a 'financial Armageddon'? Certainly with enough stimulus it would be possible for the direct stakeholders in Citi/BoA to suffer but to contain the suffering there.
"As to my "friends in finance" . . . sigh. The belief that everyone who writes anything except "first let's string up all the bankers" must simply be protecting their trust fund/rich friends/shadowy conspiracy employers is inutterably ridiculous. I have more friends in liberal academia and the liberal wonkosphere than I do currently turning the wheels of commerce on Wall Street. "
It shows Megan that you are friends with lots of liberal academics. They clearly have affected your ability to think striaght about this stuff.
Further, you are being just as rediculous as you accuse me of being. Just because someone thinks that (gasp) failed business should fail does not mean they think everyone on Wall Street should be strung up. I have no problem with Wall Street. My problem is with people like you who want to bankrupt the country to save people from their mistakes.
I'd like to "ask the editor" What exactly is it that Citi and BoA do that is so important?
Ok they have checking accounts, clear transactions etc. That doesn't seem like a big deal. Certainly other banks know how to handle direct deposits, bill pays, and so on. They would take over the accounts of individual and businesses who use Citi and BoA for day to day banking.
Ok they loan money out. That's fine but other banks do too. Certainly if the Fed is making money cheap (0% short term), other banks could take advantage of the opportunities Citi is passing up because they need to preserve cash to accomodate the losses on their balance sheet.
Ok AIG was a 'counterparty' on complicated financial transactions. From what I understand that kind of means they sold insurance on other companies defaulting on their debts. OK, so it seems to me that if other companies don't default as much, there's no problem since the insurance doesn't need to be tapped (if you never have a fire, you can live a happy blissful life never knowing your homeowners company is bankrupt). Has Citi and BoA been doing this? Regardless nearly half a year into this shouldn't the market have accounted for the risk that some of this 'insurance' may not pay off?
All in all I'm a pretty educated guy but I'm not sure I understand why Citi and BoA are so essential to the economy that they must not fail. It seems like essential functions could be taken over by other banks. Those that hold complicated positions that depend on Citi and BoA have been on notice for quite some time now that Citi and BoA are high risk institutions who may not be able to honor non-FDIC insured positions. Certainly the market has made some adjustment already.
"Legally, banks can't reorganize, they have to liquidate."
Come on, Megan, the government can do whatever the hell it wants to. Your article is largely correct, but for the underlying assumption that saving Citi and BoA involves giving them a bunch of money. Remember a few months ago when we had to do something! RIGHT NOW!! FOr the love of God, just give the banks money!!! And we did, and they kept it for the most part. And we're still here. Lehman fell, and we're still here.
I think the thing I and others keep objecting to is that you have somehow come to adopt the myopic view of bankers themselves, that if THEY can't go on banking, everything will collapse. Yes, we understand that a banking system is necessary, and your article is a very nice explanation of why. But the ultimate problem is not liquidity but solvency, and some of these banks are going to fail sooner or later, and the rest of the economy will be fine. You know, people making things. The government can print money, or lower taxes, and other banks can still lend, and people will continue to build up their savings.
Eriver makes a great point. The Congress can do whatever it wants. More importantly, why is liquidation such a terrible option? All of these banks have performing assets. Yes, the MBS's are a problem. So value them at zero and give them away to anyone who will take them in the reorganization. The MBS do have some value. It is just that no one has any idea what so the effective market price is 0. But at 0 someone will take them and spend the next few years figuring out which parts of them actually produce value. At a zero price you have nothing to lose. The profitable parts of the banks will be bought up by other banks and we will be left with a smaller number of banks, but with banks that are healthy and freee of MBS. Why not just form a liquidation coporation like we did with the S&Ls and get it over with?
"The Congress can do whatever it wants."
[Sigh] I miss the Tenth Amendment.
"The Congress can do whatever it wants."
[Sigh] I miss the Tenth Amendment."
With regard to bankruptcy law and federally insured interstate banks. Please don't highjack the thread Mr. Spock.
It's not my intention to hijack the thread. There IS NO constitutional authority to nationalize banks or allow them to reorganize outside of the normal channels that all should have available to them. There is good reason for this.
Obviously legal protection from creditors can be a necessary and beneficial practice, but when the proceedures are changed for certain special actors because they are "too big to fail" or for whatever reason, it creates the perception that it's a rigged game. That ultimately drives out competitors and investors. That also has the obvious moral hazard of encouraging excessively risky bank behavior in the future.
