Page 2 of 2 Tough love's fatal attraction
By Julian Delasantellis
chorus of voices are now saying that the government shouldn't do much more.
The commonly referred to rationale for all this financial system support is
what is called "financial stability" - that is, making sure that institutions
exist that match up, that, in banking lingo, " intermediate" between lenders
who want to lend and borrowers who want to borrow.
When a rescue is engineered for an individual financial institution such as
Bear Stearns or Fannie and Freddie, the common rationale is that these
institutions occupy such a vital and central role in the financial system that
their sudden disappearance would
lead to such financial market instability, such " disintermediation", that the
crucial flow of new finance to the actual economy would be interrupted.
Is that true? It certainly was during the Great Depression of the 1930s, but
that was three quarters of a century ago, and that lesson has begun to fade.
Besides, who talks about the Great Depression anymore except old fogeys in
nursing homes?
Many of today's economic voices, especially those of the still influential free
market/laissez faire school who, in America's boundless economic ignorance,
have still dodged the approbation they deserve for this entire catastrophe, say
that too big to fail is wrong, and that it's bad economic policy.
The argument here goes that failure is not a circumstance that should be fought
and resisted to the limit of the government's power but a healthy and necessary
purgative that cleans the system of its fetid failures and misadventures,
freeing up new resources for the next generation of ambitious entrepreneurs
with hopefully better ideas. Turn of the 20th century Austrian economist Joseph
Schumpeter called this process "creative destruction", and for him it was not
just a theory; it was the way the capitalist economies of the world worked
before the near universal expansion of government's role in macroeconomic
management in the 1920s and 1930s.
Also, there is objection as to how these government financial institution
support operations work. Most of them involve some sort of guarantee of the
threatened institution's debts and other obligations, so that the institution
can enter the debt market then borrow much more cheaply with the government's
healthy credit rating rather than its own. Thus, if the institution
subsequently does fail, the government, taxpayers, must foot the bill, but if
it succeeds, and the institution prospers, the much more limited subset of the
institution's bond and stockholders will get rich, while taxpayers will receive
almost nothing. This "socialization of risk and privatization of reward"
offends many economic observers, for it seems such a direct contradiction of
how capitalist economies are supposed to work.
Around the time Fannie and Freddie were rescued in late July, a noted American
casual dining restaurant -these are places for those who show up to dine in
flip-flops and tank tops, and think that the place is "real classy" because,
unlike in the TV commercials, "you don't have to ask for Grey Poupon - it's
right there on the table" - Bennigan's closed its doors. Some wags wondered if
this circumstance called for another Bernanke & Co emergency rescue
operation, if only to forestall threatened chaos in the market for leathery
steaks and watery beer.
Amazingly, in an American public that knows far more about Ellen Degeneres'
wedding centerpieces than contemporary economic principles and debates, there
has developed a grass roots, Main Street opposition to all these government
financial system rescue operations the elite are doing for Wall Street.
Following on the now almost universally held belief in society that narcissism
is not a vice but a right sanctioned in the constitution, that a government
benefit to someone else, for whatever reason, is unfair if I don't get a piece
of it, some say that these rescue operations, by indirectly supporting the real
estate market, are unfair to renters since, by preventing real estate prices
from promptly falling 50% or more, they continue to support the inflated real
estate values of a few years ago that kept renters, particularly young and
minority renters, from being owners.
The answer to that point, is, of course, to just see how easy it is going to be
to get a mortgage if and when about $7 trillion of America's $15 trillion of
home equity gets wiped out. With half or more of the world's mortgage backed
securities then worthless, I suppose the holders of that new very expensive
fireplace kindling will be just itching to get back into the market to
underwrite new mortgages, won't they?
Among the lonely crowd on the American far right, those who value their
constitutional right to bear guns as much or more as their God given right to
bear children, another form of opposition to the manner in which the financial;
system is being rescued has arisen.
All these efforts involve substantial expansions of the government's power and
authority, especially its power to spend money without Congressional approval.
