Friday, September 19, 2008

Bailouts and Ben Bernanke

There has been a lot of commentary in newspapers and on the Internet about the actions taken this year by the Fed and the U.S. Treasury to prevent the bankruptcy of various financial institutions. I would characterize the general tenor of the discussion as puritanical. 

People seem to think that Bear Stearns, Fannie Mae, Freddie Mac, and AIG were “bailed out”, rescued by the Federal government despite their having committed one of the seven deadly sins: greed. These corporations are now seen to have been imprudent because their balance sheets were highly  leveraged. A good portion of the assets on their balance sheets are regarded now as “toxic waste”, mortgage-backed securities which have become highly illiquid. Commentators tell us that these institutions had no business being so highly levered to finance assets of such dubious quality. 

There is another theme which runs through this commentary. It is that the federal regulators who are responsible for oversight of these institutions are “letting them get away with murder” by “bailing them out”. Worse, by bailing out these institutions the federal government is supposedly encouraging such reckless behavior in the future. 

Finally, most of these commentators think that the financial crisis of 2008 was entirely foreseeable by regulators and therefore could have been prevented. They claim we are confronted by a clear case of regulatory misfeasance. Indeed, some argue that it is actual malfeasance resulting from financial benefits congressmen have received from these corporations. 

I believe the views I have just characterized are terribly misguided. They ignore the history of financial crises and the well developed body of practical wisdom which is now guiding Bernanke’s and Paulson’s response to the current crisis. 

Every financial institution is in the business of lending long term and financing these assets by borrowing short term. Most of the time this mismatch between the durations of assets and liabilities causes no problem. But if for some reason it becomes difficult to borrow short term against the value of these long term assets a so-called debt-deflation spiral can begin. Virtually all financial crises are examples of this phenomenon. If short term financing becomes tight or unavailable, financial institutions must sell long term assets. This depresses the price of long term assets and thus reduces the value of these assets as collateral for short term financing. This in turn makes it even more difficult to borrow short term to finance holding long term assets. This self-accelerating process will inevitably lead to severe drop in the value of long term assets and a long lasting economic depression if allowed to continue unchecked. 

Depressions caused by debt-deflation spirals have happened in the past. The panics of 1857, 1873, and 1893 were the principal examples of the 19th century. Within the past 100 years the U.S. has seen debt-deflation depressions which began with stock market panics in 1907 and 1929. This last was especially devastating. The banking panics of 1931 and 1933 helped extend an economic depression which lasted until 1940. The Federal Reserve had refused to act as a lender of last resort to prevent these banking panics.

People seem to have forgotten that the Federal Reserve was created in 1913 precisely to be a lender of last resort. Congress believed then that the reason for the frequent panics and depressions in the U.S. prior to that time was the absence in the U.S. of a central bank which would act as such a last resort lender. In times of financial crisis, the job of the lender of last resort is to prevent a debt-deflation spiral which would result in an economic depression. It does this by lending short term to financial institutions which cannot otherwise obtain financing. By doing so it prevents the wholesale liquidation of long term assets which would seriously impair the economy’s capital base and ability to finance future investments. Once the crisis has passed these short term loans made by the lender of last resort are expected to be repaid and the long term assets financed in the normal way. 

It seems to me that Bernanke and Paulson are fulfilling their responsibilities as lenders of last resort. The actions they have taken are only what is necessary to prevent a catastrophic debt-deflation spiral, not just in the U.S. but in the rest of the world too. Once the smoke has cleared and people have the opportunity to reflect upon these events, I predict that both men will be seen as heroes. In fact I think because of his actions during the Crisis of ’08  Bernanke’s reputation as a central banker will eclipse the Great Greenspan’s. 

Let me say something about the term “bailout”. Many people seem to believe that the bailouts we have seen pose a serious moral hazard problem to the economy by encouraging reckless behavior by financial institutions. But I do not believe this fear withstands closer scrutiny. The first thing to keep in mind is that the stock holders in these institutions have lost most or all of the value of their shareholding. The bondholders come out somewhat better, but will still show the scars of this event. The top executives in these corporations have lost not only their jobs but a substantial part of their net worth as the share price dropped close to zero. It defies belief that these stakeholders in the troubled institutions are indifferent to these consequences. To the contrary, I think they are being severely punished for whatever bad decisions they may have made. So I think this aspect of the moral hazard problem is difficult to take seriously. 

There is a second moral hazard consideration which escapes the calculus of individual choice. Hyman Minsky (1919-1996) made his considerable reputation as an economist by developing a theory of financial crises. I think his books can and should be profitably read today. In his book of essays, Can “It” Happen Again? (1982), Minsky predicted that financial crises would become more frequent. Because the Fed was now willing to act as the lender of last resort he believed the cost of averting crises would be paid in persistently increasing inflation rates. This was the macroeconomic, moral hazard associated with the so-called “Fed put” which financial institutions may think prevents them from taking serious losses on long-dated assets.