Not with bankruptcy law, John. Each state has its own bankruptcy laws. That's why O.J.'s got a mansion in Florida and lived high on the hog (until his latest arrest) and yet the Goldman's haven't gotten a penny.
"Not with bankruptcy law, John. Each state has its own bankruptcy laws"
That is true and it isn't. Yes state law governs the substance of how debts are adjudicated in bankrupcy law. OJ kept his mansion because of the state homestead exemption. But, federal law governs the procedure of bankruptcy law. There are lots of federal overrides to state law. For example, you can't write off a judgement against you obtained as a result of an intentional tort. That is federal law not state. There is nothing to stop Congress from tinkering with the bankruptcy laws in any case they want. So the fact that Congress recognizes the state law of secured transactions, doesn't mean they don't have the power to change that if they wanted to.
"Obviously legal protection from creditors can be a necessary and beneficial practice, but when the proceedures are changed for certain special actors because they are "too big to fail" or for whatever reason, it creates the perception that it's a rigged game. That ultimately drives out competitors and investors. That also has the obvious moral hazard of encouraging excessively risky bank behavior in the future."
Who is saying you change the rules? What I am proposing is no different than what we did for the S&Ls. The fact is that these banks accept federal deposit insurance and are subject to federal bank regulation. There is nothing to stop congress from changing that regulation and setting up the rules for how these banks are liquidated to ensure that they are liquidated in a way that does the least damage to the economy.
I honestly don't see the constitutional argument for the Feds not haveing the authority to clean up this mess.
The rigged game angle is what we need to look at. Now we are finding out that Goldman Sachs was the largest beneficiary of AIG bail-out funds. Secretary of the treasury Hank Paulson (former Goldman CEO) engineered the AIG bailout. Paulson has a ton of stock on Goldman that would have become worthless without the bail-out.
More evidence of a rigged game:
MC Bank in Morgan City Louisiana gets his with an "emergency fee on banks to bolster [FDIC]reserves" when they did little of the irresponsible lending that depleted the reserve fund. It amounts to being forced to subsidize their competitors. That emergency fee could wipe out their profits this year.
Paulson and Bernanke (also a former Goldman Sachs CEO) should be indicted. The system is corrupt to the core.
"Who is saying you change the rules? What I am proposing is no different than what we did for the S&Ls. "
That is making my point for me. The mess we are now in is in a large way a result of the moral hazard created by bailing out the S & Ls. Real estate prices were protected and investment in real estate was seen to be a safer bet that it really is.
"I honestly don't see the constitutional argument for the Feds not having the authority to clean up this mess."
The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.-Amendment X, U.S. Constitution
"The rigged game angle is what we need to look at. Now we are finding out that Goldman Sachs was the largest beneficiary of AIG bail-out funds. Secretary of the treasury Hank Paulson (former Goldman CEO) engineered the AIG bailout. Paulson has a ton of stock on Goldman that would have become worthless without the bail-out."
I can't argue with you there. Don't forget about AIG, the new toxic waste dumb of toxic assets. The entire thing, all of the panic last fall and so forth, was nothing but an excuse to save rich and connected people from reaping the results of their bad decisions at the expense of the responsible. I don't believe for a minute that if AIG, BofA, Citi and the whole lot of them went bankrupt that global credit would cease. What a crock. There are still plenty of healthy banks out there who would expand and take up the slack in the market left by these people. I just can't beleive Megan can't see that and has bought into this "trade will contract and we will enter a new dark ages without Citi and BofA" crap.
You miss one critical point, where does the money come from?
You are actually describing a gold standard, where money is a freely agreed upon unit of exchange value. It appears spontaneously and the associated banking is also spontaneously created.
This, however, does not at all reflect what money is in America. Money in America consists of tokens that are forced into trade through legal tender laws. It is, in fact, illegal not to accept the tokens.
This modifies banking severely. Instead of credit as time shifted money, credit becomes the influx point for newly created tokens. It becomes, in essence, the entry port to inflation.
"That is making my point for me. The mess we are now in is in a large way a result of the moral hazard created by bailing out the S & Ls. Real estate prices were protected and investment in real estate was seen to be a safer bet that it really is. "
Percisely the opposite occured. The banks were liquidated and the people who worked for them and invested in them lost their shirts. Having lived through the S&L crisis and its aftermath in the Southwest, I never saw any moral hazard created by the "bailout" such as it was. Further, the bailout did nothing beyond meet the already promised deposit insurance.
