Wherein I ruminate on a conversation with a colleague in the financial services industry and a lecture from a guy who happens to have some street cred in the topic of economics.
Yesterday I got into a discussion with a colleague about the consequences of bailing out supersized financial institutions - chief among them the consequences of giving very risky managers carte blanche on the taxpayer dime to indulge their wildest deal-making fantasies, knowing that good ole Uncle Sam will back them up no matter how many gold pressed latinum/dollar forward currency swaps or Monopoly Chance Card default swaps they purchase.
My colleagues take is that any gummint intervention is teh evil but, if you had to go that route, the government should take a common stock equity stake. That way, it has the right to complain as a shareholder.
Apparently, you can't complain as a regulator or representative of the people but, heck, if you haz sharez you iz legit.
Let's table that one for now.
I brought up the topic of Bernie Sanders' proposal to break up Too Big To Fail (TBTF) companies as an exercise in trust-busting.
My colleague went further - we never should have bailed out anyone, that it was an incredibly stupid move.
In this, he and I of diametrically opposed politics were in accord.
I will illustrate - the bailout of AIG was presented as a must-do. If we do not do this, we were told, the consequences would be catastrophic to the global economy. Trillions of dollars of wealth would be destroyed, just like that.
Hold that thought while I rummage in teh historical data for a fact check...
On September 16, 2008, the Federal Reserve drew up a $85 billion facility - to save the world by saving AIG.
snopes covers a lot of angles on AIG in the process of debunking one of the sillier RepubliMemes out there.
The justification to save AIG was that its collapse would force the revaluation of a wider range of securities, which would greatly inconvenience AIG's credit default swap counterparties .. among them several other TBTF companies.
So... it's a good thing teh Wurld wuz Saved.
Oh, about that trillions of dollars of wealth that wasn't destroyed because we saved TBTF companies?
On September 16, 2008, the eve of Financialgeddon, the S&P 500 Index, which measure the rise and fall in value of the wider equities markets in the United States, closed at 1213.60.
On March 9, 2009, the S&P 500 closed at 676.53
As a rough rule of thumb, you can take the index close and divide by 100 to get the trillions of dollars of equity covered by this index - which represents about 70% of the entire equity value of the United States markets.
So you tell me if $12.1 trillion minus $6.8 trillion is a lot of FAIL or not.
And this is how "well" the bailout did over this period of time. It "only" cost investors $5.3 trillion dollars...in the U.S stock market. Then there are all the other trillions lost in other stock markets...and all the defaults on bonds...collapsed home prices..lost homes...jobs... benefits including health care... access to food and shelter...
Whew. Good thing we bailed out AIG and by default AIG's friends, right?
Where I concur with my right-wing colleague is that the sticker price of letting AIG and its creditors bail themselves out - or better still, endure the rigor of existing bankruptcy and receivership processes - could not possibly have been much more expensive to the overall economy.
No, that's not quite true. There's more.
Early last week I went to see Paul Krugman speak. Among the several slides he threw up on the screen "as a security blanket", he joked, was one that demonstrated the ballooning of the Federal Reserve balance sheet to cover, in his words, ALL lending in the United States debt market since last year's financial meltdown.
As Krugman put it - "I'm no longer terrified about the future prospects of the global economy. Instead I am chronically depressed about it."
That gallows humor got a chuckle from the gallery.
But what struck everyone in the room - to dead silence for a few moments - was this one takeaway - there is virtually no lending going on that isn't backed by government paper. NADA.
When liberals are blamed for the 'takeover of the banking industry', this is what is decried - the actions by people, most of whom I can assure you, do not vote Democratic - because they can.
Because they are too big to fail.
So they lend money, here and there, so long as it is "de-risked." That's the buzzword these days in financial circles. De-risking.
They mean it literally. If the risk isn't wholly fobbed onto the taxpayer, the bankers aren't interested...and the borrowers aren't getting.
And you may have noted this week's run in the markets, concurrent with yet more downward pressure on major global currencies.
The G-20 met and decided, yep, we're gonna keep printing money to keep the de-risking machine running.
So, in a nutshell.
- The banks love it this way
- The financial stockholders love it this way
- Because they can make money and bash liberals at the same time, the Republicans love it this way
- The government has taken over banking - as the sucker holding the bag. Since Democrats run the government these days, guess what that makes us.
Now, before you ask me "OK, critical person. Offer some constructive advice."
I'd love to. But I listened to Paul Krugman, one of the smartest men in any room on the topic of economics, shrug and admit he has no idea for a quick fix, either. There may not be one, given the summary of a dozen similar bank failure cases that occurred throughout the world over the past few decades.
Worse, per Krugman - This financial crisis hit everywhere at once, so the strategy that worked in the past - devaluation of the home currency to make exports attractive - just won't work.
And the last time countries tried this gambit in a depressed global trade environment was the Great Depression. So competitive currency devaluation ain't gonna help this time around - and we lack the excuse of ignorance of consequences to indulge in it again.
Krugman also tossed in that there was great resistance on massive debt spending even in the 1930s, that conservatives in both parties were even then looking to rein in the WPA as soon as possible. When they succeeded, the country fell right back into recession.
My take - It would take Pearl Harbor to overcome conservative resistance to Keynesian spending yet again. In this the meme is correct - it took the New Deal to overcome the Republican-worsened Great Depression of the early 1930s, and World War II to overcome the Republican-sparked Recession of the late 1930s. Conservatives did not learn the lesson when it was fresh, and thus we have had to suffer again and again their efforts to amputate the strong arm of the government as an economic actor, again and again.
