To whom and for what?
I am sorry to go all AWOL lately. I’ll try to post something substantative over the weekend. My temporal balance sheet looks a great deal like Lehman’s financials. Plus, despite the generous antidotes provided by Yves Smith, the events of the past few weeks have me twitchy and disoriented, reading obsessively but barely capable of drooling. I think I speak for a lot of us who’ve been on the pessimistic side of the financial blogosphere these last few years in saying I wish we had been wrong. (I wish the mighty who are now falling had paid us some mind, too.)
Today’s big news is the hint of a bail-out to end all bail-outs. I often have mixed feelings about Robert Reich’s commentary, but I commend to you his piece today.
There is no question that we are going to spend a lot of public money to address the current crisis. We have already put a very extraordinary amount at risk. The question we should be asking is not whether or how much, but to whom and for what. The financial crisis we are facing is a symptom of a much larger economic and social crisis. Wall Street is not the source of the pain. On the contrary, the financial sector has been put this decade primarily in the service of hiding, literally of papering over, unsustainable trends in the current account, income distribution, human and physical capital deterioration, and the sectoral composition of the American economy. The conventional wisdom is that this is a financial crisis, and that so far “Main Street” has been largely insulated from the catastrophe. That is rubbish. The cancer is on Main Street, and the tumor has been growing there for years. Wall Street provided drugs to hide the pain and keep us going, palliative but not curative. What is happening now is those drugs are wearing off. The American economy is fundamentally unsound, and has been for some time. We would have noticed sooner, were it not for financial methamphetamine conjured by mad scientists in lower Manhattan from a whirlwind of foreign central bank money.
I think we’ll only get one shot to set things right by throwing a ton of money at the problem, so we’d better think carefully before we throw it at symptoms rather than causes. Trying to figure this out in a week before Congress goes off to reelect itself strikes me as ambitious. Broadly, my view is that if we are going to legislate, Congress should empower regulators to declare systemically important firms insolvent, write off existing common and preferred, fire incumbent management and unilaterally convert debt to equity as far up the capital structure as they need to go until the firms are unambiguously well-capitalized, with little or no public money involved. Going forward, investors should understand that firms that are too big to fail are too big to be debt-financed, and government enforcement of debt claims against such firms will be limited. If economies of scale are real, equityholders should be glad to reap them. Otherwise markets function better anyway when populated by small actors who compete rather than by behemoths who dominate. The government should not subsidize the many negative externalities of scale. Members of the Pigou Club might suggest that bigness should be taxed and diversity subsidized.
As far as the money is concerned, throw it at infrastructure. Increase worker bargaining power by offering Federally funded retraining sabbaticals for any worker over thirty who decides they want to retool. I’d rather see a new WPA than a new RTC. If it is true that during a debt deflation, the government can spend freely without fear of inflation, let’s spend in a way that balances the economy, not in a manner that tries to ratify the imbalances that brought us here in the first place.
There’s no such thing as a choice-free bailout. The government’s largesse will go to some and not to others, and we have to decide. Don’t believe self-styled technocrats who claim that science or the market tells them who deserves the tax- (or inflation-) payers’ dollar. In a bail-out, there are winners and losers, and we get to pick. I think we should focus on a simple goal: Restructuring the economy so that the vast majority of Americans can afford a middle-class lifestyle with very little leverage on household or government balance sheets. That may be a radical suggestion in 2008, but our grandparents would have considered it only common sense.
- 19-Sept-2008, 8:30 a.m. EDT: Minor edits, added a missing “is”, replaced required with involved re public money.
It’s nice to have you back!
I’m glad you’re expanding the focus to the impact and related issues of Main Street. That subject has gotten much less attention elsewhere.
I was hoping that in a future post you could address two things that I think will be significant going forward:
1. Re. the potential inflationary impact and following up on your recent post on the subject, as you see it, does it look like there is more money/credit destroyed by the current adjustment than created by the various recent Fed actions. I’m also curious about the effect the Treasury’s new debt issues on behalf of the Fed is likely to have.
2. I still don’t see much attention paid to the fact that a lot of the “wealth” currently being destroyed was illusory/fictitious and that it therefore *ought* to be destroyed. We’re lucky that only some of it was cashed out or we would have a much worse inflation problem. Although we don’t know yet what Paulson will propose, it seems likely that much of it will be aimed at preventing that destruction. I wonder what your thoughts are about the extent to which its possible to design a package that avoids that and that limits itself to preventing the collateral damage to “real” savings from the current mess.
September 19th, 2008 at 4:14 am PDT
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Comrade Steve, welcome to USSRA. Where profits are privatized and losses are socialized.