"The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.-Amendment X, U.S. Constitution"
Interstate commerce and bankruptcy are enumerated powers in the Constitution. I don't know how much clearer it can get than that. Article 1, Section 8, Clause 4 allows Congress to enact "uniform laws on the subject of bankruptcies throughout the United States."
How can you possibly argue that Congress doesn't have the power to determine how and when or if insolvent interstate banks are to enter bankruptcy? I know Congress' powers are limited, but I think we ought to give them the ones that the document says they have.
Note that all of you have assumed that this is, in fact, a defense of bailing out Citi. It was simply a statement of fact: if BofA and Citi fail, the markets will almost certainly freak out, probably in some entirely unexpected way. Is anyone arguing that the failure of the largest bank in the world won't have any bad effects? Srsly? The universe is not here to please you. No matter how much you think it is a good idea to let them fail, you cannot wish away the nasty side effects of doing so. They are large.
It might still be a good idea to let them fail. But that's not what I was asked.
"In some sense, all of history's progress from lives that were nasty, brutish and short to today's splendiferous buffet of iPhones, nine-month courses of physical therapy, and year-round fresh broccoli can be summed up in three words: gains from trade."
Gains from trade and work specialization are important, but I do think a lot of the progress came from ideas and science: harnessing physical processes, from the wheel and fire onward. Even today's trade couldn't exist without progress in transportation techonology.
@Anon
I get that - however, none of that changes the underlying fact that all economies are barter economies. Money just makes it easier to trade regardless of where it comes from. Whether fiat or tangible, money remains a medium of exchange, nothing more.
Adding *more* money to an economy doesn't change the underlying fact that it's still barter regardless of whether the extra money is added by banks or by government or by counterfeiters printing in their basement.
In point of fact, if extra money and people to spend it is all we need to "stimulate" the economy, why not just put PDF files of $20 bills online and allow people to print as much as they want from the comfort of their own home? Why go through all the ridiculous gyrations with boondoggle pork projects, bailouts, and rescues?
"Is anyone arguing that the failure of the largest bank in the world won't have any bad effects? Srsly? The universe is not here to please you. No matter how much you think it is a good idea to let them fail, you cannot wish away the nasty side effects of doing so. They are large."
No one is argueing that Megan. The arguement is that bailing them out is a worse option. Yeah, no kidding the universe isn't here to please you. We all know that. I would think knowing that fact would cause us to want to take our medicine now by letting the banks fail so that we can get on with the job of rebuilding something better in their wake. Pretending that the government can borrow and print money to avoid that reality looks to me like symptom of believing that.
I suspect that this entire post, save the last few paragraphs, has been lifted wholesale from an introductory money and banking textbook. I just might have to dust off my Jaffee.
Otherwise, it's just a vailed argument to reprise the Paulson plan: let the big boys feed on the public largess OR ELSE. And MM considers herself a libertarian.
What I want to know is, how do I get my old bank back? I have a Bank of America credit card. This was not by design. About 15 years ago, I got a credit card from a bank. That bank got bought out, and then the buyer got bought out, and then the same thing again, and then MBNA, and then Bank of America.
What was the point of those buyouts? And how can we break up the monsters that resulted? If Bank of America were in 20 separate parts, would they ALL have gotten into the exact same mess? And would any of them be too big to fail?
It might still be a good idea to let them fail. But that's not what I was asked.
But you didn't answer what you were asked; effectively, you just shrugged and said "beats me." The point is that if you can't plausibly explain what disasterous consequences there will be if they fail, then there's no clear/honest argument for bailing them out.
Why not attempt to address the very good follow-up questions raised here instead?
"Is anyone arguing that the failure of the largest bank in the world won't have any bad effects? Srsly? The universe is not here to please you."
Wow. So we should avoid anything that causes any 'bad effects' now? And this makes US children? Once again, let the damn markets freak out. They'll soon readjust like they always do. Jeez, you sound like one of those CNBC shills that think the markets need to go up all the time and it's the job of the government to see that they do. Fuck the markets, fix the damn economy. I repeat, Lehman failed and we already went through one sky-is-falling bullshit plea to give the banks money AND WE"RE STILL HERE. Also, most of us would prefer the toxic asset arms of these banks being cut off from the rest of them. I kow that's easier said than done, but the MBS/CDO mess has to be addressed, and the Geithner plan of giving the banks money until the mess somehow goes away isn't gonna work.