But Minsky’s prediction was only half right. Yes, financial crises have continued to recur periodically and the Fed did act as lender of last resort. After Minsky’s book we saw crises in 1987, 1990, 1998, 2000-2002, and now 2008. In each instance the Fed acted to provide enough liquidity to prevent a debt-deflation spiral. But the upward spiral of inflation which Minsky predicted did not happen. In fact, just the opposite occurred. From 13.5% in 1980 the rate of inflation dropped to 1.6% in 2002 before rebounding slightly during the past six years. Thus an inflationary spiral is not a necessary  consequence of the Fed’s actions as lender of last resort.

Let me close this short essay with a few remarks about the often heard assertion that better regulation would eliminate the need for these so-called bailouts by the Fed. In a word, this is nonsense. Does anyone really think that a bureaucrat in Washington can foresee the risks associated with a financial asset better that the firms which create them and hold them on their balance sheets? 

Hindsight is always 20-20, but it is foresight that is needed to prevent financial crises. Sadly, foresight is in short supply and for good reason. To understand this we can look to Minsky's theory.

Minsky believed that financial innovations play a central role in creating financial crises. New assets are created and new portfolio strategies implemented to exploit profitable niches for financial intermediation. But these innovations, precisely because they are new elements in an evolving financial structure, will interact with the economy’s balance sheet in ways nobody can anticipate. Regulators are necessarily behind the curve when it comes to innovative financial products. So if Minsky is right, and I think he is, it is hopeless to expect that new layers of regulation can or will prevent the next financial crisis. No one, let alone a government bureaucrat, can foresee the future well enough to do this properly. 

I think we all should be grateful that public servants like Bernanke and Paulson have taken their responsibilities seriously. In doing so they show the courage to endure the misguided criticisms of people who see their actions as either immoral, as benefiting only “the rich”, or as "bankrupting" the U.S. and its taxpayers. These men are saving us from an economic depression whose consequences would be terrible to contemplate.

48 comments:

Anonymous said...

Interesting explanation Carl. But the fact remains that many of these companies knew exactly what sorts of crap they were buying. But they never thought that they would become so illiquid. These were not high-quality assets no matter what the rating agencies say. They adopted a new metric which fit the market at that time. Just like the crazy tech stock investors who cared nothing about revenues but how many "clicks" or "eyeballs" a web-site received. Heck, I think in 1998 or 1999 you could have sold your blog for at least $10MILL!!!
Financial crises happen beacuse you can never underestimate the greed and sheer stupidity of other people! The disconnect between house prices and income was clear since early 2000's ... but what did you expect, the FED to warn us that this can't go on? How many people would have listened? They would have gotten mighty pissed indeed at the FED for trying to spoil their party. And now the FED is left with the unenviable task of cleaning up this big mess. easy money, easy come, easy go! Fancy financial accounting is useless, as it is apt to create illiquidity. KEEP IT SIMPLY STUPID (KISS)

Rico
Toronto ON

Sqroot said...

I have been reading for two or three years this was coming. There were a number of people who saw the signs and have been writing/warning about it.

Anonymous said...

Carl,
Brilliant essay. It is amazing the lack of economic savvy that some of these influential commentators possess.

I listen to Bill O'Reilly rail against the big oil companies and applaud the politicos for proposing massive new regulations to control the "greedy wall street entrepeneurs" He actually thinks that the government bureaucrats can prevent these crises. When the government started the War on Drugs, the drug epidemic flourished. When it started the War on Education, the education deteriorated drastically. Similar results ensued with all of the major programs started by our government. One can only hope they don't start a War on Financial Panics.

Of course, O'Reilly took his economic courses at Harvard. That might account for his stupidity.

Carlo

Anonymous said...

Thankyou for these posts Carl. I've always enjoyed the depth and breadth of your reasoning. It was always a clear sign to me that the choice of Bernanke and Paulson were made to address very specific challenges.

I agree that there actions have probably averted a catastrophic failure of the democratic way of life. However we decide to label there actions, the reality is that without this intervention, we would be in the dark ages of the 1929. The world has undergone tremendous advance since those dark days and it would be an abysmal failure to take democratic movement back to an era of hunger, strife and a feeling of hopelessness.

Great posts.

Anonymous said...

12:50:00

I think the government just started the War on Financial Panics.

Anonymous said...

Hi Carl,

Wow! Here is yet another post among many that leads me to believe you are one of the most sensible voices in the world of financial commentators. Thank you for posting this.

I'm curious, though, about your last statement. During this entire decline since last October, you have continued to have a bullish bias. And yet your last statement that Bernanke and Paulson are saving us from an economic depression whose consequences would be terrible to contemplate would imply that had you really believed that that was an outcome that had a probability much above zero, you too would have been bearish these last 11 minths. So I conclude that during this time you must have held the belief that Bernanke and Paulson would step in when it was necessary and because of this you continued to hold your bullish stance. I am reading you correctly?

To me, this fits with a post you made some time ago about the Fed not driving the market but being a part of the market, being a part of the complete picture.

Thanks again for your great blog and for sharing your views with us.

Greg

Anonymous said...

