Jim Manzi has a good, albeit depressing, description of the financial crisis and its likely outcomes.
[Saturday morning update]
One bit in the piece that I found amusing (and a little depressing):
[They] Promulgated a temporary ban on naked shortselling for about 800 financial stocks (in related news, the new recommended medical practice when you discover that you have a fever is to smash the thermometer against the wall, since this makes the problem go away).
Yes, I don’t think this was necessary, and it will probably have bad consequences.
‘Tis one of those chilly days in hell when I am reminded why I check this Blog out. Thanks for that, it’s a good article.
Yep, that pretty much sums it up.
Jim Manzi doesn’t seem to identify and understand the situation properly.
Capitalism does not and should not apply to failed companies.
First of all defaulting just the unprofitable parts is plain madness: all that don’t deserve it get away with it and the rest pays for it (it’s what China does constantly). The companies in question have defaulted, their management and owners (yes, all stockholders) have zero claims for anything at all and should be investigated for economic criminality and given fines and jail time if appropriate.
And that is not nationalization, it is not appropriation, it is what happens beyond “normal” bankruptcy: the government as guarantor.
Once again: divorcing the duty of the state as ultimate guarantor and the right of the state to assume ownership in such cases is plain madness.
Capitalism does not and should not apply to failed companies.
Frankly Norway handled this sort of thing far better during the 1992 Nordic financial crisis: the guilty (owners and upper management) got shredded, the innocent (savings accounts etc.) got spared, and as the companies got back on solid ground under government ownership the companies were sold back into the market while the government retained minority stakes to recuperate the effort.
What really pisses a person off is there’s no mystery here. Some people saw the problem when interest only ARM were being handed out to anyone with a pulse half a dozen years ago. Including my semi-employed ex-wife who probably wishes now she hadn’t insisted I sign the papers making me uninvolved. She wanted to be a millionaire all by herself. She’s still living in one of the houses (she now has a good job with the state of CA) but she’s thinking of abandoning it for another exactly like it but half the price if she can figure out how to swing the deal. I guess she going to learn how tight money becomes after a crash.
HH,
I’m not sure I understand what you mean that capitalism doesn’t apply to failed companies. My understanding is that failure of companies is a feature of capitalism that gives it its strength.
Govt. bailout is not capitalism because it makes others besides the principles assume the risk.
It is a good essay. I question the assumption that there would have been a massive run on the banks had the government not stepped in, however. I don’t see it. This isn’t the 30s, and not many people have their major equity in savings accounts. Furthermore, even if they have it in mutual funds — where are they going to take it to? Under the mattress? What seems more likely is a run on some institutions, which then go under, to the benefit of those that are still strong. It’s not like everybody was holding subprime mortgage paper.
I also find unlikely his hope that the government will promptly divest itself of this chunk of what should be private finance. The days when Virginian Congressmen would dispute the Constitutionality of this kind of thing are long gone, and who else will object? The Democratic Congress? When it enormously increases the amount of government? Bwa ha ha. We don’t even have to imagine what Mr. Chicago Machine Democrat would do, either, assuming he has time to think about it while trying to find his ass with both hands in his first term.
One would like to pin some hope on McCain, but, first, I don’t his odds of winning are that good, and, second, this kind of economic wonky principled stuff isn’t that interesting to him. The only hope I see is, (1) a disastrous one-term Obama Presidency, or a McCain voluntary retirement at age 77, followed by a Palin Presidency. I can see her pruning the government kudzu way back before it strangles us all, Soviet style.
History repeats itself again because the politicians have no memory. This isn’t the first time for this type of problem and the Depression wasn’t either. Most times, the gov’t took a socialist action to solve the problem because the politicians wanted to get re-elected. Before these gov’t caused disasters got too big, someone like J P Morgan was able to help solve the problem without huge gov’t bailouts. People should have to pay for their bad decisions and too many are not. Personally, I would be ashamed to accept public money in this fashion.
Remain calm says this article.
I only have one dispute with this article. Megan McArdle brought attention to the fact that the banks that are failing are the ones that have no investment branch (Countrywide, Washington Mutual) and the ones with no retail side (Lehman, I think, and some others). The ones with both commercial and financial sides have actually been weathering the storm better.
It’s not a big point, but he makes the statement that one of the consequences is a risk to checking and savings accounts if these banks go under.
HH,
The assumption that the government is the ultimate guarantor is what isn’t capitalism. Capitalism does apply to bankrupted companies, in the same way that Natural Selection applies to extinct species. What you fail to understand is that 1. companies exist as large, diverse companies if the profitable parts support the unprofitable parts in some way (otherwise, there would be too much overhead to put them in the same company and they’d be separate companies, possibly both owned by a holding company, or possibly not), which means that defaulting the whole arrangement does make sense and could be the solution to the problem, and 2. rewarding the people that took risks because the risks worked is not a bad thing because it apparently wasn’t so bad for them to do it; after all, it worked. Working or not is a pretty good test of whether it was a good idea. The owners should absolutely not be investigated for criminality. They just lost millions of dollars of their own money; in what sense haven’t they already been punished? People should only be punished by government for breaking the law; that’s kind-of the point of “The Rule of Law”.
