I am about to get on a plane to Miami and should be hitting the clubs in just a few hours. Although I am not sure it is possible I will be out as late as 7:45 tonight.Anywho, I have been wrestling with a small dilemma and candidly I do not know what conclusion to draw.
Others have said this before but is the US really a capitalistic country or are we only capitalists when markets are going up.
Whatever the best description for the Bear Stearns story it is not being allowed to fail in the purest sense of the word. Whatever the Fed's role really is, JP Morgan was nudged into the deal (not that it isn't a good deal for JPM but would they have gotten involved without the Fed?). I believe that an outright failure, because of BSC's leverage would have dominoed to create problems, maybe really big problems, for other firms and by extension the US economy and maybe the global economy.
No doubt you have seen rumblings for more regulation as a result of all this which is not a shock especially considering that this is an election year.
I could be easily convinced that all of this intercession makes the short run better but I do think that it puts the future at risk. All of that free market theory you read about at some point in your past, well it holds some water. Treading on that does create a risk for long term consequences that would probably be less of a shock and more of a deterioration. I tend to think that bouncing back from a painful, but fast (fast could be two years), dislocation would be much easier than bouncing back from a ten year erosion.
What do you think? Maybe a productive discussion can break out while I'm on the plane watching Miami Vice DVDs so I'll be ready for my visit.
14 comments:
Roger - I'm a new blogger and read that I should try to network with other bloggers, so here I am.
I started a new blog called "Logic-Over-Emotion Investing" at http://asburyresearch.blogspot.com/
Check it out and feel free to use any content that you find useful.
Best,
John Kosar
john@asburyresearch.com
I agree that the Fed's interference may cause us quite a bit of trouble in the future. Of course, we don't have a free market economy so this is hardly a new thing.
I'm curious what the real inflation rate is in this country now. The numbers the government offer are just wrong. How can you not include things like food and fuel? Of course, inflation is going to get worse here pretty shortly; as soon as the printing presses can crank out a few hundred billion more dollars. But, look on the bright side, it will be easier for us to pay off our enormous national debt! We are acting just like a third-world country; maybe we are becoming one too. Hey, maybe all the illegals will leave when life in their home countries is better than here.
Roger. OT, but I see that Iceland just raised their main lending rate to 15% to combat inflation. The cost of eggs there must be too high I guess.
I know you have talked about Iceland in the past, so here's the link:
http://tinyurl.com/2hcev3
thanks
Roger
This strikes me as an important point. As Americans we like to think of ourselves as believers in the free market, but socialism creeps into our existence in so many ways. From fire protection to education to (mostly) medicine, we collectively do not seem to trust the invisible hand when the heavy hand of the government may be brought to bear.
Regarding the financial system, this was clearly a government bailout. The major haircut equity holders took was not the point - all the holder of debt and counterparties to Bear's derivatives have been made good via fed's balance sheet. They got bailed out in massive way. This is troubling to me.
Of course if fed had just stood aside the potential consequences are troubling as well. So litmus test of belief (it defines one's faith since we can never observe the counter factual) is whether we prefer unknown of free market solutions versus unknown of intervention (moral hazard, taxpayer as guarantor of last resort, etc.).
For me, I observe that empirical data throughout history and around the world suggest more govt is bad, more market is good, so I tend to come down on side of free markets. But I concede that there are strong arguments for some government e.g. to force transparency, and the proper place to draw line is usually not clear cut.
Further, since our fiat money regime is a form of de facto socialism, it's impossible for government to step completely aside - they've made themselves integral to the playing field. I suppose there is a separate question about value of fiat money, but it seems to me academic since I see no path by which that might change anytime soon - so just accept that it's inevitable.
So I'm left being troubled, but with no clear opinion about whether the decision was right or wrong. From a practical standpoint, I try to separate what I think government should do from what it the actual evidence suggests government will do - that's generally hard enough.
Michael
My understanding is that capitalists are people who support an economic system where the means of production and distribution are privately or corporately owned and the whole operates in a free market. Americans like to think of themselves as capitalists and in favour of free-trade but, just like gold, it is very difficult to find that product free of all impurities in its natural state because, unlike gold, pure capitalism is a highly unstable state. No country operates a pure capitalist model of an economy and all of them that say they do in fact pay lip service to the concept in practice. The Bear Stearns episode is only one example in the finance business but there are many others, particularly when it comes to advocating free trade. I don't want to be the one accusing the Americans of any of that sort of behaviour because all countries are guilty to a lesser or greater extent. However, may I suggest that we all lower our heads and humbly contemplate our respective navels. Willy
The American economy depends on credit. Credit depends on trust. Recent debt events has broken trust. It will mtake a long time for trust to return to the credit market. New delivery systems, that take time to develop, are needed. Those that figure out what form will be the winner will prosper the most. It would be interesting for Roger and this blog's readers to speculate on what new tool will be the winner. After all, what will replacethe broken securitization market?
The system will not work with only upside risks.
They need to have away to let failed banks stock go to ZERO just like any other company or they will just keep creating bubbles that devastate main street while wall street is guaranteed a safety net.
