How ‘Bout We Try More Capitalism?
Everyone right now is focusing on the financial crisis and with good reason. There are so many claimed causes spanning decades. What really caused all this is the government monkeying around with the basic rules of capitalism, and by that I mean hard-core basic economics.
The first basic rule: Price is set by one thing only – Supply and Demand. Cost is NOT relevant to price. It is only relevant to whether the price you can get on the streets will net you a profit as against your costs. The amount of supply and the demand of people to purchase that thing drives prices.
When supply exceeds demand, as in the market for finished single-family homes, the market for Auction Rate Securities, etc., the price goes down. Lots of product. No buyers. Have a sale to clear out the inventory.
When the demand for something exceeds the supply, as in the demand for new mortgages and loans, the price goes very high. Right now if you are a bank and you have cash, you have two choices:
a. Buy really good loans on the street from struggling banks for below par guaranteeing a great return, or
b. make a new loan at par.
No one in their right mind would do the latter. So we wait for the market for loans to run its course and prices to get back to par, and then the supply of loans will go up to meet demand.
I realize this is late and the bail-out has already occurred, but what the government needs to do is get out of the way and let the stupid greedy companies fail. Nothing will happen. The solid banks, and there are many, will buy all the loans out there for pennies-on-the-dollar in bankruptcy. When the banks buy these loans at well below par, they hold them on their books at a lower value and need a much-lower return to make money on them. So they can more easily renegotiate or refinance them so that borrowers can pay them.
The longer we let failing banks stick around with a hope of getting back on their feet, the longer they will hold these loans for a better price and the process takes much longer. Whenever the government gets involved, the process takes much longer.
6 Responses to “How ‘Bout We Try More Capitalism?”
Ned — I share your overall view. I'd prefer to let things work themselves out. If government intervention were sought, I'd prefer at least their trying to avoid mistaken predictions, and engaging in favoritism and other political corruption of the current state of affairs, and simply come in as a lender or safety net of last resort _after_ the failures. (Example that already exists, that too many don't pay attention to, but will “discover” if the Detroit Three automakers likely fail soon — the federal Pension Benefit Guaranty Corporation, which is where terminated pension plans are dumped by companies, most appropriate in the case of bankruptcy.) We certainly shouldn't be bailing out those firms destined to fail — that's not merely a case of moral hazard, but downright pathological to the extent some would claim we're _obliged_ to prevent the failure or perpetuate a failed existence.
Sadly, the non-interventionist case is out-voted; in addition to the ignorant or morally flawed in our vast body politic, even others are considering that in theory it makes sense to prevent problems now rather than face and suffer worse, longer-lasting problems later. In this light we have to try to distinguish between trying save the financial sector in general, and the mistake-prone efforts we have seen from the Treasury Department that smack of favoritism as well as resulting in public relations disasters (as bad as the recent Detroit Three-plus-UAW foolishness, expecting a bailout while continuing to live in denial of reality and not taking steps to reform and rescue themselves first) where the bank-bailout money was misspent on bonuses, dividends, and expensive junkets.
Can't those who love and lust after government interventionism at least be somewhat smart as well as logical, and let happen what can't be predicted, and what can't or shouldn't be prevented, and step in after the failures (a wiser fiscal form of post-Hurricane Katrina intervention, in effect)?
As for another federal interventionist role, the Fed has stated it's willing to go below one per cent with interest rates (it cannot go below zero but is more willing now than before to approach or go to zero) and become expansionist by purchasing Treasury bonds as well as other federal agency securities. (The quasi-public, quasi-private agencies have been and are effectively public, i.e., government entities, anyway, you realize.) The agency securities and the private-sector securities purchases even more so, bother me. What's next, federal directors and “social responsibility” and other political nonsense as requirements of business, even without any federal legislation?
That was the funniest thing I've read all day.
“Price is set by one thing only – Supply and Demand. Cost is NOT relevant to price.”
While this is true while looking at long time horizons, it's not true on shorter timescales. The more something costs, the more it exhibits “stickiness” where price does not reflect supply and demand. This is why for things like housing demand can fall a ton and it will take years for prices to reach the steady state level. This is why making forward projections on long term assets is so difficult: do prices have a lot further to fall to meet up with supply or will demand rebound? There is also the problem of “hidden supply” where sellers aren't officially on the market and try to hold out for a better price before offering goods for sale, e.g. housing again or even oil tankers literally sitting there full but being “lost” to the market.