I’ll respond to the different parts out of order because I think it brings a bit more clarity.
Ken Anthony wrote:
“My understanding is that failure of companies is a feature of capitalism that gives it its strength.”
Short version: yes but what has happened here has little or nothing to do with capitalism.
Long version: any failed companies are themselves completely unimportant; what can be important depending on the circumstances is maintaining the functions and services they provided. It doesn’t matter whether it is sudden or gradual as long as the functions and services are smoothly transferred (either by the customers or otherwise). In almost all situations the market is capable of taking care of this.
More or less simultaneous or highly interdependent failures of a significant portion of all companies in a specific market is not the same as a company going belly-up if there is no transfer or capacity for transfer of the functions and services. Such a situation is not company failure but market failure and capitalism has no methods at all that can be applied to such a situation. Capitalism functions within a market not outside it.
And just because capitalism does not have applicable tools for the job does not mean that doing nothing is a sensible decision.
Which in turn is why there exists such a function of government as acting as guarantor in the first place; this is nothing new, it has happened before and will happen again.
Ken Anthony wrote:
“I’m not sure I understand what you mean that capitalism doesn’t apply to failed companies.”
Think of this as the foreclosure of companies (as collateral) for a loan (license to operate) to the companies’ owners (debitors) from the government (creditor) on account of the government being guarantor (of the license to operate in accordance with existing rules and regulations).
What’s going on here is not economics but law, please excuse my pitch black humor but it’s no different from people being unable to pay their mortgage and losing their property.
Ken Anthony wrote:
“Govt. bailout is not capitalism because it makes others besides the principles assume the risk.”
I agree but it’s worse than that: the government and society get nothing of value in return except for the avoidance of economic collapse. That’s a very rotten deal but would still be worth it if it was the only option, but it’s not the only option and thus completely unnecessary. This is why divorcing the act of guarantor from the legal right to the assets is such a terribly bad and senseless idea.
To transplant a meme: letting financial services be under the control of the market economy is not a suicide pact.
The only options are:
1. Let the economy collapse.
2. Bailout.
3. Exercising guarantor privilege.
None of those are capitalistic and capitalism just doesn’t have any measures or tools to offer for this kind of situation but that said option number 3 is the most reminiscent of capitalism and what could/would happen in a capitalistic free market if one decreased the scale of the situation.
Option 1 is completely unnecessary and a thoroughly bad idea; all pain and no gain. Option 2 exempts those responsible at marginal gain for society as a whole and weakens future capitalism in the market in question. Option 3 allows for a lot of flexibility in deciding the details of implementation and results and if done correctly is far superior to both the other options.
Jon Card wrote:
“The assumption that the government is the ultimate guarantor is what isn’t capitalism.”
Capitalism is not a juridical system nor a governmental system, never has been and never will be.
And by the way it’s not an assumption, it’s the law.
Your comment doesn’t really make any sense at all to me but hopefully all the above helps you understand what I’m saying.
There’s something fundamentally wrong with the analysis I’m hearing but I can’t clearly define it.
Underwriters are part of the capitalist system, an important part. A private underwriter is taking the long term gamble that their charges will cover their costs. Using an underwriter is simple prudence. Without any need for government regulation they will protect their own interests.
Government is acting as underwriter with the addition of adverse selection. They don’t collect any charge from the ones they protect and are guaranteed to pay (no gamble involved) unless the understanding and will of the people could prevent them. Instead they are forcing taxpayers (spreading the pain) to encourage bad business practices insuring they will survive to make the same bad decisions in the future. Thereby diminishing the economy in a two fold way.
The result we’ve seen in the past is the lengthening and deepening of the great depression.
With regard to a market collapse verses an individual company collapse. I don’t completely buy the argument.
Destroy every mortgage company today and an equivalent group will arise tomorrow. This is because mortgage companies are a profit making business. Where does the capital come from? It never went away. A bankrupt company didn’t suddenly lose capital, it didn’t have any to lose.
What about people losing their life savings? That’s why we have FDIC and such (FDLIC or whatever.) Most people will diversify and not keep more than the $100k that is covered in any given account. Yes, some are foolish with their money and don’t diversify. Punishment for that decision is a feature of capitalism, not a bug.
I’m saying, not only should the government not bail out anyone (because it punishes the wrong people and actually prolongs the crisis.) I also reject the idea that capitalism is not up to the challenge.
This is just my opinion.
Another myth I think needs to be exposed.
Money is not capital.
Land is capital. Your house is capital. A bag of sugar is capital. When a market collapses, capital doesn’t change.
Money is a fiction that makes capitalism work. Understanding the time value of money is what makes the fiction of money work.
This is why fiat money is just as good as the intrinsic kind (actually better.)
I think there’s an awful lot of errors in that reply –too much to respond to briefly– but I might get around to it later. For now I’ll just point out the following easy bits:
Money is a form of capital just as much as machinery, labor, knowledge, land etc.
