White knights

Well of course the plutocrats go running for a bailout when there is a problem. They always have and they probably always will. They invented government as a means of bilking the poor and are determined to keep it running that way.

They really do have to bail out these banks. Otherwise, we really would have the Great Depression II on our hands. (Though arguably, they should just nationalize them, as Christian suggests.)

(Sorry for the dangling modifier. “they” being the investment bankers and hedge fund managers, of course. Not the workers. Or the banks.)

Bear Stearns hasn’t been bailed out. It’s been liquidated to JP Morgan. They’ll chop the hell out of it, retaining mostly the prime brokerage, which they lack.

It’s a shit-storm. The yen is at 97 to a dollar; the Asian markets are diving now and Europe will follow in a five or six hours; the Fed cut the discount rate on a Sunday night; and gold is over $1,000.

It’s not reverse-trickle-down; it’s across-the-board down. Workers get fired, and most retirees lose income because their pensions get socked.

The WSJ explains that bankruptcy was not an option

Bankruptcy experts said filing for bankruptcy protection wouldn’t have been an attractive option for Bear Stearns, partly due to recent changes in the federal Bankruptcy Code relating to financial instruments like derivatives and repurchasing trades. Unlike most parties in bankruptcy, lenders in such transactions aren’t stayed or prevented from acting to seize or control the assets involved in those deals.

“They can send you a letter saying the value of the assets is falling, so either pay us back or we will liquidate the asset,” said Holly Etlin, a managing director at AlixPartners, a turnaround and business advisory firm.

“Some light relief is provided by the announcement by Standard & Poors, the day before Bear imploded, that the worst was over”

I also guess that there’s a quite bit more pain left for the financials, and the coming recession will depress other sectors. But S&P says, of the 1.2 trillion outstanding subprime debt, they expect 200-300 billion to go bad. And 180 billion has been written off already. So, arguably, they’re over the hump.

I wonder if other pessimists expect that the 200-300 billion number will prove larger, or that the credit crisis will infect other markets, like Mr. Quiggin’s previous post forebodes, so the 1.2 trillion at risk is larger.

White Knights or vultures?

If memory serves, the original robber baron JP Morgan made his great fortune by causing crashes and panics, and then buying up for pennies on the dollar the distressed properties his depredations had created. But, of course, we no longer live in such benighted times, and surely the contemporary firm founded by Morgan could not even be thought to have any hand in creating these conditions from which it has profited. Nowadays the robber barons simply rent a government to create the disasters from which they profit.

Walt, the Fed has taken the symptom – the Stock Market falling – way too seriously. There was no way last August the banking system was going to fail. And, in truth, the banking system that does what it used to do – the Wells Fargos of the world – IS in fairly good shape.

Of course, if you have a financial system that is making enormous equity bets, you can’t let the stock market fall too much, can you?

On the other hand, we live in a world in which 70 trillion dollars in derivatives supposedly exist out there. At a certain point, reality has to catch up with what is, in essence, fiat money created by the financial sector. If all of those derivatives were redeemed tomorrow, the ratio of redemption would be something like the ratio between Bear Stearns book value and its purchase price. Eventually, that system is going to blow up. Or at least, it is going to shrink.

But is it going to affect anybody’s ability to get a house, any business’ ongoing expenses? I don’t know.

I still think this is going to be a three trillion dollar recession, and that it has little to do with the banking system – or perhaps I should say, the banking system is a symptom of the deeper cause. That is the stasis of wages that was compensated for, incompletely, by the inflation in assets over the last eight years, allowing the spread in the wealth disparity between the wealthiest and the middle and working class – the bottom 80 percent – to spread enormously. Which is pretty hazardous when the consumer spending accounts for something like 73 percent of the U.S. GDP. The spread was papered over by easy credit, and that in turn meant that the growth rate for consumption over the growth of GDP over the last ten years has been about 3 trillion dollars according to Business Week. Until that gap closes, we will be in trouble.

And yeah, I agree with roger that this has deeper causes than a simple financial panic. Or rather, those deeper causes make the whole machinery vulnerable to a simple panic following some over-optimistic investments. The new Gilded Age may suffer the same instabilities the old Gilded Age did.