As always you hit the nail just on the head.
September 19th, 2008 at 5:23 am PDT
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From your lips to Paulson’s ears.
Sadly, with the current crew, I think we’re going to see the public money buy a stronger round of pallatives with only a few crumbs tossed in the direction of the cure. The only hope I see is that we choose to change direction this November and that the competent technocrats (i.e. Bernake and Paulson) can hold things together until the changing of the guard. I’m not optimistic.
Separately, I’ll comment that the cancer is both growing on and fed by “Main Street”, since “Main Street” keeps voting for the politicians who want the tumor to grow… If that doesn’t change, the tumor is inoperable and terminal.
September 19th, 2008 at 6:12 am PDT
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“Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”. – John Stuart Mill
September 19th, 2008 at 9:55 am PDT
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Steve:
Welcome back. I agree. I’ve been saying things like this for 28 years. We have too many “services” and not enough manufacturing and mining. When the “paper dollar system” collapses and Uncle Sam repudiates his debts, left, right and center, we will be ready for the American Napoleon. Or worse. Have a nice day.
September 19th, 2008 at 10:10 am PDT
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Yes, real wages have basically been stagnate, or even fallen, over the last decade, but workers have been able to boslter consumption by tapping higher housing prices through home equity loans and the illusion that they were becoming wealthier. Now that that game is up, maybe we will see a fundamental shift in U.S. politics and start focusing on the real standard of living of the nation.
One can always hope.
September 19th, 2008 at 11:59 am PDT
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Welcome back Steve.
I am very worried. Just saw this on the AP release:
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He [Paulson] said that the administration would present Congress with a proposed legislative package and then work with lawmakers “to flesh out the details through the weekend. And we’re going to be asking them to take action on legislation next week.”
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I absolutely understand the need to move quickly. However, let’s not underestimate the gravity of the solution and rush a sloppy, ill-conceived plan into place in our haste to “do something”.
The way the markets are rallying today, they clearly are expecting a solution for Monday morning, and will likely fall over if they do not get one. Now is the time for REAL LEADERSHIP, which means telling the market in no uncertain terms that this is a large complex issue that we absolutely have to get right, and that it may take some time.
September 19th, 2008 at 12:22 pm PDT
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“Broadly, my view is that if we are going to legislate, Congress should empower regulators to declare systemically important firms insolvent, write off existing common and preferred, fire incumbent management and unilaterally convert debt to equity as far up the capital structure as they need to go until the firms are unambiguously well-capitalized, with little or no public money involved.”
I like the idea of forced conversion of debt to equity. Not necessarily in this case, but for the future. “Tier 3” capital could be debt that automatically converts to equity at disaster trigger points. Along the lines of the capital insurance paper presented at Jackson Hole, but where the Tier 3 debt holders are short the insurance.
September 19th, 2008 at 12:27 pm PDT
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Welcome back Steve!
Like you, I’ve been rendered twitchy by the goings on off the last few weeks. I have a feeling that the next few weeks will be no better.
However, I do not agree with you that “Wall Street” is not the source of the pain. On the contrary, the monetary dilution that the US economy runs on, plus the maturity mismatch that guarantees credit bubbles and bank runs, has been at the very heart of the economic distortions in the country, and the ruin it is currently facing.
If anything, this economic crises underlines who petty and marginal the old arguments were. Suppose fiscal armageddon does come, Wall Street collapses, and the fortunes of the Mega Wealthy are reduced forever more. Income inequality has been dramatically reduced, but, if I were a laid-off steel worker in Detroit, or an 17 year old youth in East Baltimore, I would find my lot no better off.
You want to use this crises to pick “worthy winners and losers”. I would prefer that we use it to transition to a financial system that is not engineered to have regular, systematic bank runs. We would all be winners then.
-zanon
September 19th, 2008 at 7:22 pm PDT
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zanon — I agree with everything you’re saying… I do agree that Wall Street is deeply implicated in the economic problems we face, as an enabler and enthusiast for all the “real economy”‘s awful errors. However, what I don’t think is that we can “fix” Wall Street and all will be well. Main Street is badly broken, and it would not have got to this point without tender mercies from Wall Street. But even if (when?) Goldman’s balance sheet is suddenly cured of all its “Tier III” assets, the real economy will still be broken.
I agree with you that the ultimate fix is a good financial system, one that doesn’t promote false booms and sudden reckonings, but that only rewards worthy projects with capital, and that is capable of taking a holistic view of the panoply of investment required by the whole economy.
I also agree with you that most people would be fine if every proud financial were to fall, as long as they don’t abruptly liquidate but are restructured or nationalized to operate through a transition to a more reasonable and sensible financial system.