Citi, BofA, and the other large financial firms are the props holding up the pyramid of debt/financial assets. These debt instruments are part of the asset base of most Americans, whether they realize it or not. These instruments of debt reside in your money market funds, pension funds, annuities, insurance policies, and the various 401K funds. Your stock funds rely on the value of all of the above because the companies themselves hold these same types of assets.
The collapse of enough of the big firms will bring down this entire edifice of debt/assets, and the citizenry, upon realizing their money-like assets were nothing of the sort, will storm capitals everywhere and symbolically (or otherwise) execute the politicians of both parties. The politicians know this, and will do everything to prevent it from occuring. I think they will succeed for a time- about 6-7 years- but then the jig is up because the Baby Boomers will start calling in their largest asset, the promise of SS and Medicare. At that point, the US government's bankruptcy will no longer be able to be concealed.
Exactly what to do in the current predicament - the words from the master. Here, he examines pretty much all alternatives.
"A bank bailout that works" - http://www.thenation.com/doc/20090323/stiglitz
Why can't they interview Joe Stiglitz more often? He is the Best Economist in the World! No, really, there's a ranking: http://ideas.repec.org/top/top.person.all.html
Bottom line: temporary nationalization is the way to go, and almost everything else results in the taxpayer getting robbed blind. And people just began getting robbed blind.
Savage View,
Megan is not a libertarian. She is a cosmotarian. There is a difference.
"Assume the Fed is aggressive with monetary stimulus and Obama is aggressive with fiscal stimulus. Why should the failure of Citi & BoA together be a 'financial Armageddon'?"
Their failure won't matter at all in this situation. We'll all be f**d anyway. The Fed got us into this but keeping interest rates below market in the first place. And Obama's "fiscal stimulus" is intended to break what's left of the economy so all the sheeple start howling for more socialism and nationalizations.
John: Yes, we need credit. But where is the evidence that credit will disapear with Citi and BofA?
The evidence is that a lot of credit disappeared with the Lehman Brothers.
Of course this is not a proper scientific proof. Citi and BofA are not the Lehman Brothers, the world is a different place to when the Lehman Brothers collapsed in a million different ways.
But then you never do get proper scientific proofs in macroeconomics as we can't do controlled experiments on the whole economy. We have to make do with what we have.
Clay: The point is that if you can't plausibly explain what disasterous consequences there will be if they fail, then there's no clear/honest argument for bailing them out.
I can agree that such an argument may not be clear, but why do you call it not honest? What did Megan say that was a lie (as opposed to an honest mistake)? What's fundamentally dishonest about observing in the past that certain events have had undesirable effects and worrying that in the future a similar event will also have undesirable unexpected events? Megan gave a theoretical argument for such unexpected events - that people lose confidence in credit trading, and an illustration - the Lehman Brothers in case.
We may not be able to quantify unexpected results, but we should at least be aware of them. I don't think there's anything dishonest about pointing out such risks.
ECSL: Gains from trade and work specialization are important, but I do think a lot of the progress came from ideas and science: harnessing physical processes, from the wheel and fire onward. Even today's trade couldn't exist without progress in transportation techonology.
But could past progress in transportation technology have occurred without trade?
For example the average car is made up of various types of raw materials, including different metals, rubber, plastics, etc. The raw materials to make everything in a car is not found all at one place, nor can any one person extract them all, refine them, and build a car single-handedly. We only have cars and aeroplanes and so forth because of trade - both trade between people in one place (you weld the car doors on and I will pay you) and trade between people in different places (you send me rubber and I will pay you.)
All the bright ideas in the world are no use if no one actually builds them.
"The evidence is that a lot of credit disappeared with the Lehman Brothers.
Of course this is not a proper scientific proof. Citi and BofA are not the Lehman Brothers, the world is a different place to when the Lehman Brothers collapsed in a million different ways.
But then you never do get proper scientific proofs in macroeconomics as we can't do controlled experiments on the whole economy. We have to make do with what we have."
Really what evidence? Further, how does your theory mesh with the fact that one of the reasons the big banks cannot get themselves out of trouble is because they can't find enough borrows to lend to? As someone pointed out above, if the demand for credit goes down, which is does in a recession, the effects of reducing credit are less than otherwise would be expected. The country is awash in cheap credit right now with the fed running effectively negative interest rates. Please explain why, given that fact, that the loss CIT and BofA are going to cause such dire effects or greater harm than the harm caused by bailing them out and incurring trillions of dollars in debt.
What evidence??
Why post hoc ergo propter hoc and wishful thinking, of course.