Walt, I think you are exaggerating – the ‘bank system’ wasn’t headed for failure last August. Certain parts of the financial sector certainly were. And it was a great time for them to fail – the third quarter of 2007 had the fast GDP growth, and corporate earnings were great.

By trying to keep the market from falling – and the Fed responded not to some independent audit of mortgage firms and hedge funds, it responded directly to the stock and credit markets – the Fed both masked the problem and spread it. Masking the problem was ultimately completely pernicious – the system, as per Bear Stearns, exists on confidence. Once you start bullshitting about how good things really are, you better be sure they are really good. Of course, that bullshitting also hinders you from taking actions that might address the weak players, by showing up your words as hollow. This weekend might well have doomed the minimum amount of credibility Paulson has. And by responding to the market continually, the Fed spread moral hazard – it assured the market that it would keep coming back, like Doctor Feelgood, to administer shots.

It is obvious that Bear Stearns should never have had a book value of 80 per share in December. And it wouldn’t have – or perhaps it wouldn’t have – if the Fed had not intervened by aggressively cutting interest rates and opening the lending door in August. That was simply way too soon. The majority of economists that I’ve read think that the Fed did a great job coming in and intervening like that. That’s because economists, now, suffer from the same managerial hubris they suffered from, collectively, in the seventies, when they thought they knew exactly how to control an economy.

If what you are saying is true – if the whole banking system was “headed for failure” back in August, then of course the Fed operated with almost criminal negligence, like trying to bandage a volcano. I doubt very seriously the banking system was headed for disaster back then, though – and I think the Fed’s reassuring steps, going deeper and deeper into capture by the market, have been a totally misguided course.

I’m not sure I know what I’m talking about, but as far as nationalization is concerned: don’t all those social-democratic European (and other) states tend to nationalize, fix and then quickly privatize again? Because the prevailing dogma everywhere these days is to privatize anything and everything, correct? And if I’m right, then how’s that not a bailout? Seems to me, compare to the Europeans the Fed’s just skipping unnecessary steps.

Another minor quibble, are you sure they haven’t leveraged the building? If you take the asset off their balance sheet, you need to take any associated debt off as well.

in the past Europeans did nationalize and then hang on to things like collapsing banks. That was a smarter move than allowing things to collapse

I think you got that partly backwards. European countries have been privatizing their state owned companies for decades now – that’s just the trend, occasional moves in the opposite direction notwithstanding. And it’s not as if state-ownership fixes anything. Many problems have been created precisely by the (partly) state owned nature of certain banks and companies, both for business and taxpayers – e.g. the banking scandal that brought the state of Berlin to its knees or the corruption scandal at VW.

Bear Stearns does not own the land (99-year lease) and has already sale-leasebacked the building.

This does not entirely negate the “negative enterprise value” thesis, but it does make it more complicated than “it’s worth $1.2 billion.”

“I would reflect on the occasional lemming-like behavior of these highly trained and compensated finance geniuses and think to myself: This won’t end well.”

See Krugman’s “SEVEN HABITS OF HIGHLY DEFECTIVE INVESTORS”, at
http://delement.typepad.com/my_weblog/files/krugman_7habits.pdf

Quo vadis, you seem to answer your own question. A lot of people knew that it wasn’t going to end well, but that’s different from knowing what to do about it.
To quote Frost: some say the world will end in fire. Some say in ice. Some say in a massive liquidity meltdown.

17, meet 33.

Derrida Derider captures the official position here — his argument can be sumamrized as “There is no alternative. Because we say so. Shut up!” But if fair has nothing to do with it — if all that matters is who’s holding the gun — then at some point people are going to start wanting some guns of their own.

I doubt you’ll find many people who want bread lines Walt. Rounding up a few patsys and shooting them is fairly useless though. The people `responsible’ are emergent properties of a system that encourages this sort of game.