Dear Sir,
Even conceding that Bernanke and Paulson are doing a great job mopping up, you are forgetting to mention who created this mess in the first place.
Banks leveraged their assets to the hilt, not because they were greedy fools, but because in a low interest environment spreads are so compressed that risky and safe assets are virtually indistinguishable for conventional risk management techniques. So a thousand regulations would not have made any difference if the price of risk is artificially distorted to a negligible level due to the Fed's monetary policy. Not one regulator or business school academic saw any risk in the banks' portfolios due to this relative price distortion.
Not to mention that the housing bubble was caused by cheap credit. Commercial banks were under great pressure to lend, again, because of spread compression.
As for trading, you mentioned a few months ago, that the next few years will be great for market timers. I concur. Indeed, I expect that the US stock market will experience an increase in volatility due to the monetary and fiscal mess the US government is getting itself into, with spams each time more violent, and climaxing into a final and unavoidable crash, which might be accompanied by the bankruptcy of the mighty Federal Reserve.

Anonymous said...

There is a big difference between providing short-term liquidity and trying to pawn permanent losses on the long term assets off onto the taxpayer. We have this nice sterile term now, "moral hazard", that's supposed to replace words like 'theft'.

I'm sure you've read it a million times by now--the problem is solvency, not liquidity. The 1930s Fed refused to sacrifice the government's solvency to make the banks solvent, because the collapse of the Weimar Republic was fresh in their memory. This time, the US govt is putting itself in front of the debt deflation steamroller at the behest of the banks and foreigners that own it, and will be forced to print currency like Zimbabwe.

Anonymous said...

To say this crisis was not predictable is ridiculous. I have been reading about it for several years and throughout those years the individuals that were predicting this crisis were the recipients of scorn and ridicule from those who said it couldn't possibly happen.

Also, to suggest that this will not fuel greater exposure to risk in the future is ignorant at best. The penalties - job losses and much of their net worth (1 billion - 80% = 200 million...poor babies) - are hardly severe all things considered.

If in fact the bear market is over it is only because of intervention that those of us who played responsibly will be paying off for decades to come.

Anonymous said...

Carl, Now I know for a fact YOU are one of them. You just lost all credibility.

poncho

Anonymous said...

I agree with you Carl. Socialism is the only way to prosperity.

Anonymous said...

Now I know why you posted the RIGHT & WRONG post below .... massive leverage is obviously wrong! By why does the fed have to be the lender of last resort? If the first resort was responsibility and fiscal constraint, would we have such a mess? Stupid people with too much money is the problem. Financial crises ARE AVOIDABLE! To make it happen you have to base it on sound and reasonable expectations.

Barbara Kopline

Anonymous said...

Although I do not agree with your economic/monetary policy views, I do believe your trading reads and discipline are outstanding and profitable.

Was Minsky really only half right? The inflation statistics you provide come from the US government which totally changed the measurement of inflation under Clinton. You can't compare reported inflation after Clinton with reported inflation before Clinton. Try using shadowstats.com data to provide meaningful comparisons.

Also, inflation created by the Fed would have been much worse had it not been for the exportation of thouands of US jobs to China, India, and Mexico. This has not only destroyed the US economy -- the real reason we are and will remain in an economic bear market, it has simply delayed the inflationary effect until import price increases (already starting) become a major inflation contributor. Without the props of dual income family (it is hard enough for one person to find a decent job), the use of credit cards (credit max, inablity to pay), and the home equity/mortgage ATM (now gone with the credit crisis) which drove the spending the last few years, the economy has nothing left to support it or cure the housing market falling prices driving the credit crisis.

Sounds like you are an investor who has been right about the bull market because you believe the Fed is right to keep inflating the equity markets along with consumer spending. However, the Fed has only been able to do it because the rest of the world allows the US government to keep the printing presses rolling.

What is in question now is whether the rest of the world will allow the Fed and the US Government to print enough money to bail out the US (and Worldwide) financial system and more importantly, the US consumer. If they do, Minsky was right -- we are headed for much higher inflation -- and you are right -- we are headed for a much higher (albeit nominally-valued) equity market.

Anonymous said...

Carl, your honesty and forthrightness are admirable. You are courageous. Nevertheless, it is a massive dissapointment (to myself) to witness your apologist stance. No doubt you are a Gramm and supply side booster, eh? Both massively and empirically discredited. "The trouble with this country is that the cocksure are arrogant and the intelligent full of doubt." (B. Russell).

Anonymous said...

carl
ill add to your thoughts about minsky even though i have not read his books. if the fed is creating inflation and it is not showing up
then wouldnt that imply that the deflationary forces are actually much stronger then we perceive ?
if this is so then we are on the onset of what will be come extreme deflationary forces once this stock market does peak , weather it be from a lower high or a new all time high . and to add further
could the inflationary forces be considered priced into the stock market itself yet not actually showing up in the actual day to day or quarter to quarter or year to year numbers . the fed does put in more money each time we have a crises yet the outcome becomes less and less sucessful . take for example the money pumped into the economy since the 2000 2002 drop
we did get a housing boom out of it yet we also got more household debt and the stock market is lower today then it was in 2000 . so the lender of last resort may work
but in the end deflation is begining to win .
we wont know the true end of this
untill many years from now .
good luck
joe

Anonymous said...

