Thursday, April 23, 2009

Moral Hazard: Bailouts and Regulation

Since the beginning of this economic crisis, there has been a steady demand for more control and regulation of banks and financial institutions in order to protect retirement accounts and the economy as a whole (jobs). That reaction is engrained in our nation's history as government regulation has only increased in response to banking and accounting scandals and asset bubbles. Not once has it decreased. Yet, after one year of dramatic government intervention, it is all too clear that our financial system remains as fragile as it was a century ago, despite the creation of countless government agencies whose mission is to protect and strengthen that system.

Some deregulation did take place in the 1980s and 1990s, but the only policies that could be tied to the current crisis have only exacerbated the fallout of the housing bubble, such as the 1998 bipartisan Gramm-Leach-Bliley Financial Services Modernization Act, which relaxed Glass Steagall provisions (leading to more securitization a la Freddie and Fannie) and exempted financial products such as CDSs. There are some like, Paul Krugman, who claim the act was instrumental in the crisis, but they cannot explain how the original laws would have saved Freddie and Fannie, who wasn't affected at all by the GLBA, and why European banks, which never had anything like Glass Steagall, did not suffer the same problems. The amount of financial regulation since 1907 dwarfs the recent deregulation, which at the very least helped financial institutions stay in business as they were acquired by healthier banks.

It is a widely held view that the asset bubble--fueled by cheap loans (artificially low interest rates) and easy credit, both for borrowers (think low/no doc loans) and investors (think bogus triple-A ratings)--had to pop sometime. There had never been a bubble like that in human history, and low interest rates only encouraged consumption, which meant that MBS investors lacked adequate capital in chasing these diminishing returns. But that didn't stop them.

Why didn't it? The investors purchased an insurance policy from Congress, unbeknownst to taxpayers. But the deal was too good to be true, for Congress, that is. For a nominal amount of campaign contributions, the bankers were able to get stinking rich, knowing all along the risks were being mitigated. The extent of the S&L Crisis of the 80s was a direct consequence of deposit insurance, and eventually cost taxpayers $200 billion, while many kept their profits of their risky practices. Only a handful went to jail. A decade later, the creditors of the Long Term Capital hedge fund, (the names might be familiar to you: Bear Stearns, Merrill Lynch and Lehman Brothers) were bailed out by the Federal Reserve. Over the years, as sort of a quid pro quo, those same companies donated heavily to candidates of both parties, just in case more of their investments should tank. It's no small wonder that two of the three were recently deemed "too big to fail".

These competing forces are actually anti-competitive and destructive. The regulators try to prevent bad behavior while the elected officials are financially compelled to make it all better should the behavior result in trouble. This is analogous to the life of a typical teenager who has a set of rules and responsibilities (regulations), but also enjoys a big safety net in the form of loving parents and free rent (the full faith and credit of the U.S. government). If the rules are broken, the lawn isn't mowed, no biggie, at least the teen won't be kicked out of the house. And most kids get to come home from juvenile hall. This codependent family dynamic apparently has weaved itself to every corner of industry and the bureaucrats who regulate it.

So with the same incentive structure, albeit more regulation and more bailouts, why would we expect different behavior, both on the part of careless investors and corrupt politicians? The pattern shows that problem isn't the undesirable actions that we regulate against, it's the current set of actors and incentives that lead to the undesirable actions that regulation can't keep up with. We need to change the incentives if we expect a different result. Our elected leaders are just as addicted to power as big corporations are addicted to money. This codependent relationship is a destructive monopoly that costs taxpayers and investors huge sums of hard earned money, and only by letting them both fail, will the destruction stop.

Monday, April 13, 2009

Tea Time

Growing up in a conservative family, the extent of my government protest was limited to a 1 page fax to my representative opposing Clinton's tax increases. And since then it's been limited to letters to the editor and blog posts. I've never picked up a sign or attended any political rallies. Crowds frighten me because the average IQ drops about 30 points when people get together and emotional appeal takes center stage: typical mob mentality that just gets peoples attention without any kind of coherent message. The G-20 protest/riots are a good example.

Republicans and their rallies are no exception to this rule. Their one size fits all platform of social+fiscal conservatism attracts people who like to expand the government in the name of national security while refusing to do anything about the incompetence in everything else the government does, so long as social issues like drugs and gay marriage are sufficiently fought against. That kind of mob mentality has turned off many small efficient government proponents like myself.