Clay: "The point is that if you can't plausibly explain what disasterous consequences there will be if they fail, then there's no clear/honest argument for bailing them out."
I can agree that such an argument may not be clear, but why do you call it not honest? What did Megan say that was a lie (as opposed to an honest mistake)? What's fundamentally dishonest about observing in the past that certain events have had undesirable effects and worrying that in the future a similar event will also have undesirable unexpected events? Megan gave a theoretical argument for such unexpected events - that people lose confidence in credit trading, and an illustration - the Lehman Brothers in case.
We may not be able to quantify unexpected results, but we should at least be aware of them. I don't think there's anything dishonest about pointing out such risks.
I didn't say Megan said anything dishonest. As she noted, she wasn't arguing for a bailout. And of course there's nothing dishonest about pointing out perceived risks.
When one is, however, arguing that trillions of taxpayer dollars need to be used to prop up insolvent banks, I don't think it's too much to ask for an explanation better than "some bad, unexpected stuff might happen if we don't" for the position to be considered honest. I assume that's what prompted the question to begin with.
"MM considers herself a libertarian. "
This crisis in certainly revealing who has real free market principles and who doesn't. Sadly, genuine libertarians are a tiny fraction of the group that identifies itself as such.
I wonder how cosmotarians can dismiss the more consistent free market types as insufficiently pragmatic without noticing that it is precisely the same charge leveled at them from the mainstream "moderates."
Extremism in defense of liberty is no vice. Moderation in the pursuit of sound policy is no virtue. The fact that really sound policy is not remotely politically possible any time soon should not mean that we should promote half measures whose only virtue is that they suck slightly less than mainstream idiocy.
Bearded,
you're, obviously, fighting the good fight, but you should know that the majority of this crowd, including the our blog hostess, wouldn't know a Goldwater reference, even if you denoted it w/ AuH2O..
Yancy, above, is the best proof of it-- he knows better, sees the bait, understands the outcome, yet, still, can be found with his teeth sunk into the bait..
Goldwater, aside, it's, too, telling that the 'Editors' of this tract let McArdle get away with her 'libertarian'-schtick, when, quite really, she's the worst kind of Pro-State stooge--one with no original Ideas, just gimmicky prose..
John: Really what evidence?
Ummm, as I said, in the bit you quoted, the Lehman Brothers bankruptcy leading to a seizure in the credit market. You quoted the bit I said that was the evidence, did you read what I wrote at any stage?
Further, how does your theory mesh with the fact that one of the reasons the big banks cannot get themselves out of trouble is because they can't find enough borrows to lend to? The country is awash in cheap credit right now with the fed running effectively negative interest rates.
I'm surprised. I thought banks were focusing on building up their balance sheets, and *not* lending. For example, all the tighter requirements for getting a mortage (http://meganmcardle.theatlantic.com/archives/2008/08/no_shirt_no_shoes_no_credit.php), stories about credit card companies cutting back credit limits (http://meganmcardle.theatlantic.com/archives/2009/02/crunching_credit.php)
The Fed may be supplying very low interest rates, but my understanding is that very few people can borrow directly from the Fed, the banks are intermediaries in the whole process as the Fed doesn't have the staff to deal with millions of credit applications.
So not only can my theory not explain this "fact", I'm not sure it's a fact at all.
Clay: I didn't say Megan said anything dishonest.
To quote from what you said earlier: ...then there's no clear/honest argument for bailing them out. As Megan was making an argument for bailing the banks out, and you claimed that there was no clear/honest argument for doing so if the person can't explain what disasterous consequences there will be if they fail, then I conclude that you were implying that Megan was dishonest for making that argument.
When one is, however, arguing that trillions of taxpayer dollars need to be used to prop up insolvent banks, I don't think it's too much to ask for an explanation better than "some bad, unexpected stuff might happen if we don't" for the position to be considered honest.
Call me oddly literal, but I think for a position to be considered dishonest it requires some actual evidence of dishonesty. I don't think it is a good idea to sling around accusations of dishonesty as eagerly as you do because we shouldn't be overlooking possible effects of a policy (be that policy decision to bail out or not bail out), even if they can't be quantified.
I suggest that you call the explanation "inadequate" instead. Or if you have to be insulting "foolish", or "idiotic" or something else in that line.
Clay: "I didn't say Megan said anything dishonest."
To quote from what you said earlier: ...then there's no clear/honest argument for bailing them out. As Megan was making an argument for bailing the banks out, and you claimed that there was no clear/honest argument for doing so if the person can't explain what disasterous consequences there will be if they fail, then I conclude that you were implying that Megan was dishonest for making that argument.