Your commentary was, IMHO, OUTSTANDING...The fact that these financial intitutions must lend for longer durations and borrow in the short-term alone puts them at a disadvantage....you sir have just escalated in stature and A plus caliber in my eyes. I have always respected your insights in the past but must say now I have an even greater appreciation of them. Kind regards, Janet

Anonymous said...

Paulson Goes All In
by Peter Schiff

shilly











Just three days ago, after looking at the prospect of bailing a string of distressed financial institution in the country, the government seemingly drew a line in the sand, and refused to bail out Lehman Brothers. The authorities clearly saw Lehman's demise as a trial balloon to see how the markets would react if the government stayed on the sidelines. That trial balloon quickly turned into the Hindenburg. Immediately reversing course, the Government has decided to go "all in" and bail out every institution with financial exposure to U.S. mortgages. Simply put, Americans will not be allowed to visibly suffer losses after the greatest asset bubble in U.S. history. But make no mistake, the losses are real and Americans will pay one way or another.

Moving beyond the guided munitions of selective bailouts, the Government is now trying the financial equivalent of carpet bombing (for AIG, Merrill Lynch, and especially Lehman Brothers, this gives new meaning to being a day late and a dollar short). To continue with the military analogies, Paulson's bazooka turned out to be a nuclear tipped ballistic missile.

By committing trillions of tax payer dollars (not the "hundreds of billions" that Paulson predicts), the plan will save commercial and investment banks from certain bankruptcy. In his statement today, Paulson made clear that Congress must pass new legislation to allow the Government to acquire even those loans too poorly collateralized to currently qualify for GSE or FHA absorption. The losses baked into these mortgage products, which Wall Street has been reluctant to even estimate, will now be borne wholly by taxpayers.

In his press conference, Paulson assured us that this plan was designed to safeguard our savings. But in typical government fashion, the plan will have the reverse effect as savings is wiped out through inflation. He also claims that the plan will safeguard home equity by keeping real estate prices high. Since when did high home prices become a strategic national priority? If the plan succeeds, the gains for home sellers will simply be matched by losses for homebuyers, who end up paying inflated prices, and taxpayers, who get stuck with the losses when those buyers default.

Paulson's distress and confusion was clearly evident when he fielded questions from reporters. The first asked Paulson to describe his fears regarding the probable economic consequences of government inaction. Paulson provided no answer and promptly exited stage right.

When the U.S. government owns all mortgages, the real estate market will be completely subject to political, rather than financial, concerns. Will foreclosures be outlawed? Will loan term easements and principal reductions become standard campaign issues?

While it is dizzying to predict how this plan will be implemented, it is fairly simple to foresee the macroeconomic consequences. The U.S. dollar will be shattered beyond repair. The government simply has no means to make good on the trillions of new liabilities. Interestingly, while both Paulson and President Bush acknowledge that the plan will put "significant amounts of taxpayer dollars on the line," they did not mention any tax increases. Given the politics, no such move is forthcoming. The printing press is their only solution.

The government has also decided to insure all money market funds, adding trillions more in unfunded liabilities to the Federal balance sheet in the blink of an eye. Of course, since bad real estate loans are not the only toxic assets on the balance sheets of financial institution, we will also need to absorb other classes of asset-backed securities, such as those backed by credit card debt and auto loans. So while the move ensures that depositors will not lose money, is does insure that the money itself will lose value. Is the trade-off really worth it? Washington thinks so.

Further, since I assume the plan will apply to all mortgage debt, U.S. taxpayers will also be on the hook to bail out foreign institutions that loaded up on the financial sludge. However, once the government takes them off the hook, do not expect them to re-invest the windfall back into other U.S. dollar denominated assets. This get-out-of-jail free card will likely scare them straight. The global mass exodus from the U.S. dollar and Treasury debt is about to begin: do not get caught in the stampede.

Although gold initially sold off as the apparent need for a financial safe haven ebbed, look for a spectacular rally to commence as its traditional role as an inflation hedge returns with a vengeance.

Anonymous said...

Banks should lend with no interest and release debt every 7 years with a forgiveness of debt every 50 years and we wouldn't have these problems. Oh and btw "the LOVE of money is the ROOT of all evil.

david Paul

Anonymous said...

Fascinating times that we are living in. After 10 years of full time trading, I have learned to pull an average of $750 a day from the markets. I'm comfortable and happy working a few hours a week. Forget the BS the markets shell out to us everyday and focus on taking money from the market. It's why we are here. Thanks Carl for your interesting essay.

Anonymous said...

Well said, Carl.

Anonymous said...

Very well said, but I'd still add that "subprime" and "30-1 leverage" are two things that shouldn't exist by themselves, let along together.

Anonymous said...

But is there any example in history of a government conquering the credit deflation at the end of the Kondratieff cycle?

Anonymous said...

