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The President and other proponents of Free Markets have suddenly come begging for nearly a trillion dollars -- to start -- to rescue the firms in the heart of laissez-faire capitalism. Unfortunately, failing to provide an amount of money that staggers the imagination may allow a collapse of our economy not seen since the Great Depression. What are the causes? What are reasonable free-market solutions? I'm aiming for a one-page description of the problem and one page on solutions. I'd encourage anyone reading this to write their representatives and demand quick action not based at all on corporate handouts.
1. A credit economy and the deficit. When Japan bombed Pearl Harbor, our nation's President told us to save and conserve: put your extra money in a War Bond. When terrorists struck the World Trade Towers, our President told us to spend. A teenager spending mom and dad's money might feel wealthy but hasn't joined the real economy yet; a nation of mom's and dad's spending our kids money is wrong as well as unstable. We're about to cross a national debt of ten trillion dollars, on top of our personal mortgages and credit cards. A credit economy is nice while it lasts but goes away as fast as pissing off mom and dad -- or in this case foreign investors. Eventually this will happen: if it happens fast, the economy collapses.
2. Separating responsibility from consequences. Both CEOs and investors can make huge profits by taking big risks -- even risks that are most likely to end in disaster for the company. But the CEOs pay from last year is protected, the investor's profits intoxicating during the good times, and liability is limited to their investment during bankruptcy. The game is rigged: especially by selling mortgages as bundled packages, financiers have had many opportunities to get rich by playing with the value of assets. There are two groups that have been ripped off in this process: not surprisingly, people who needed to borrow for a home (especially sub-prime) and now find the rules of the game changing, and -- surprisingly -- other financiers who have been making such great short-term profits by believing their own lies. They'd package and repackage ownership of the mortgages, a paper profit with every sale, but not real value behind it. We've done little to rescue the homeowners, but financiers in trouble have brought bipartisan support for taxpayer help. Unknown trillions of dollars that people and financial companies thought they had in the value of homes has turned out to be fragile or imaginary.
3. A liquidity crisis. Even without corruption, even with responsibility and thrift, capitalism tends to cycle. Right now a liquidity crisis is overlapping the deeper causes. As lenders panic, there isn't enough money in the system to grease the market. It's not just that assets (owning mortgages) were overvalued and are now worth less, but that everyone is in a panic and short of money, so the newly-cheap packages of mortgages can't be sold even at their reduced prices.
Analogy
A credit economy and separating responsibility from consequences on Wall Street are like gunpowder: unstable and ready to explode, but not a day to day problem if you want to shut your eyes. The liquidity crisis is the spark. The problem for ordinary Americans, even those without debt or mortgages, is that the machinery of our economy is likely to be taken out in the explosion. We're playing with consequences similar to the Great Depression. That is the gun to our head: the financial sector wants taxpayers to fix the mess they made, or we lose our economy. The President's $700 Billion package is an incredible subsidy to the financiers: we would buy up their bad assets at artificially increased prices, removing the gunpowder that's ready to explode, while making sure that the investors who made bad choices get bailed out and the overpaid CEOs keep getting paid from our giant subsidy.
Two more causes (or skip to Solutions below):
1. Legal loansharking. As the real economy has tanked, ordinary hard-working people looking for the American dream have found their employment shaky. This makes them high credit risks. As the old adage goes, banks only want to lend money to you if you don't need it: or in the new economy, they'll charge you extra because you can't afford it. When Wall Street's actions sent the financial sector into a nosedive, that means interest rates go up for working class people who needed a subprime loan in order to try to live the American Dream. As some can't pay their mortgages they have to sell their homes, the extra supply causes prices to drop, and we get a domino effect. People unable to pay their mortgages are one of the roots of the current crisis: progressive answers tend to focus on helping them instead of the banking industry.
2. Lack of regulation. It really didn't take long. We had the Great Depression for reasons similar to what we face today, and for two generations banking was carefully regulated. Reagan started stripping regulations from the banking sector just over twenty years ago, we almost immediately had the Savings and Loan debacle, and now this. If you allow corporations to go bankrupt, rather than CEOs and investors being forced to pay to keep them afloat, you simply have to have regulations. Otherwise any "good" profit-maximizing CEO will rake in billions as long as possible and let the ship sink whenever the economy worsens. Regulations would have helped prevent all three of the main causes.