Also, since these people have observed that with so much of the mortgage backed
securities and associated debt issued by the GSEs owned by foreigners,
particularly the foreign central banks of countries with very questionable
intentions regarding the US such as China and Russia, defaulting on these
obligations is more an example of patriotic serendipity and valor than welshing
on a debt backed by the nation's honor.
All the various free-market opponents of the expanded government interventions
to save the economy from the worst possible effects of the credit crisis
coalesced into a fairly significant working minority in the Congressional
Republican caucus, led by Senator Jim Bunning of Tennessee, that for months
successfully stalled progress and eventual passage on the Dodd/Frank housing
finance rescue bill (sponsored by House Financial Services Committee chairman
Barney Frank and Senate Banking Committee chairman Christopher Dodd. During
this delay, hundreds of thousands of American mortgage holders that could have
been helped by the bill defaulted on their mortgages and thus entered
foreclosure proceedings that are resulting in the loss of their houses.
The question then becomes, have all these factors, particularly the diverse,
sometimes inchoate opposition to the manner in which the government financial
elite have recruited from the private sector is reaching back to save their
buddies (and their future jobs ) in the private sector sufficient to stop any
further rescues of the financial sector? Is the next supplicant, maybe Lehman
Brothers, maybe once again Fannie and Freddie, to knock on the door of Paulson,
Bernanke and Cox saying that they're too big to fail going to be told that, in
actuality, they're not?
It's not hard to imagine the consequences of such a denial. However soothing
such a stand on free-market principle would undoubtedly sound to those seduced
down the Pied Piper's road by ideology, for the rest of us the results would be
catastrophic.
I've shown here how it has only been the US government's implied promise of
support that has supported US, and to a certain extent world, stock prices
these past 12 months; take that away and it's anybody's guess as to how far
below current prices stocks would find their new equilibrium. Also, the wave
after wave of mortgage backed security defaults that would follow upon the
withdrawal of government support from the housing finance industry would
undoubtedly raise interest rates on all US dollar corporate borrowing, pushing
both a housing and/or economic recovery even further into the future.
At the annual meeting of Nobel Prize winners in economics, held last week at
Lindau in southern Germany, both conservative Myron Scholes, the father of the
modern options market and winner of the Nobel Prize in 1997, and former Clinton
administration economic advisor and 2001 winner Joseph Stiglitz warned of more
pain and retrenchments to come in the financial markets.
Against this backdrop, you might think it a form of madness for the government
to withdraw support for the financial markets at a time like this. But madness,
specifically, the madness of ideology over reason, is precisely what awaits
America for the next 70-odd days (and many will be very odd, indeed!) until the
presidential election on November 4. With the nation continuing to be polarized
into an almost perfect 50-50 split between left and right, those on the right
well know that opposing further government intervention to rescue the markets
is a key way to prove the ideological bona fides that will motivate their base
to win on Election Day.
In the same way that the New Testament's Book of Mark asked "For what shall it
profit a man, if he shall gain the whole world and lose his own soul?", the
thinking among this ideological point of view would be "what profit a party if
it saves the financial system, but loses the election?"
So the financial system should not automatically assume further rescues, at
least not for the next 70 days. It should not assume that anybody's too big to
fail.
In 1979, Pink Floyd's song Comfortably Numb portrayed a feeling very
much like the markets have been feeling recently following a government
bailout: "There is no pain; you are receding ... I have become comfortably
numb."
But if the government does withdraw support from the financial system, the
markets will be feeling a lot more like John Lennon did in his 1969 song, Cold
Turkey
Temperature's rising, fever is high.
Can't see no future, can't see no sky.
My feet are so heavy, so is my head.
I wish I was a baby, I wish I was dead.
Thirty-six hours rolling in pain
praying to someone free me again.
Oh, I'll be a good boy, please, make me well.
I promise you anything, get me out of this hell.
Julian
Delasantellis is a management consultant, private investor and educator
in international business in the US state of Washington. He can be reached at
juliandelasantellis@yahoo.com.
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