You said Minsky was half right since we have not had severe inflation recently. I thnk inflation can wax and wane. Since the Federal Reserves was created in 1912 or 13 the dollar has lost more than 95% of its value. The Feds are not a branch of the federal government and are owned by the Banks. I do not think they have the interests of the American people in their hearts. The problem with this moral hazard will be an ongoing/long term one. That is to say; if what was done today with the federal government intervention works then such tactics will be tried again the next time something like this occurs. But the next time it may not work and the results will be more catastrophic. Like playing russian roulet with 5 chambers empty and one loaded with a bullet. Eventually the loaded chamber will be the draw. But I do appreciate reading what you have to say to give me ideas to ponder further.

Dennis

Anonymous said...

Carl,

As usual I agree with you. The ranters and ravers about what the FED and Treasury have done are shamefully ignorant of market history and ignorant of the whole financial system. They have simple-minded and wrong opinions which they will often call "Austrian" or "Kondratieff". I've spent decades on the Long Wave, and only about five public people in the world have a clue about it. Roto-rootering the system with a total meltdown is not "creative destruction".

I recently wrote about Larry Summers' article in the Financial Times a year ago against the "Moral Hazard Fundamentalists". http://twocents.blogs.com/weblog/2008/09/beware-moral-hazard-fundamentalists.html

Firefighting, which this is all about, isn't pretty, but it's essential in a rational, civilized world.

Anonymous said...

Also bank crsis in 1884 and 1890. So before 1914 FED ( a private bank ) is formed, there are more banking crisis. Since FED, these crisis is dramtically reduced. The captialist by its nature will naturally lead to chaotic state driven by greedy and fear. A central controller will smooth the whole system only if the controller does the right thing. If it does wrong thing, the system is not only unstable, but will oscillate ( the worst case of unstability ). This controller may be a dictator (Chairman Mao) or a policy ( Greenspan). On the other hand, the very definition of democracy is the concesus from majority of people, this is exactly what we refer to herd behaviours. We all know in the market the crowds is always wrong. So to be successful in the market, you have to be Super-human (the elite like you), not crowds. In worst case, you have FNM and FRE, it is half socialism and half captalism. You ended up with worstlism.


JH

Henry Bee said...

Yes! Finally someone speaks the truth. By the way, congratz on successfully navigating through this bear market in the past year.

Henry

Anonymous said...

Carl,

You have completely lost all your credibility with this post. Many people predicted this crisis - even some in the group of nitwits known as Congress have complained for years that FNMA and FRE were nothing more than overleveraged hedge funds. Real house prices soared several standard deviations above their historical values. The outcome was not only forseeable, but obvious (just as the stock bubble was obvious in the late 1990s).

The recent actions by the government will, as usual, only make things worse. Too much credit and too much leverage created this problem, and rather than allow the necessary deleveraging to take place, the government wants to encourage leveraged speculation. You saw a big rally in "risky" assets (commodities, the Mexican Peso) on Friday. Yeah, that will really help the economy. And what do you think managers of a "guaranteed" money market fund will do? Obviously, load it up with the highest yielding (lowest quality) assets they can find. This will cost far more than people can imagine.

Anonymous said...

As Carl said the Feds and Treasury did the right thing. They were the rescuers of last resort. They have the muscle to affect a global bailout and they used it in the name of benefiting the middleclass (which is probably true).

In addition to Bernanke and Paulson, let’s not forget to thank the Nixon administration for removing the gold standard from our currency and installing a warp speed drive on the printing presses.

Now that all intrinsic value is removed, our currency is valued solely on a “perceived” value. As long as US Dollars are in demand globally to buy bread (and crude, gold etc) the presses can continue to roll to bail out greedy investment bankers or fund our invasions of other counties without too much burden to the US taxpayer.

However, the US empire, like the Romans, will one day fall (call it a cycle if you like) and when the Feds attempt a bailout by dropping money from helicopters people will pick them up to only to wipe their ***, not to buy bread.

Thank goodness that day is not in sight. As long as we continue to be the global superpower you can bet that the bailouts and war funding will continue to be effective. Watch the demand on our currency and teach your children to watch it. I hope reckoning day doesn’t come in my or my children’s life time but if it does having a few New Zealand Dollars and Swiss Francs might just buy you a loaf of bread.

Tim Mack

“Democracy... while it lasts is more bloody than either aristocracy or monarchy. Remember, democracy never lasts long. It soon wastes, exhausts, and murders itself. There is never a democracy that did not commit suicide.”
John Adams

Anonymous said...

How many shills did you pay to post favorable comments to this propagandist essay?

Anonymous said...

"These men are saving us from an economic depression whose consequences would be terrible to contemplate."

American DESERVE A GREAT DEPRESSION for their reckless spending, PERIOD!

Gosh, I don't know what the H*** are you talking about Bernanke and Paulson are Heros?! They are as idiotic as Greenspan! They are just going to keep this bubble alive and great bubble after bubble... is that what we want?

American need to learn the hard way and stop these reckless spending (and borrowing) the HARD WAY BY HAVING A GREAT DEPRESSION ALL OVER AGAIN!

After this problem, they want bank keep on lending so that American can keep on borrowing? WTF are they thinking? IS time to get back to HARD WORK AND SAVE, NOT SPEND!!!

Anonymous said...