Solutions at the Congressional Level
A. Short term: Letting major banks* go bankrupt would be a disaster. We simply have to provide liquidity or the economy looks likely to collapse: more cash must be injected into the system. We do not have to do what the Bush administration has asked for: subsidizing the people who've made the mistakes. There are a number of good answers:
1. The usual answer in a banking crisis is to have governments take over bankrupt corporations, good assets and bad. This is difficult because our bank-like institutions are slowly dying, and chapter 11 is a slow process, and we can't wait.
2. If we don't want to wait for the financial giants to fail, there are other options. The government should not provide subsidies to Wall Street. It is shameful, but apparently necessary, for the government to rescue Wall Street. This should be done as much as possible by purchasing assets or equity (partial ownership; stocks) at fair market value: injecting cash into the system, but only at market rates. We shouldn't be listening to Warren Buffet: we should be imitating him. Major banking companies in danger of causing cascade effects will be required to issue and sell stock to the government (or other investors) at market rates. Do this five or ten billion dollars a day, in a way that doesn't subsidize investors and make them happy, and we could simultaneously solve the liquidity crisis and pressure investors to come up with their own solution rather than wait for handouts.
3. The only bailouts to be considered should be for homeowners, especially people who've bought homes at the median value or below. The courts are not really ready to handle having millions of people deal with these problems one at a time. While the government is surging money into the banking system, all mortgages for homeowners can be adjusted to allow slightly slower payments without being considered in default. Interest continues to accrue, so this isn't more than a minor breathing space for homeowners. People who borrowed too much will still suffer the consequences, but they will have breathing room during the Wall Street insanity.
B. Long term: Corporations need to be brought back to producing goods or services of real value for which they earn their investors profits. CEOs have too much power at the expense of investors, and both have too much power to ignore risks at the expense of the public, as well as too much power to manipulate government. A combination of regulation, tiny taxes aimed at reducing sudden flows of huge amounts of capital unconnected to real investments,
1. Corporations must choose: either become a partnership where the stock owners continue to be liable for the losses incurred, or lose the right pressure politicians and other "corporate personhood." Lobbying and political donations -- at the heart of ripping out the regulations that prevented "profits I win, losses you lose" banking -- will now violate the charter of any corporation with limited liability. Corporations that limit the liability of their owners can no demand all the rights of those owners: limited liability corporations no longer must be considered "persons" under the law.
2. Punitive efforts to grab CEO pay warm my heart when the CEOs have done so much damage rather than create wealth. But this is just a token. The real action that needs to be taken regarding CEO pay in the future. At ENRON and again now, executives have hurt employees, investors and the general public. Perhaps any salary about $250,000 per year and any stock options should require a five year holding period: if a company cannot pay its debts, creditors should be able to demand the CEO return absurd wages from recent years.
3. Finally implementing a tiny [modified] "Tobin Tax," a tax on financial flows. The purpose is to discourage money flowing back and forth across the globe at super speeds, gaming the system, without being significant enough to slow down real investments.
* I use the term banks to include institutions that are meeting the same borrow and lend functions that could be used as the definition of a bank. Sometimes this is called the "shadow banking system" since it doesn't all fall under bank regulations; would be better termed the under-regulated banking system.
The Basic Basics [skip]
Lenders lent vast sums of money based on bad predictions such as ever increasing property values. Then they bundled the mortgages into strange and poorly understood financial instruments and sold them back and forth like commodities. Financial institutions have made huge profits on paper and are now highly "leveraged" on these mortgages: using a relatively small amount of capital to both borrow and lend much larger amounts. Everyone has realized the mortgages aren't worth nearly what they thought they were, the assets that these bank-like institutions have used to leverage their loans are shrinking: all the leveraged companies need money to meet their obligations at the same time, and the credit markets have frozen. Very similar to what caused the banking crisis that made the Great Depression Great.
The Causes of the CrisisLenders lent vast sums of money based on bad predictions such as ever increasing property values. Then they bundled the mortgages into strange and poorly understood financial instruments and sold them back and forth like commodities. Financial institutions have made huge profits on paper and are now highly "leveraged" on these mortgages: using a relatively small amount of capital to both borrow and lend much larger amounts. Everyone has realized the mortgages aren't worth nearly what they thought they were, the assets that these bank-like institutions have used to leverage their loans are shrinking: all the leveraged companies need money to meet their obligations at the same time, and the credit markets have frozen. Very similar to what caused the banking crisis that made the Great Depression Great.