Capital does change, it’s why the economy is not a zero sum game. Yes some change more than others at our current level of technology where the more abstract the capital is the higher the rate of its change can be.
Capital is defined as any form of wealth capable of producing more wealth. However it is not a one-way street, if it was there wouldn’t even be a science of economics because the whole point of economics is to figure out how to ensure one is using available capital as well as possible. That implies that capital can be used badly which implies the possibility of wealth destruction.
In fact the default change for capital is wealth destruction: it is what usually happens for most kinds of capital if it’s left untended. Use it or lose it.
Of course it’s not even a two-way street as in some cases destruction of capital can be wealth producing in sum total.
I should have added after:
“In fact the default change for capital is wealth destruction: it is what usually happens for most kinds of capital if it’s left untended. Use it or lose it.”
That this is also why greed is good.
Ken Anthony wrote:
“I’m saying, not only should the government not bail out anyone (because it punishes the wrong people and actually prolongs the crisis.)”
We’re in complete agreement on this.
Ken Anthony wrote:
“I also reject the idea that capitalism is not up to the challenge.”
I’m going to use this as the base from which to try to unwind and possibly clarify your reasoning, where we agree or disagree and so on.
Ken Anthony wrote:
“What about people losing their life savings? That’s why we have FDIC and such (FDLIC or whatever.)”
While avoiding discussing details and applicability I’ll point out that the FDIC and similar structures are not capitalistic mechanisms but regulatory ones.
Ken Anthony wrote:
“Most people will diversify and not keep more than the $100k that is covered in any given account. Yes, some are foolish with their money and don’t diversify. Punishment for that decision is a feature of capitalism, not a bug.”
No it would be a feature of not knowing the details of the regulatory framework. Once again nothing to do with capitalism.
Ken Anthony wrote:
“Destroy every mortgage company today and an equivalent group will arise tomorrow.”
Yes and in at least this specific situation it would also have equivalent flaws. That is not a solution be it capitalist or anything else.
Ken Anthony wrote:
“This is because mortgage companies are a profit making business.”
It absolutely should be a (very) profitable business if it’s done right. It was done wrong.
Ken Anthony wrote:
“Where does the capital come from? It never went away. A bankrupt company didn’t suddenly lose capital, it didn’t have any to lose.”
Huh? I don’t get your point ^_^ Yeah a bankrupt company doesn’t have any significant amount of capital left to lose (called insolvency, and bankruptcy is but a juridical ramification of that) but just how do you manage to make that into a case that capital never went away?
Ken Anthony wrote:
“With regard to a market collapse verses an individual company collapse. I don’t completely buy the argument.”
1. Scale matters.
2. Capitalism requires both buyers and sellers.
If there had still been enough interested buyers the crisis wouldn’t yet exist. However even those buyers who did exist (there were plenty of them –just about everybody in the market segment) are now in the same trouble: a rotten apple doesn’t get less rotten just because you managed to sell it to somebody. It didn’t stop there though; as it got harder to sell rotten apples someone diced them up and repackaged them and managed to sell them to even more companies and perhaps also to some of the old sellers…
That’s perfectly sound capitalism (in a perverse way it’s downright admirable) but also the reason why there’s not a single country on the planet that has an unregulated economy.
Ken Anthony wrote:
“The result we’ve seen in the past is the lengthening and deepening of the great depression.”
I would argue that the New Deal was a massive amount of bailouts all across the US economy and that is what I’m arguing against. bailouts are not a good solution. I’m also arguing against doing nothing as doing nothing changes nothing.
Ken Anthony wrote:
“Government is acting as underwriter with the addition of adverse selection. They don’t collect any charge from the ones they protect and are guaranteed to pay (no gamble involved) unless the understanding and will of the people could prevent them. Instead they are forcing taxpayers (spreading the pain) to encourage bad business practices insuring they will survive to make the same bad decisions in the future. Thereby diminishing the economy in a two fold way.”
You’re describing bailouts as they happened in the thirties, I’m not advocating bailouts either of that kind or as they’re happening now (somewhat different details but not much better).
Ken Anthony wrote:
“Underwriters are part of the capitalist system, an important part. A private underwriter is taking the long term gamble that their charges will cover their costs. Using an underwriter is simple prudence. Without any need for government regulation they will protect their own interests.”
Nothing wrong there except that the situation we’re talking about is one where all or nearly all underwriters in a market segment more or less willfully made poor decisions. So what do you do when all the applicable underwriters go out of business at more or less the same time? What do you do about them taking down all the other things they do with them? When there are no buyers for their poor decisions? See my earlier short comment for more.
Ken Anthony wrote:
“There’s something fundamentally wrong with the analysis I’m hearing but I can’t clearly define it.”
It could be as simple as a failure of communication but either way I’ll look forward to your reply.
Repeating what Ken Anthony wrote:
“I also reject the idea that capitalism is not up to the challenge.”
I didn’t find any methods of capitalism that actually solved the problem in your comment.