Hi, Tim

Love the quotation of John Adams, I will like to add Democracy now is different from Adams' now. Now the whole election process is like marketing effort taking a long process, during which people swing from one end to the other, just like market. As Adam said, it is wasteful process, a lot of money is wasted in the process, the elected more likely will be reflect views of special interest group. As I came from China and grew up under red flag, one thing I can say, one good thing about Democracy is at least you allow someone to step down after 4 years. It cannot be done in China.

Greenspan says he will not be an intellect without Ayn Rand. He went to her home every Sat and she was there when Alan became a Chairman. She also grew up under red flag, her thinking had huge inflence to the Chairman. He prefer de-regulation, not regulation. This time goes too far.

patrick neid said...

“If we don’t do this, we risk an uncertain fate,” Mr. Bernanke added. He said that if the problem wasn’t corrected, the U.S. economy could enter a deep, multi-year recession akin to Japan’s lost decade of the 1990s, or what Sweden endured in the early 1990s when a surge in bad loans plagued the economy and sent unemployment to 12%.

Yeah. So what.

I’m not trying to be cavalier about a major recession or a lost decade but that in fact may be what we need after 30 years of continuing intervention by the government in preventing the free market from cleansing itself after extended periods of excess. Each intervention in turn leads and encourages further excess. Much has already been written of the infamous “Greenspan put”. You can google it for more detail.

http://en.wikipedia.org/wiki/Greenspan_put

If you want, we all pretend to, the benefits of capitalism you have to accept the creative destruction that comes with it. The markets were crashing/trading lower because the previously cheered on housing bubble had burst. Banks, brokerage firms, Fannie and Freddie, AIG et al were disappearing because they were meant to. Morgan Stanley and Goldman should have been next. They had all readily participated in the false economics of the bubble. Who forgets the 100’s of tech companies that disappeared when that bubble burst bringing down the NASDAQ 85%. No one intervened for them and rigthfully so. Trillions were lost in shareholder equity. We survived and Tech is healthier for it. Now IPO's have to come to the market bearing profits not promises.

Yes people were/are losing their homes as it should be in most cases. They were not qualified to own them in the first place and they knew it. This whole madness was an attempt to take home ownership from the then 65% to the current 69% starting during Clinton’s first year in office. Hello to Fannie Mae's new mandate--hit the "ask" on everything.

Now once again the government has stepped into the breach to prevent the market from straightening out the mess. I find it interesting that the man waving the wand just happened to be the ex-CEO of a major instigator in this whole mess–Goldman Sachs. A firm I might add he only left in 2006 to become Treasury secretary. Of course he knows about the problem, he personally made 100’s of millions in salary and bonuses in benefiting/causing it in the first place. As we stand by and witness/cheer–talk about Stockholm syndrome–we also take as gospel Paulson/Bernanke's description about the outcome of no action as the quote I used to start this comment indicates. How do they know that? If they could not foresee the problem how do they know where the market solution was leading? They didn’t and they don’t. All they are certain is they did not want a free market solution. By controlling the solution at potentially trillions of dollars in cost they get to design the future. I’d gladly settle for a market solution.

I trust the “secret hand”. With a little luck this market will rally and then roll over to new lows washing out all the firms and practices that caused all these problems to begin with. Otherwise welcome to the next, ever bigger, bubble. These new trillions are going somewhere!

Anonymous said...

Hi, Carl,

I love your blog. Your calls are much more often prescient than not. But while I agree that the Fed and Treasury are doing what they need to do at this point, I would have to say that Greenspan's actions pretty much set the table for this. The continuous loosening of oversight and Fed rules for the financial industry did make a difference. Governmental and quasi-governmental leaders did much to create an environment of excess in terms of risk. This was the biggest problem of all. The signals were clear: do whatever you can dream up, and throw the old standards and checks out the window. This led to the entire financial system becoming corrupted enough to lead to today's crises.

I would like to think that you are correct about the Fed's and Treasury's actions will solve the problems. Unfortunately, I tend to agree with Mike Shedlock's Rule of Unintended Consequences and Robert Prechter's call that, once the system was on the brink, all actions taken would ultimately prove to make the suffering worse, albeit delayed somewhat.

None of us have a crystal ball, and I hope your optimism proves valid. But I believe even if it does, Humpty Dumpty will be too broken to ever put back together again, and a depression of some sort will be the end result.

Thanks for all the ideas and calls over the years, and I remain a loyal reader. You provide an invaluable service, and pro bono, on top of it.

John in NYC

Anonymous said...

As a follow up to my previous comment, I would have to say I'm in agreement with the last section of Keven Depew's most recent posting at Minyanville.com.

One thing I have to find amusing about this whole situation is, I was expecting it from a technical standpoint for about 10 years now. I thought that the downturn had begun on '00, and in essence that may be correct, the 02-07 rally notwithstanding. '00 was the first big warning that few listened to. Yet now that the situation I expected has actually started, I find myself in no better position than most people. There are good reasons for that, but still, I can appreciate the irony.

John in NYC

monkeypicks said...