1. A credit economy and the deficit. When Japan bombed Pearl Harbor, our nation's President told us to save and conserve: put your extra money in a War Bond. When terrorists struck the World Trade Towers, our President told us to spend. A teenager spending mom and dad's money might feel wealthy but hasn't joined the real economy yet; a nation of mom's and dad's spending our kids money is wrong as well as unstable. We're about to cross a national debt of ten trillion dollars, on top of our personal mortgages and credit cards. A credit economy is nice while it lasts but goes away as fast as pissing off mom and dad -- or in this case foreign investors. Eventually this will happen: if it happens fast, the economy collapses.
2. Separating responsibility from consequences. Both CEOs and investors can make huge profits by taking big risks -- even risks that are most likely to end in disaster for the company. But the CEOs pay from last year is protected, the investor's profits intoxicating during the good times, and liability is limited to their investment during bankruptcy. The game is rigged: especially by selling mortgages as bundled packages, financiers have had many opportunities to get rich by playing with the value of assets. There are two groups that have been ripped off in this process: not surprisingly, people who needed to borrow for a home (especially sub-prime) and now find the rules of the game changing, and -- surprisingly -- other financiers who have been making such great short-term profits by believing their own lies. They'd package and repackage ownership of the mortgages, a paper profit with every sale, but not real value behind it. We've done little to rescue the homeowners, but financiers in trouble have brought bipartisan support for taxpayer help. Unknown trillions of dollars that people and financial companies thought they had in the value of homes has turned out to be fragile or imaginary.
3. A liquidity crisis. Even without corruption, even with responsibility and thrift, capitalism tends to cycle. Right now a liquidity crisis is overlapping the deeper causes. As lenders panic, there isn't enough money in the system to grease the market. It's not just that assets (owning mortgages) were overvalued and are now worth less, but that everyone is in a panic and short of money, so the newly-cheap packages of mortgages can't be sold even at their reduced prices.
Analogy
A credit economy and separating responsibility from consequences on Wall Street are like gunpowder: unstable and ready to explode, but not a day to day problem if you want to shut your eyes. The liquidity crisis is the spark. The problem for ordinary Americans, even those without debt or mortgages, is that the machinery of our economy is likely to be taken out in the explosion. We're playing with consequences similar to the Great Depression. That is the gun to our head: the financial sector wants taxpayers to fix the mess they made, or we lose our economy. The President's $700 Billion package is an incredible subsidy to the financiers: we would buy up their bad assets at artificially increased prices, removing the gunpowder that's ready to explode, while making sure that the investors who made bad choices get bailed out and the overpaid CEOs keep getting paid from our giant subsidy.
Two more causes (or skip to Solutions below):
1. Legal loansharking. As the real economy has tanked, ordinary hard-working people looking for the American dream have found their employment shaky. This makes them high credit risks. As the old adage goes, banks only want to lend money to you if you don't need it: or in the new economy, they'll charge you extra because you can't afford it. When Wall Street's actions sent the financial sector into a nosedive, that means interest rates go up for working class people who needed a subprime loan in order to try to live the American Dream. As some can't pay their mortgages they have to sell their homes, the extra supply causes prices to drop, and we get a domino effect. People unable to pay their mortgages are one of the roots of the current crisis: progressive answers tend to focus on helping them instead of the banking industry.
2. Lack of regulation. It really didn't take long. We had the Great Depression for reasons similar to what we face today, and for two generations banking was carefully regulated. Reagan started stripping regulations from the banking sector just over twenty years ago, we almost immediately had the Savings and Loan debacle, and now this. If you allow corporations to go bankrupt, rather than CEOs and investors being forced to pay to keep them afloat, you simply have to have regulations. Otherwise any "good" profit-maximizing CEO will rake in billions as long as possible and let the ship sink whenever the economy worsens. Regulations would have helped prevent all three of the main causes.
Solutions at the Congressional Level
A. Short term: Letting major banks* go bankrupt would be a disaster. We simply have to provide liquidity or the economy looks likely to collapse: more cash must be injected into the system. We do not have to do what the Bush administration has asked for: subsidizing the people who've made the mistakes. There are a number of good answers:
1. The usual answer in a banking crisis is to have governments take over bankrupt corporations, good assets and bad. This is difficult because our bank-like institutions are slowly dying, and chapter 11 is a slow process, and we can't wait.