September 19th, 2008 at 7:47 pm PDT
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Hi Steve:
Could you share some details on where “Main Street” is badly broken, apart from Wall Street driven excesses?
It has become almost impossible to build anything in America. That surely is a Main Street driven issue.
The US also has too many houses, although this was a Wall Street driven distortion.
Main Street has income inequality, but reducing that equality by killing all the iBankers does not aid the poor (except maybe in Manhattan, where the real estate may become more affordable. Although most Manhattanites live in rent stabilized apartments, so I guess we’re just talking about people who are 1) poor, and 2) decide to move to NYC anyway, but having been that person, I don’t think they are in particularly dire need of largess). An unemployed steel worker in detroit will not be helped if the tall poppies get cut down. The main street failing here is the inability to put all of our human resources to work.
Main Street has been consuming beyond its means. Circumstances will make it consume less. This will be a lower standard of living, but being sent back to 1998 is not the worst thing in the world.
What else?
-zanon
September 19th, 2008 at 8:13 pm PDT
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zanon — I think the usefulness of the WS/MS distinction is beginning to wear thin here.
I agree with what I think is your view that most of the things that are wrong on Main Street are driven by “distortions” provoked by Wall Street. Fundamentally, I think the most important thing we could do is get a real financial system together, which would look a whole lot different from what we have.
But what I’m reacting to in the piece is the notion that if only Wall Street were “fixed”, if these “toxic assets” would go away, Main Street would be fine, and that in fact Main Street largely is fine, other than the hazard of contagion from Wall Street. Yes, the broken excuse for a financial system may largely be the responsible for why Main Street consumes more (in exchange value terms) than it produces, underproduces tradable goods and services, squanders useful capital, and distributes the fruits of production absurdly. But these are now “facts on the ground” in Main Street USA, and they won’t go away just because GS’ balance sheet is restored to health. Main Street has never been “isolated” from the years-long tragedy playing out on Wall Street.
“Circumstances” in your comment is what a financial system was supposed to have provided gradually, as real world constraints would have been translated into incentives in real time, as they emerged. Wall Street by doing what it oughtn’t have done while shirking what it should have done failed to provide those circumstances, sure, but the reality on the ground is that Main Street is living and working in a manner that just won’t do.
BTW, cutting down tall poppies is not what I want to do. But to the degree we are spreading public fertilizer throughout the land, I’d rather we apply it to the short poppies, and let the tall ones suffer the consequences of their own poor investment decisions. When you lend to a 30x leveraged entity, however famous the name, you are accepting credit risk.
September 19th, 2008 at 9:56 pm PDT
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Steve:
We are in violent agreement about the desirability of cultivating short poppies, and letting the tall poppies suffer the consequences of their actions.
We are also in violent agreement that the bad decisions made by Wall Street over the years are now facts on the ground in Main Street, and we will never get those squandered energies or opportunities back.
But we know that Main Street must pay for Wall Street’s follies. After all, Wall Street needs money but does not have any, and that money can only come from Main Street.
I’m still not sure why you think Main Street is fundamentally broken. If Wall Street was made whole (suppose China went mad and gifted the US all of its money) wouldn’t the US continue on it’s OK but muddled way? Main Street may do foolish things that slow it’s growth, but it isn’t designed to blow-up every 5-10 years like maturity mismatched Wall Street is.
-zanon
September 20th, 2008 at 12:53 am PDT
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Zanon — I don’t mean that Main Street is irreperably broken. We’re really violently agreeing. I just mean that Main Streets fundamentals, conditional on its current behavior, which itself is conditional on current incentives, is broken. That is, it’s not the case that everything is cool at Home Depot, except that HD’s payroll might be frozen at the Wall Street bank. Home Depot has to shrink and Rust Belt, Inc. needs some antioxidants.
I think that Main Street would not have erred had the financial sector guided its incentives properly, and that Main Street can recover when those incentives are realigned. But that realignment will involve making a lot of changes to Main Street, not just breathing a sigh of relief that the bad news from Wall Street has been staunched.
September 20th, 2008 at 3:56 pm PDT
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My favorite part has to be:
“Going forward, investors should understand that firms that are too big to fail are too big to be debt-financed, and government enforcement of debt claims against such firms will be limited.”
So simple, and yet so elegant. And the best that the treasury could come up w/ is: give us $700 bil and unfettered authority to do with it as we please. Srsly?
September 21st, 2008 at 1:31 am PDT
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I just found you and all I can say (right now) is, you are awesome!
September 22nd, 2008 at 5:12 am PDT
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