John has it right the domino effect will lead to humpty dumpty.It is much worse than just bailing out a couple institutions. How can they pay the taxes if they have no money they made them fail in the first place.They want to fix it solve the energy crisis and bring back the jobs and start making stuff here in america. Otherwords we will just be headed lower. I have watched carl for awhile and just waiting to here him start his 1500 prediction again.

Carl Futia said...

1500 Or Bust !!!

Anonymous said...

Everything has to be in context. The net wealth of US is 55 trillion 2 years ago. Is this 1-2 trillion big deal ? The balance sheet of US is 110 trillion, is 1-2 a big problem if ROE of US is 15% per year. This country is strong than you think.

JH

Anonymous said...

Where Mr Greenspan bears responsibility is his role in ensuring that the era of cheap interest rates created a speculative bubble. He cannot claim he was not warned of the risks. Take two incidents from the 1990s. The first came before he made his 1996 speech referring to "irrational exuberance". In a Federal Open Market Committee meeting, he conceded there was an equity bubble but declined to do anything about it. He admitted that proposals for tightening the margin requirement, which people need to hold against equity positions, would be effective: "I guarantee that if you want to get rid of the bubble, whatever it is, that will do it." It seems odd that since then, in defending the Fed's inaction, he has claimed in three speeches that tightening margins would not have worked.

The second incident stems from spring 1998 when the head of the Commodity Futures Trading Commission expressed concern about the massive increase in over-the-counter derivatives. These have been at the heart of the counter-party risk in the crisis. Mr Greenspan suggested new regulation risked disrupting the capital markets.

At the turn of the millennium, with no move to tighten margin requirements, a feedback loop sent share prices into orbit. As prices rose, more brokers were willing to lend to buy more shares. As share prices went up the buying continued, until the bubble burst. To create one bubble may be seen as a misfortune; to create two looks like carelessness. Yet that is exactly what the Greenspan Fed did.

Bruised by stock market losses, Americans bought houses. The mortgage industry used securitised bonds to ensure that the people who initiated the mortgage did not worry about getting paid back; risk was packaged and sold to others. This time Mr Greenspan did not just stand aside. He said repeatedly that housing was a safe investment because prices do not fall. Home owners could wait out any downturn. Is it any surprise that so many people thought if the world's financial genius held this view it must be all right?

Even as things went completely wild, Mr Greenspan dismissed those who warned that a new bubble was emerging. It was just a case of a little "froth" in a few areas. Later, after waiting until 2007, two years after he left office, he conceded that "froth" had been his euphemism for "bubble". "All the froth bubbles add up to an aggregate bubble," he told the Financial Times.

This time, as with the equity bubble, the mistake was not to set interest rates too low; it was to stand back as wildly imprudent policies were pursued by mortgage lenders. Indeed, any lender would have been encouraged by his words in April 2005: "Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending." Well, he was right about the rapid growth in subprime lending.

Mr Greenspan was in charge of supervising and regulating much of the banking industry for two decades. The Fed says it is responsible for ensuring "safe and sound banking practices". It is right that other regulators should have stepped in, too – the US regulatory structure has not kept pace with market changes . But given the Fed's institutional importance and Mr Greenspan's personal stature, does anyone doubt that the Fed could have used its limited powers to ensure a closer examination of what was going on?

Mr Greenspan realizes that something big has happened and describes it as a "once in a hundred years" event. But then, you do not get Alan Greenspans coming along every day.

rodgerdodger

Anonymous said...

Carl, Being a mathmatican, you may like this http://www.edge.org/3rd_culture/taleb08/taleb08_index.html

Anonymous said...

I don't know what happened to my previous reaction...

But considering you history of crisis allusions, there's one thing you missed. The crisis that started in 1929 became the worst depression in history because of political decision to become isolationist, the system switch killed the economy that was much more globalized at the start of the century. World war II was finally what permitted the economy to get over the crisis...

Morality, sometimes you have to let the system crash if you want it to survive.

Paulson/Bernanke's action is nothing more than a first step into isolationism in a globalized economy...They won't become heroes, that's for sure...

- they are underestimating the cost, 700 billions wont be enough.
- Secondly they are disregarding the fact that they are asking the world to pay for them while they'll save only US institutions although those institutions sold their craps to the whole world.
- They are changing the rules of the game (in the middle of the game) by forbidding short selling those institutions...

AS stated above, the only thing that keeps AMERICA standing is TRUST...Watch the dollar as a measure of this trust...It could fade big and fast...

Balsamo

Kash said...

Hi Carl,

Great essay, and very eloquently written... thanks for sharing it with us.

You are right that Bernanke and Paulson will be judged as heroes by history. What they are doing is not easy. You are also right that Bernanke will eclipse Greenspan.

Look at who is crying bloody murder. These are they permabears, and the shorts. They are upset because they are losing money... its not about any ideals.

Desperate times call for desperate measures. That is what we are seeing. The government is doing exactly what it is supposed to do. Just look at the fact that the whole issue is being conducted in a non-partisan fashion... for the collective good.

Regards,
-FK

Anonymous said...

That essay was almost perfect. You forgot to laud the shadow job the Trilateral Commission has done all these years to save the planet.

Anonymous said...