2. If we don't want to wait for the financial giants to fail, there are other options. The government should not provide subsidies to Wall Street. It is shameful, but apparently necessary, for the government to rescue Wall Street. This should be done as much as possible by purchasing assets or equity (partial ownership; stocks) at fair market value: injecting cash into the system, but only at market rates. We shouldn't be listening to Warren Buffet: we should be imitating him. Major banking companies in danger of causing cascade effects will be required to issue and sell stock to the government (or other investors) at market rates. Do this five or ten billion dollars a day, in a way that doesn't subsidize investors and make them happy, and we could simultaneously solve the liquidity crisis and pressure investors to come up with their own solution rather than wait for handouts.
3. The only bailouts to be considered should be for homeowners, especially people who've bought homes at the median value or below. The courts are not really ready to handle having millions of people deal with these problems one at a time. While the government is surging money into the banking system, all mortgages for homeowners can be adjusted to allow slightly slower payments without being considered in default. Interest continues to accrue, so this isn't more than a minor breathing space for homeowners. People who borrowed too much will still suffer the consequences, but they will have breathing room during the Wall Street insanity.
B. Long term: Corporations need to be brought back to producing goods or services of real value for which they earn their investors profits. CEOs have too much power at the expense of investors, and both have too much power to ignore risks at the expense of the public, as well as too much power to manipulate government. A combination of regulation, tiny taxes aimed at reducing sudden flows of huge amounts of capital unconnected to real investments,
1. Corporations must choose: either become a partnership where the stock owners continue to be liable for the losses incurred, or lose the right pressure politicians and other "corporate personhood." Lobbying and political donations -- at the heart of ripping out the regulations that prevented "profits I win, losses you lose" banking -- will now violate the charter of any corporation with limited liability. Corporations that limit the liability of their owners can no demand all the rights of those owners: limited liability corporations no longer must be considered "persons" under the law.
2. Punitive efforts to grab CEO pay warm my heart when the CEOs have done so much damage rather than create wealth. But this is just a token. The real action that needs to be taken regarding CEO pay in the future. At ENRON and again now, executives have hurt employees, investors and the general public. Perhaps any salary about $250,000 per year and any stock options should require a five year holding period: if a company cannot pay its debts, creditors should be able to demand the CEO return absurd wages from recent years.
3. Finally implementing a tiny [modified] "Tobin Tax," a tax on financial flows. The purpose is to discourage money flowing back and forth across the globe at super speeds, gaming the system, without being significant enough to slow down real investments.
Addendum: Government backed insurance.
The money to bail out investors who paid no insurance premiums has to come from somewhere.
The President's plan is to have taxpayers buy the bad assets at subsidized rates with a huge one-time payment and take the blame for the disaster. Providing government backed insurance would simply delay and spread out the mess: the money has to come from somewhere. If you place an "insurance premium" on future mortgages to pay for past losses, this -- by basic supply and demand if anyone left still believes in free market theory -- will get passed on to consumers. Current investors who never paid any insurance premiums will be bailed out; future taxpayers or mortgage buyers will have to pay for it. It's largely an effort to call a tax an insurance program [similar to a "user fee"], even though the wrong "users" will be, um, taxed. It's very similar to the President's plan, asking ordinary people to bail out investors. It's main benefit is being sufficiently complex to confuse everyone about just how bad it is, where the President's plan was overt.
The money to bail out investors who paid no insurance premiums has to come from somewhere.
The President's plan is to have taxpayers buy the bad assets at subsidized rates with a huge one-time payment and take the blame for the disaster. Providing government backed insurance would simply delay and spread out the mess: the money has to come from somewhere. If you place an "insurance premium" on future mortgages to pay for past losses, this -- by basic supply and demand if anyone left still believes in free market theory -- will get passed on to consumers. Current investors who never paid any insurance premiums will be bailed out; future taxpayers or mortgage buyers will have to pay for it. It's largely an effort to call a tax an insurance program [similar to a "user fee"], even though the wrong "users" will be, um, taxed. It's very similar to the President's plan, asking ordinary people to bail out investors. It's main benefit is being sufficiently complex to confuse everyone about just how bad it is, where the President's plan was overt.
* I use the term banks to include institutions that are meeting the same borrow and lend functions that could be used as the definition of a bank. Sometimes this is called the "shadow banking system" since it doesn't all fall under bank regulations; would be better termed the under-regulated banking system.
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