So when a bunch of my fellow Americans, regardless of political affiliation, decided to rally together in the name of a single cause, over-taxation, I definitely took notice. So have many in the media.

Today, the reasonable, and totally non-partisan "economist" Paul Krugman had this to say about Tea Parties:
One way to get a good sense of the current state of the G.O.P., and also to see how little has really changed, is to look at the “tea parties” that have been held in a number of places already, and will be held across the country on Wednesday. These parties — antitaxation demonstrations that are supposed to evoke the memory of the Boston Tea Party and the American Revolution — have been the subject of considerable mockery, and rightly so.
The G.O.P. has as much to do with overtaxation as the Democrats. Krugman conveniently forgets that the poor showing for Republicans the last two elections has a lot to do with their embarrassing abandonment of small government principles under George W. Bush. A lot of Democrats justify their increase of government spending because Republicans were no better under Bush.

Republicans typically act like Democrats when they have power and Libertarians when they're out of power. But acting like our Founding Fathers in protest of an out of control tax and spend, spend, spend regime? Now that's something new. And that's why I plan on attending my local tea party.

Critics of the Tea Parties think that if anyone protests big government or tax increases, then it must just be the work of bitter Republicans in response to the election. But how come they've never taken to the streets before? Why is it not obvious that certain policies of this administration AND the last one are so unpopular and go against everything this country was founded on?

If you believe government is out of control, that they work for us, not the other way around, it's time to send them a message. Please vote on the poll to the left if you plan on attending a tea party. And please let us know about your tea party experiences in the comments section below.

Sunday, April 12, 2009

Are we all socialists now?

According to Benjamin Sarlin @ The Daily Beast Socialist Shocker:

Maybe Glenn Beck and Rush Limbaugh are right—socialism is a real and dire threat to America. The latest Rasmussen poll shows a stunningly low 53 percent of Americans favor capitalism over the dreaded "s" word, with a full 20 percent preferring socialism and an additonal 27 percent unsure.

So, 20% committed and 27% on the fence constitutes a dire threat? Since when? Wouldn't it be intellectually honest to compare these stats to those when times are good? How about we ask some of the 27% how well versed they are in the track record of socialism vs. capitalism. Oh, wait, that wouldn't be a feelings based story.

This comment caught my attention, because I've probably read it 100 times on different sites since the start of this debacle:

"Government intervention in the economy is the source of these problems."

Can you please explain what you mean by this statement? Is there any evidence that the financial industry was under-regulated? Have you ever heard of the Glass-Steagall Act? Do you know what effect the Gramm-Leach-Bliley Act had on speculation and investment? What, exactly, do you think brought us out of the Great Depression? If it wasn't the massive government spending of FDR's New Deal or the massive government spending of WWII, what was it?

Bailouts suck. So does chemotherapy.

So here's my response:

The Fed created artificially low interest rates, which combined with tax subsidized home loans, caused a housing bubble. Bailouts have hindered the recovery process by making banks hold off on selling assets for 10 cents on the dollar when Uncle Sam and Taxpayers will pay 30 cents on the dollar. Capitalism has as much to do with punishment as it does reward. The government is rewarding failure, and ensuring that these people are around to make the next bubble turn into a disaster.

The bi-partisan deregulation in the late 90s has exacerbated the problem, but it was not the cause of the problem. CDS need to be regulated, but they are not evil things all by themselves. No one complains about insurance when there's a hurricane, only the fraud and insolvency of institutions that don't make good on their promises.

The Great Depression affected much of the world. Coincidentally, much of the world also had to contend with the destruction of WWII. Our industry was one of a handful that remained undamaged. The U.S. was the only major industrial superpower remaining after WWII. That's how we got out of it.

Debt is useful to bootstrap your company, afford a house, or pay tuition. You know there is a surplus of income down the line that will eventually pay for it. How does the country know that? Our personal finance reality prevents us from taking on more debt than we can repay in our lifetimes. Our elected officials can just pass it to the next generation. But at some point, servicing the debt will take up too much of our resources. Then it's total economic collapse.

If you find yourself in a hole, stop digging.