Tuesday, September 23, 2008

Bailouts, the Housing Mess, and Socialism

I don't usually post on finance and the economy since I don't have any particular expertise in those areas apart from being well read, but here are a couple of articles I came across that you might find interesting reading.

From the left-leaning Slate's The Big Money:
For years, the Republican Party has preached the virtues of the "ownership society." Americans should own their own homes, goes the songbook; they should own stocks; they should take ownership of social benefits like heath care; they should approach their lives as if they are in charge rather than look for dependency-inducing welfare programs.

It's a compelling vision—and it has completely collapsed. The only important ownership that the Bush administration is peddling today is government ownership of the country's financial institutions. On Friday, Treasury Secretary Henry Paulson—the former CEO of Goldman Sachs—announced an unprecedented plan to salvage the largest banks in America. Just days after declaring that a bailout of Lehman Brothers would constitute an unacceptable moral hazard, a Republican administration has decided that the only way to keep the American economy alive is to have the federal government take the reins of some of the largest financial institutions in the world.

There is a term in political philosophy to describe a government takeover of a critical industry: That term is socialism. The government is telling us that capital and credit markets cannot, for several reasons, solve the current crisis on their own—only the federal government and its massive taxpayer base have the authority and the resources to solve it. That is state socialism: the philosophy preached by the founders of the Second International, by the radical wing of the American labor movement, through the formation of the Soviet Union and its satellites, and now by Henry Paulson. ...

From Barry Ritholtz' insightful blog The Big Picture, on a proposal to fix the housing and finance crisis:
The response to this financial crisis from the Treasury Secretary Hank Paulson borders on Insanity: An outrageous trillion dollar plus bailout, with the potential for unlimited expenditures at the behest of the Treasury Secretary. It is a terribly expensive plan, one that prevents judicial or administrative or budgetary review. It is fraught with moral hazard, rewarding bad judgment and excessive risk taking. It punishes the prudent and rewards the profligate.It focuses on all the wrong issues.

Worst of all, it is unlikely to work.

Most of the current solutions under discussion amount to throwing obscene amounts of money at the problem, rather than recognizing what the key issues are.

These approaches have several fundamental problems. The goals are less than desirable: 1) they attempt to keep people in homes they cannot afford; 2) The Paulson plan takes bad loans off of the books of poor lenders, and dumps them onto taxpayers; 3) They maintain price supports for homes that remain significantly over-priced. ...

And from Bloomberg, on the potential effect of the Paulson Plan on the dollar [Hat Tip: The Big Picture]:
Sept. 22 (Bloomberg) -- Treasury Secretary Henry Paulson's plan to end the rout in U.S. financial markets may derail the dollar's three-month rally as investors weigh the costs of the rescue.

The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York. While the rescue may restore investor confidence to battered financial markets, traders will again focus on the twin budget and current-account deficits and negative real U.S. interest rates.

"As we get to the other side of this, the dollar will get crushed," said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion. ...

What a mess! As Barry Ritholtz points out, the proposed Paulson Plan has some fundamental shortcomings and drawbacks, and as Slate points out, this kind of government action looks an awful lot like socialistic behavior. The danger, of course, is that government intervention will only postpone (even greater) economic pain, or even prolong such suffering. For example, last week the SEC instituted a ban on short selling the stocks of 799 financial companies (the ban is scheduled to expire on October 1st). As the Wall Street Journal points out, such actions helped prolong the Great Depression:
Police short sales and block them, says Securities and Exchange Commission Chairman Christopher Cox. Fire the SEC chairman, says John McCain. Investigate those short sellers, say state attorneys general. Hold hearings to grill Wall Streeters says Nancy Pelosi. "Fire the whole Trickle-Down, On-Your-Own, Look-the-Other-Way crowd" says Barack Obama, and "get rid of this whole do-nothing approach to our economic problems." The Democratic presidential candidate wants public affirmation of his argument that the whole free-market philosophy of economics has been wrong.

Some of this talk carries an implicit suggestion: Do what I say or we will have another Great Depression. And no wonder: This September feels a lot like autumn 1929.

But there's an important fallacy here. The stock market crash of October 1929 and the Great Depression were not the same thing. What made the depression great was not magnitude but duration -- the fact that unemployment was still 20% 10 years later. In the 1930s, policies like the ones described above did not speed recovery; they impeded it.

With election-year politics inextricably intertwined in this whole mess, we may see, at the very least, a new zeal by the government to try to regulate the markets. The obvious danger is that the government will over-regulate, as often happens in the wake of financial crises (think: Sarbanes-Oxley, but on a much grander and imposing scale), and that such over-regulation will stifle the economic growth and make the likely downturn worse for poor and middle class Americans. Not a pretty picture, by any standard.

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