Umm ... no. Megan was not arguing for bailing out the banks, at least according to her at 11:30: "It might still be a good idea to let them fail. But that's not what I was asked."
Call me oddly literal, but I think for a position to be considered dishonest it requires some actual evidence of dishonesty. I don't think it is a good idea to sling around accusations of dishonesty as eagerly as you do because we shouldn't be overlooking possible effects of a policy (be that policy decision to bail out or not bail out), even if they can't be quantified.
And the literal dishonesty is staring us in the face. Is theft dishonest? Is advocating theft a dishonest position to hold? Then prove the bank bailouts are something other than theft from the taxpayer, if you advocate them. Again, "bad stuff might happen" doesn't cut it, at least for me.
Clay,
On your two points, firstly Megan was making an argument for bailing the banks out. She may have felt that the other arguments on the other side are so strong that the banks should not be bailed out, but that's an assessment of the sum of the arguments, some individual arguments could well point the other way.
On the other point, you're shifting your position. You started off by calling the argument itself dishonest. To quote you "...there's no clear/honest argument..." [Emphasis mine]
Now you are arguing that the bailout is dishonest because it is theft. That's quite different from calling the *argument* for the bailout dishonest. You still haven't shown that the argument itself is dishonest. I can honestly argue that, say, theft should be allowed (and might well do so, for example, if I was in a Communist country where theft as legally defined included setting aside land for private use). On the other hand, I could dishonestly argue that theft is a bad thing, say if I made up data or consciously used logical fallacies to try to make my case appear stronger than it is.
"Citi, BofA, and the other large financial firms are the props holding up the pyramid of debt/financial assets. These debt instruments are part of the asset base of most Americans, whether they realize it or not. These instruments of debt reside in your money market funds, pension funds, annuities, insurance policies, and the various 401K funds. Your stock funds rely on the value of all of the above because the companies themselves hold these same types of assets."
Are we now responsible for each others private retirement accounts? I personally got completely out of the stock market in October - anybody who didn't obviously was comfortable with the risk they were taking, or completely ignorant. How are they my problem?
Citibank and BofA were not always this large - they can be small again. Washington Mutual and IndyMac used to be quite large, too, and they no longer exist. The sun with still rise in the East if Citibank and BofA fail. I'll sleep sounder, in fact.
Then prove the bank bailouts are something other than theft from the taxpayer, if you advocate them.
How could it be theft from the taxpayer if the funds were duly approved by our elected representatives and signed into law by our President?
On your two points, firstly Megan was making an argument for bailing the banks out. She may have felt that the other arguments on the other side are so strong that the banks should not be bailed out, but that's an assessment of the sum of the arguments, some individual arguments could well point the other way.
Fair enough distinction. In other words: Megan was not arguing that the banks should be bailed out. Megan was making an argument that could support such a larger argument. I hold that the former is dishonest absent better evidence. I admit that the latter is not necessarily dishonest in itself. But I thought I already made that clear.
Now you are arguing that the bailout is dishonest because it is theft. That's quite different from calling the *argument* for the bailout dishonest. You still haven't shown that the argument itself is dishonest.
If I did shift my position, I didn't intend to. To be more precise, I think the argument that the banks should be bailed out is dishonest if based on unsubstantiated claims of disasterous consequences. Unless substantiated they are, to use one of your criteria for dishonesty, "fallacies [that] try to make [the] case appear stronger than it is."
Clay - what's the name of the logical fallacy that you believe that Megan committed? It's not an "appeal to consequences" fallacy, as Megan is not arguing that we should believe something because of the likely consequences independently of whether the thing itself is true or not, she is arguing that we should make a policy choice based on the likely consequences, a subtle distinction but an important one - I don't see any rational basis for choosing policies if you decide that chosing based on likely consequences is logically bad.
And I thought Megan's claim of disastrous consequences had some substantiation in light of the Lehman Brothers collapse and its subsequent effects. This is of course not very good substantiation - the world is now different in many ways. But then in macroeconomics we very seldom get good substantiation, and when we do it's generally only for a limited policy, (eg hyperinflation is bad).
I hold that the former is dishonest absent better evidence.
And I disagree that it is dishonest. You have not come up with any evidence of dishonesty in the arguments itself and I don't like flinging around accusations of dishonesty as easily as you do, as I think it would tend to discourage valuable debate if such behaviour becomes widespread.