Carl, you call them heros... gosh, WTH are you thinking?

http://market-ticker.denninger.net/archives/587-The-Mother-Of-All-Frauds.html

Anonymous said...

Now, the governmental actions are a real mixed bag here, and hard to understand. What I understand fairly well is that the short sale ban in the financials was a bad idea. It does nothing to really help the situation and only calls the credibility of the market into question. I've actually heard pros talk about getting out of the business due to this action. They'll likely change their mind as this action is only temporary, but the fact that Cox thought it was a good move means that the leaders at the helm are ignorant of how our market really works. Now, steps to shore up money market funds is good. These are what bank deposits were in the 30's. Shore them up or watch the system grind to a halt and for a trillion dollars to go to money heaven. These funds need to be revamped a bit and policed long term (probably by someone other than the Feds), but near term, the Feds did the right thing there. The RTC-type bail-out of the bank' toxic mortgages is NOT a good idea. Just like RTC was a bad idea. There are a lot of bad mortgages. There's also a lot of salvageable value there, so long as there is an incentive to exploit it. If the Feds take that debt in, there will be no workable salvage possible and the value destruction will be far greater. The housing mess will go on and weigh on the markets for a decade. Certainly the Feds can play a role, but this is not the right one. So, plan on a cap for the market for some time. It's well above our heads, and we've probably got a floor below, too, but it's not a great time for Buy and hold.


--------------------

Mark S Young

Anonymous said...

There are many astute traders who saw this downturn coming who at the same time were critical of government intervention and handling of this crisis. Ofcourse Bernanke and Paulson and Bush will be seen as heroes....by the majority, but as a contrarian, who wants to be part of that crowd???? Bush waged an illegal war against Iraq and broke it. Now he and mccaine want to be hailed as heroes for the apparent success of the "surge" LOL. Sound familiar?? Too funny. Sorry , it's not funny at all. I have documents and documents and videos of many economists, fund managers and professional daytraders who warned of this fiasco, so sorry if I can't sympathize with the FED cheerleaders here. I don't want to be part of that majority, which is a bad habit to get into anyway. Ofcourse these guys have to take extra-ordinary action to stabilize the markets. But where was the preventative maintenance in the first place?? LOL. If you want the names of great trading service sites who nailed the spike up , I've got a nice list of them. We aren't crying for lack of making money but we're not going to shy away from calling a spade a spade. Don't follow the crowd mentality folks. I have never made a dime following government advice or watching the government aligned, corporate backed media circus. So why should you?? LOL.

Bugsy Silverstein

Anonymous said...

LITTLE INFATION??

Guess the Mrs. did the grocery shopping for the past 20 years and you don't have kids going to college.

I saw this coming more than 3 years ago and took advantage of it on the short side.

All you are is a bull, another Cramer!!!

Anonymous said...

Over at NakedCapitalism

Why You Should Hate the Treasure Bailout Proposal.

….Now to the substance. The Treasury has been using the formula that it will buy assets at “fair market prices”. As we have noted, there is simply huge amounts of cash ready to bottom fish in housing-related assets (we saw an estimate of $400 billion a couple of months ago). The issue is not lack of willing buyers; it’s that the prospective sellers are not willing to accept prices that reflect the weak and deteriorating prospects for housing. Meredith Whitney, the Oppenheimer bank analyst who has made the most accurate earnings and writedown calls of her peer group, has noted how the housing market price decline assumptions used by major banks fall short of where the market is likely to bottom, given traditional price to income ratios and expectations reflected in housing futures prices.

In addition to the factors that Whitney (and others) have cited, the duration of the 1988-1992 US housing bear market and major financial crises suggests that that a peak-to-trough decline of 35-40% is realistic (obviously, this average masks substantial variation across markets and housing types). We are thus only a bit more than halfway through, as measured by the fall in prices.

Yet as we discussed, the plan makes no sense unless the Orwellian “fair market prices” means “above market prices.” The point is not to free up illiquid assets. Illiquid assets (private equity, even the now derided CDOs were never intended to be traded, but pose no problem if they do not need to be marked at a large loss and/or the institution is not at risk of a run). Confirmation of our view came from a reader by e-mail:….

Read the whole thing.

I enjoyed the commenter who remarked - “This makes the sacking of Rome look like Sunday School!”

christopher carolan

Anonymous said...

Many people regarded this outcome as inevitable, such as the late esteemed economist Dr. Kurt Richebacher. And he was warning of it since at least 1999. I have an article by Rick Ackerman about Richebacher dated 8/23/99 titled "Basic Facts Point Inescapably Toward Disaster". Here is one of the things Dr. Richebacher said: "Derivatives can insure individual market participants against risk, but not the system as a whole. Ultimately, they have spurred higher risk-taking through leverage, exposing the global financial system to the prospect of devastating failure." Ackerman, paraphrasing Richebacher, says that "U.S. economists in the 1960s would more readily have recognized [several problems in the economy including derivatives] and acted stridently to counteract them, and that public discussion was still influenced back then by staid economists who represented the banks and knew their theory." Richebacher said the current crop, "is really a part of Wall Street's sales force to sell shares."