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Looting the taxpayer
In the latest iteration of the government's plan to save the financial system, Treasury Secretary Tim Geithner says the government will give money to both banks and private investors. The money is an incentive for the banks to sell their toxic assets and an incentive for the investors to buy them. Apparently, we have to pay both sides to make a deal happen.
Geithner made his comments on the Charlie Rose show last night. Let me point to one exchange in particular:
Rose: You're saying you have private investors who are prepared to step forward and buy these toxic assets, if, if...
Geithner: If they're able to get financing from the government. Because again, that financing is unavailable now. So that's one of the kind of important things a government has to do in a financial crisis, cause again, financial crises reflect an unwillingness by the private sector to take risk, because of uncertainty and things they just can't do (inaudible)... and that's why governments have to step in in financial crises and take risks the market would otherwise not be prepared to take.
Geither mumbles the part about "things they just can't do." How telling. Yeah, things they can't do NOW. Before the financial crisis, the private sector was willing to take plenty of risk. And today, the New York Times has a great explanation of why. The Times points out a research paper written in 1994 called "Looting." It was written by economists George Akerlof and Paul Romer.
They argued "that several financial crises in the 1980s, like the Texas real estate bust, had been the result of private investors taking advantage of the government. The investors had borrowed huge amounts of money, made big profits when times were good and then left the government holding the bag for their eventual (and predictable) losses."
Sound familiar?
The Times interviewed Romer:
"If you think of the financial system as a whole, it actually has an incentive to trigger the rare occasions in which tens or hundreds of billions of dollars come flowing out of the Treasury."
Or maybe trillions? So now, the taxpayers have to provide an incentive (bribe?) to banks and investors to untangle the mess they had an incentive to create.
Looting, indeed.
Here's the entire Geithner/Rose interview:
While all eyes are on how to fix the economic crisis we are in, the foxes are getting away billions of dollars in bonuses, etc., that allowed them to be called "Masters of the Universe" and live like one. Case in point: Ken Lewis, CEO of Bank of America, tried to negotiate a deal whereby ex CEO of Merrill Lynch, John Thain, does not have to testify regarding the "perfectly timed" billions of dollars of bonuses paid out to the star employees of ML one month ahead of the normal scheduled date and just before takeover by BofA who received taxpayers' bailed out money. They looted the "house" before it bured down. What do we need to do?
1) We taxpayers should first recoup all the ill-gotten money from every single one of them. Selling their multi-million dollar mansions and their contents if necessary and let them live in a $200,000 homes like so many Americans do. I can guarrantee you, no one will die from this lifestyle.
2) Clean the financial houses of all these "Masters of the Universe" who were in control prior to the crisis. By keeping them on as the heads, CEOs, CFOs, COOs, or whatever titles they bestowed upon themselves, of these institutions and allow them to receive our taxpayer dollars so they won't collapse, is equivalent to rewarding their collosal failings and greed. To say that we would not be able to find qualified replacements, who would work for half a million dollars a year plus company stocks (here we should put a cap as to how much, less they become greedy), is hard to believe when so many people are out of work.
3) The real crisis in this entire financial world is not mortgage-baked securities and credit-default swaps or subprim lendings. at the heart of it is a moral and ethical failure of grandest scale. This failure, no amount of regulatory rules can fix. To this end, Ken Schultz is correct to say: "No matter how the regulatory regime is structured, there are people who will lie awake nights until they have figured out how to game it."
But the explanation is this has to be done to avoid a financial calamity that will engulf the global economy to the point where we really will enter a "depression". If that means 25% unemployment, deflation, political instability and the rise of extremist governments isn't this a better price to pay now?
Or do you think if we allow numerous large financial entities to fail, the economic fallout won't be nearly so severe? And if that's what you think, why should I believe you instead of our government?
Good points, rwh. I was just providing a little context for what Geithner said. It's beyond frustrating to hear him say the gov't has to take the risks the market is unwilling to take when the market took extreme risks knowing full well the gov't would be there to catch the fall.
But you're right - we may just have to swallow this one because no, I can't tell you the economic fallout will be less severe. Bernanke and Co. keep saying it'll be calamity. Do we really want to find out?
However, I will point you to an article today on Clusterstock: http://tinyurl.com/b3ga9y
It cites a Stanford University "event study" that suggests it was not Lehman's collapse that triggered the financial crisis, but rather it was "the dithering and incoherent government reaction that brought on the crisis."
Interesting.
But the main point is this: After the bailout, the real remedy will be yanking away the incentive for the private sector to put the government in this position.
But in this case it seems the "fool" is anyone who didn't fully understand all the ramifications of these complex mortgage-baked securities and credit-default swaps. In other words... just about everyone.
The people selling these securities didn't even have to know that much about them... they only had to make the buyers think they were a good deal. It's modern day snake oil! The sales pitch is great so you buy a bottle; but after you get home and use the product, results are less than what was promised.
The worst part is: regulating the market vehicles which caused the disaster this time will only prevent another collapse from the same tools. As soon as the next generation finds a new medium that's not sufficiently understood / regulated this "looting" is sure to happen again.
John, your last paragraph is an insight none of the 'experts' have had. No matter how the regulatory regime is structured, there are people who will lie awake nights until they have figured out how to game it.
This is a perfectly good reason for a progressive, soak-the-rich tax structure. Perhaps more accurately, we should tax high-rate-of-return investments at a steep rate, on the well-founded assumption that either a) they are outright frauds, or b) the returns are high because the risk is underpriced. Either way, there will eventually be a mess to be cleaned up, but we will have a source of funds for the purpose. Better we should call it an insurance premium than a tax; to be collected by the FBIC (Federal Bubble Insurance Corporation). You want to be Commissioner?
Swallow this one Scott? I wish it was just one.
I never seem to be in on the boom side of these things; this, the savings loan debacle, etc, but I sure seem to be in on the clean up. Can't we get our house in order and keep the pirates out of the captain's chairs of our society.
Dennis, in the last paragraph of the Times article, you'll find this:
"Mr. Akerlof and Mr. Romer finished writing their paper in the early 1990's, when the economy was still suffering a hangover from the excesses of the 1980's. But Mr. Akerlof told Mr. Romer - a skeptical Mr. Romer, as he acknowledged with a laugh on Tuesday - that the next candidate for looting already seemed to be taking shape.
It was an obscure little market called credit derivatives."
A painful prophecy in hindsight. That's why I think the key is more transparency in the system so insights like Akerlof's get attention sooner. Otherwise, we're just banning liquids on airplanes when the terrorists have moved on to something else.
About 13 min. into this Geithner said something to the effect that pouring money into the banks is intended to serve as a sufficient motivation. . . . "to maximize the chance that the banks will clean themselves up so that private capital will come in so what Gov is doing will be repleced by private capital."
maximize the chance? All too weak a hope if we are to stop the looting that is going on.