The fed should not have guaranteed all of the bond holders value either. Although I do see how the fed probably needs to guaranty 60 or 70% of the bonds worth to prevent the system from failing.
But the way this was handled was ludicrous and way to expensive for the government. No wonder Wells Fargo CEO said "I would not be averse to a Fed-assisted transaction,"
Who would not want billions free from the Fed. This statement proves the Fed is an idiot because Wells Fargo is now implicating other banks are in dire straights hopping to get a run on another bank so Wells Fargo can be the beneficiary this time.
The Fed is to stupid to realize the issue they have started of banks WANTING other banks to fail.
Let's just say that they somehow save the the planet from financial armageddon and manage to get the trust back on track,will they be able to fix and prevent the future use of these financial timebombs? It's a global issue and if Long term Capital is any indicator than I would say no and we are just buying time so the ultra rich who've made some on the short side get paid and get out. I mean what's the point of bailing if we can't put in strong regulatory measures that will put a stop to the insanity. If this spreads to CDSs then it's light out. Capitalism...right.
Steve
I think the procedure used for the BSC bailout was a mistake, setting a bad precedent that encourages corporate management to continue business as usual.
Yes, I agree, a BSC failure would create negative repercussions at home and abroad, but, I suspect the harm - our creditability - has already been done. The difference now is all USA investment institutions are suspect not just BSC.
I guess future investors will need to discount for risk ( lack of disclosure ) the face value of investments from American investment institutions
What has American Corporate management learned from this? Consequences to BSC corporate management - maybe damaged ego - financially they are OK with their multi-million dollar bonuses and salaries. They can retire today and live better than most of us and never give a thought to needing a supplemental income in the future, irregardless of inflation.
Major mutual fund houses put a lot of political pressure for a Government bailout to protect their investors ( T. Rowe Price, etc ). It is bad for business if your institutional mutual fund takes a big hit and you lose the account.
Remember Chrysler corporation financial problem? There was a bailout with a payback. BSC has no payback, it is a payoff with taxpayers money, $29 billion.
"Under the plan, the Fed will release 29 billion dollars in taxpayer funds to help support the takeover in return for 30 billion dollars worth of Bear Stearns assets, including ailing mortgage-backed securities. The portfolio of distressed Bear Stearns' assets will be managed by BlackRock Financial Management on behalf of the Fed which will accrue any gains from the portfolio."
BSC should have been allowed to fail or a ( $30 billion ) payback bailout should have been constructed. If allowed to fail - go to zero - then all assets corporate and those of management ( manager and manager family members ) should be seized and used to off-set investors lost. Management would be allow to keep assets (home, car, furnishings) equivalent to those of a medium income family living in the area of corporate headquarters using current census data.
Yes, this is severe financial punishment but without holding management accountable and corporate funds for bad judgement corrections how will we stop these problems, BSC, Enron, MCI ...... Management and family will recover as easily as those investors who trusted management's written and spoken word in regard to corporate affairs. Yes, ex-management will need to get a job and work like the rest of us.
The real losers are those who purchased BSC investments. American taxpayers will lose as well, $30 billion of distressed assets less auction price and BlackRock management fees.
Richard
Can you say "privatize gains, socialize losses".
Im a recent interview, PIMCO's El Erian referred to the need of good "Financial Infrastructure" as oppose to regulation. I understood him to mean that we needed clear transperancy, good accounting, accountability, etc. to have well functioning financial markets (i.e. things we are missing today).
Regarding the FED action on Bear Stearns, I view that the FED let Bear Stearns fail, kept the toxic waist and sold the remainder to a stronger competitor with limited overalp for 2~10 dollars + the cost of the mark down of the toxic waist. I think it was an orderly unwinding.
Now, if they could come up with a similar plan for the housing market that does not involve anymore rate cuts.
CA
The Economist has a good article covering what we have been talking about.
"WHAT WENT WRONG"
Mar 19th 2008
From The Economist print edition
In our special briefing, we look at how near Wall Street came to systemic collapse this week.
http://www.economist.com/finance
Also interesting.
Economist Front Page - At a Glance section. The article "Free Fall"
Optimism erodes among global finance chiefs. In a U.S.poll of over 1000 CFO's, 9 out of 10 give a thumbs down on the economy.
Richard
There is plenty of blame to pass around, the investment banks, regular banks, mortgage brokers, bubble homeowners AND the Federal Gov't. The Gov't has insanely pushed homeownership beyond any sensible bounds, insisting that everyone should own their homes and allowing people to buy overpriced homes with nothing down and no proof of ability to pay.
Remember the '29 crash was partially caused by exess margin on brokerage accounts, allowing people to buy inflated stocks with little down, which caused even more inflated stock prices. Eventually the bubble burst.
Well, guess what? Again we have people buying inflated "securities" (homes, expected to keep rising) with ZERO down!
Seeing how our gov't is so far in debt and dependent upon excessive credit, I have to wonder if the regular credit markets melted down, would it eventually take the U.S. Gov't credit "house of cards" down with it? Maybe that is why the gov't HAD to stop it early!
Ken
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