Friday, January 28, 2011

Where Did I Flush That Baby

So, a governmental commission investigated, and it turns out that mistakes were made.

Financial Crisis Was Avoidable, Inquiry Finds

The report, which was heavily shaped by the commission’s chairman, Phil Angelides, is dotted with literary flourishes. It calls credit-rating agencies “cogs in the wheel of financial destruction.” Paraphrasing Shakespeare’s “Julius Caesar,” it states, “The fault lies not in the stars, but in us.”

Of the banks that bought, created, packaged and sold trillions of dollars in mortgage-related securities, it says: “Like Icarus, they never feared flying ever closer to the sun.”
Yahoo News Story Panel cites roots of meltdown, but does it matter?

We all know that the crisis was avoidable, and we generally agree on why it happened. You may wonder why I have I remained so pissed off about this particular topic. Sometimes I wonder myself. Who really gives a rat's ass? Well, perhaps a rat's ass is all that I care to give.

One of the primary but generally undiscussed causes of the "crisis" is the very response which occurred. The expectation of and reliance on the bailout caused the true crisis. Every time there has been a bailout of "too big to fails," it has gotten progressively worse. Read Lowenstein's When Genius Failed about the LTCM bailout.

In a 2000 review of When Genius Failed, Ron Feldman, Asst VP to Minneapolis Fed, predicted;

Unlike the banking crises of the 1980s and 1990s, where regulators allowed insured institutions to double up their losses after they became insolvent, the markets were proving themselves unrelenting in trying to shut down LTCM. Lowenstein correctly notes that by halting that process and encouraging protection, the Fed's behavior could have long-term costs.

By sparing creditors, equity holders and managers some of the pain of loss, we are more likely to see a repeat of the behavior that produced the LTCM crisis in the first place. Indeed, the expectation of future bailouts could have played a subtle role in the growth of LTCM in the first place. Did the favorable financing of LTCM go beyond reliance on the LTCM brand name and reflect the brand name and potential support of the U.S. government? Will LTCM's resolution make the too-big-to-fail problem even worse? Perhaps with time we will have a clearer sense if the benefits of the Fed's role in the LTCM resolution outweigh potential costs. For now, enjoy Lowenstein's fable but come up with your own more satisfying moral.

Investment banks and hedge funds learned the lesson. They bet, correctly, that they would not be permitted to lose.

If the financial system had seized, counterparties had defaulted, and gamblers suffered their losses, they would have had to start the machine anew. I fail to see how that could have taken more than hours let alone months. We would all use the same contracts and many of the same players would be at the table, just with very different relative positions. Some players would have fallen out of the game. Some very large players. And the players who bet right would have won.

Communism, that old hated system which we were raised to despise, sought to socialize the profits and losses of business activity. That will never work, that will destroy incentives, and that is not fair, we were all taught.

So, what have we done? We have socialized the losses but left the profits in the hands of those "businesses" which are intricately plugged into the government. How stupid are we? This is even worse than communism. We have not even bothered with the facade of logical redistribution of the profits. We have not even bothered with the facade of free markets. In the name of saving the free-market capitalist banking system, we have completely abandoned it. Why isn't that mentioned by this little commission?

Now, has anyone seen my baby?


Anonymous said...

our little lives are kept in equipoise by opposite attractions and desires...

OneEar said...

Speak for yourself.

Anonymous said...