Krugman suggested that carbon cap and trade could spark a wave of valuable economic activity, that this could be the New Deal/World War II level commitment that gets us out of our current economic malaise. This would represent a restructuring of our overall economy.
The problem being - everyone wants to help the environment - in principle. They just don't want windmills in their backyards. Or have to change to public transportation. (Because, really - once you start telling people to get out of their SUVs, that's crossing the line for some of our brethren!)
Krugman was not optimistic about emerging new technologies opening up sectors for start-up investment. He mentioned nanotech. I am not sure if I agree on this one - I think there are plenty of ideas out there, sufficient to map out the technological roadmap of our civilization (assuming we survive the next century or so) for a very long while. But, as the pursuit of fusion power demonstrates, even the simplest of concepts can have a host of daunting challenges when you move from paper to practice.
HOWEVER... there is SOME good knews because of this. Krugman answered a question about the scenario wherein China dumps dollars and tanks our currency. He said - "They won't do that. They'd be doing us a huge favor and themselves a lot of damage." So, out of self-interest, the two great powers, sometimes rivals, always trade partners, are in this together.
So....tying this all together
Much of the catastrophic hit to global markets between September 2008 and March 2009 was due to causes in which the AIG was but, truly, a small part. Financiers placed a huge bet that the embedded economic value within chronically underpriced U.S. real estate would sustain a long run-up in resale values, if only banks could justify to the credit rating agencies that lowering the down payment limits, while raising risk of default on residential loans, would be more than made up by the price increase of opening up home ownerships to tens of millions of new American homeowners who would otherwise be locked into renting. A quantitative ... excuse to do this was drawn up, the rating agencies nodded, the bond insurance companies licked their chops at all the additional business they were going to get and everyone thought making trillions of bucks turning bad debt into gold was going to be not just fun but a worthy service the world.
And "to the world" the practice of easy credit was sold. Subprime and Alt-A is but part of a globe-spanning seemingly-salutary epidemic of generous credit terms that seems Too Good To Fail. It was so "TGTF" that banks and other financial institutions, such as AIG, felt comfortable entering into side bets on default rates for all this excellent new business that the industry created out of the creditworthiness equivalent of thin air.
And for so long as it took the real value of residential real estate to catch up to its long-run trend point...and even a good bit above in some markets...this was a very safe bet. They all were.
Let me explain that one - in the United States, real home values (in price per square foot) from about 1987-2004 were flat. The two century trend for real value appreciation for U.S. homes is about 7% per annum.
At some point the residential mortgage lenders figured out that part of the answer was that the U.S. population of qualified borrowers wasn't growing very quickly, if at all. Now, some relaxation of standards did occur prior to 2004, but it really is the 2004-2007 market where prices in some markets just went nuts. Banks are conservative institutions. Few traditional banks (Krugman makes this point) were comfortable lending to anyone with less (and later, no) skin in the game as a debtor. Most institutions never bet the farm on this segment of business, regardless.
However the industry as a while became more comfortable with the existence of this debt...and the existence of lending institutions that were outside all of the many safeguards set up during the Great Depression to keep this very thing from happening again. Krugman calls them "shadow banks" - workarounds to the rules to keep credit markets well regulated and working for all stakeholders. Rules that were likewise in the way of making trillions of dollars...and therefore had to be mooted.
And so banks and other creditors - mostly others -relaxed the requirements. And, boy, did homes start selling.. and getting built. By the tens of millions.
Even the stodgy respectable banks - the ones that you can just see going "Harumph!" at the very idea of subprime lending - were surprisingly comfortable entering into credit default swaps that were partly backed by subprime notes or just going out and buying AAA-grade investment bonds that included tranches (groups of policies of comparable characteristics, for example interest rate and year of origination) that were only AAA grade by fiat - because a Standard and Poor's or Moody analyst signed off on the tranche as suitably insured from default risk thanks to a guarantor such as Ambac or MBIA.
So, for one brief shining series of quarterly earnings report moments, we were all.... in Camelot. Ok, no, not really. That's the point. The financial services industry was in Fool's Paradise.
Too Good To Fail...failed.
And Too Big To Fail did not make it any better.
Much is made of the subsequent rebound in equities markets. See? The bailout worked!
Well... let's just see how some major financial companies have fared over the past year relative to the S&P 500 index
Citi..........-40%
AIG...........-18%
BofA..........-17%
Wells Fargo....-1%
XLF............11% tracks financial sector.. underperforming
JP Morgan......22%
S&P 500........22%
Annaly Capital.23%
Fannie Mae.....50%
Freddie Mac....50%
Goldman Sachs.140%
Genworth......800% (rival to AIG in insurance segment, coming off bad times of its own)
Some high profile companies - Goldman comes to mind - seem to be beating the market. A lot of other name brand banks and financial institutions aren't. And as you can see, with the federal promotion of residential lending, Fannie and Freddie are getting back into the game. They are actually lending to prospective homeowners.
A lot of banks aren't. Not everyone is posting Goldman's numbers. Does this mean that many banks have become risk-averse and just the time they need to be lending more? At just the time that home and business owners need more credit, not less?
Given how often the term "de-risking" is employed these days? Given how many business owners I have spoken with, complaining about their lines of credit being cut in half... if they are lucky? Given how many refinances AREN'T happening because the some banks are charging high fees for the service? The answer appears to be yes.
But look on the bright side - All those under-performing banks above? They're all Too Big To Fail.
Awesome... I guess.