These crises just don’t happen often enough and they aren’t predictable enough to guarantee that ‘holding the bad actors responsible’ will serve as a deterrent. I believe #36 is correct that this an institutional failure rather than misbehavior of individuals. Individuals in this case are perfectly rational actors. Shoot them all today, there will be a legion of new ones doing the same thing tomorrow.

I think people are a bit too confident that the Fed bailed out Bear Stearns to avoid financial collapse. It is seems to be just as probable that the bailing out of Bear Stearns will cause a financial collapse.

Basically the behaviour of the Fed for the past twenty years has been to do the most expedient thing and worry about the consequences later. We will be paying a high price for this lack of fortitude.

Well, it wasn’t the Fed which repealed the Glass-Steagull Act, was it?

It is really, really unlike that anybody is going to get lined up against a wall.

It’s not a binary. There are a range of possible consequences for the executives at a bailed-out firm like Bear Stearns. Obviously they are not literally going to be shot but there are a range of things more or less along those lines that could indeed happen. Like, they could go to jail.

Anyway, *talking* about shooting Bear Stearns executives seems like it only lead to good things.

“In the short run, bailing out Bear Stearns may avoid financial panic. But in the long run, the “deserve’s got nothin’ to do with it” approach guarantees further crises and undermines the legitimacy of government and the financial system in the eyes of those who didn’t get such assistance.”

Why is everyone talking about a bailout? Bear Stearns investors are losing everything and almost certainly getting less than they would in bankruptcy. And that is as it should be. They made poor choices and lost 98% value on their investment.

The key is to create a situation where you don’t sell off all the assets at once, flooding the market and knocking off prices further. This way you get an orderly sell off over time.

I don’t think BoA/Countrywide is a done deal yet – as far as I recall, BoA retains some kind of option until September, with share price target at $17. That could blow up, like Citic’s arrangement to pour $1 billion in to Bear Stearns.

Why is everyone talking about a bailout? Bear Stearns investors are losing everything and almost certainly getting less than they would in bankruptcy. And that is as it should be. They made poor choices and lost 98% value on their investment.

No, the investors didn’t make poor choices. The Bear Stearns executives who actually controlled the company made poor choices, and are being bailed out, in that they don’t lose their jobs or their money, aside from what small proportion of their fortunes is actually in BS stock at this very moment.

“The Bear Stearns executives who actually controlled the company made poor choices, and are being bailed out, in that they don’t lose their jobs or their money, aside from what small proportion of their fortunes is actually in BS stock at this very moment.”

Since the company was largely employee owned, your division between stockholders and executives isn’t accurate.

And since JP Morgan is talking about laying off half of Bear Stearns in the acquisition (see for example here) they aren’t keeping their jobs either.

Which leaves I’m not sure what of your argument to respond to.

I was particularly impressed by his recent remark that a premature withdrawal from Iraq would be allegorically equivalent to “driving the country into a ditch”, which reminded me of those bumperstickers, stating: “Frat Boy Drives Country Into Ditch”.

“But derrida derrider doesn’t want to have that conversation, he wants us to just shut up …”
Fat chance of that.

Look, my heart says some of these scum should be shot too (though on what we know so far, Bear Stearns’ people were no more unwise or greedy than their peers – they just happened to be the first to face the inevitable run). Nationalisation would at least take their bonuses and put them out of a job.

But my head says that on Friday the Fed had no choice but to do what it did, for fear of much worse injustice (ie average joes losing their jobs). By all means argue about overly-lax credit, regulation, etc afterwards. In the meanwhile this was battlefield medicine.

The free-market advocates at the CATO institute argued in 1998 against a bail-out of the hedge-fund firm Long-Term Capital Management, arguing
“intervention also [has] more serious long-term consequences: it encourages more calls for the regulation of hedge-fund activity, which may drive such activity further offshore; it implies a major open-ended extension of Federal Reserve responsibilities, without any congressional authorization; it implies a return to the discredited doctrine that the Fed should prevent the failure of large financial firms, which encourages irresponsible risk taking; and it undermines the moral authority of Fed policymakers in their efforts to encourage their counterparts in other countries to persevere with the difficult process of economic liberalization.”

http://www.cato.org/pubs/briefs/bp-052es.html