I absolutely agree with you that housing in particular, and consumption in general, must fall to meet historical baselines. Housing is still overpriced nationally by about 15-20% based on income levels (and as income starts to fall due to deflation that will of course make the difference larger) and consumption in general has been way overblown the last 30 years due to a massive credit bubble. We don't have a choice about standards of living changing, but letting all the bad debt deflate and then renegotiating it so we don't have millions of empty houses and millions of homeless is far better than trying to inflate it away and punishing savers.
That said, I'm not sure who the “solid” banks are. All the major banks are insolvent if you count on housing falling another 10-15% and factor in rising defaults from a severe recession. Many of the regional banks are insolvent due to betting too heavily on commercial real estate. Letting things deflate will see a gigantic number of banks fail, and we would have to expect severe disruptions…but eventually from somewhere people would scrap together enough money to start new banks and buy assets for pennies on the dollar and then start making new loans.
The market/government dichotomy is a false one as it's been taken to have the same meaning for both businesses and individuals. I agree that we should let market forces dictate asset prices and which companies make it/let new ones start, but at the same time our social welfare net would collapse and we'd have widespread misery. If our government had spent even a fraction of the money spent so far on revamping the social welfare programs (that would kick in based on a certain level of unemployment or something and then go away when there was a recovery) then I think it's logical to be against their intervention; but now it's seen as the government either spends trillions on dinosaurs that made bad judgments, or else we're all left to fend for ourselves.
Yes, Mikkel – housing is overpriced relative to income. Plus the home-related special interests' influence in our lives, as well as in many cases, the oversized demands and egos of the home owners are still overdue for more shrinkage.
“The market/government dichotomy is a false one “
Yes and no. Yes in that throughout history and that includes the history of this country, government has not merely supported and protected the market, or provided our nation's currency, say (been a true government) but has gone beyond pure government functions and intervened in the market (economy). As far back as the 1980s, Milton Friedman had stated that the USA's economy was already approximately 50 per cent subject to government intervention. No in the sense that what's public and private are easy and simple to distinguish, and given there is no trouble identifying the two it's easy to identify the presence of one versus the other (which includes in the scope of “intervention” the substitution of public for private sector elements of the economy). (Note that the quasi-public or quasi-private federal agencies, and other similar schemes like Amtrak [National Railroad Passenger Corporation] are “mixed,” too, though that word is as clumsy as “the mixed economy” and in fact, it's effectively public, not private, in such instances.)
* * *
“let the stupid greedy companies fail. Nothing will happen.”
I would disagree with this, and you implicitly say so, too,
“The solid banks, and there are many, will buy all the loans out there for pennies-on-the-dollar in bankruptcy”
and there would be other consequences (reduction of credit lines, rising interest rates even if Fed funds rates keep declining toward zero, calling in loans early if this is legal, et cetera) but you have a point in that it's not all catastrophic. (Also, the federal government would likely do better to wait for the failures and _then_ intervene, as has been noted already).
Note with the Detroit Three automakers, for example, that going through bankruptcy (those of us following the news who have a good logical and moral underpinning of our views and our positions are amazed not only at the lack of effort already to make substantial corrections, by the companies and the UAW, but why they aren't seeking pre-packaged bankruptcy already) is actually the best thing that can happen to them at this point. Some viable remnants of GM made modern like Toyota, Honda, and Nissan (my preferred example is keeping Chevrolet alive and turning Cadillac into Chevy's luxury brand — Chevy and Cadillac are the best parts of GM) are widely identifiable, and Ford is in better shape than the other two and would likely do quite well. (If either of the other Detroit companies went bankrupt, Ford would have to do the same thing to force competitiveness as well as modernization.) Many Detroit customers would switch to Ford or the viable parts of GM (I think Chrysler is doomed; its holder was simply hoping to sell it and is stuck with it now that the economy is so poor and that Chrysler is in such horrible shape. Serves 'em right) and hopefully there won't be any bailout (notably with Barney the barking dog Frank saying that any talk of bankruptcy is just union-bashing and “war on the worker,” which is complete nonsense, to be most kind). If there is a bailout, hopefully there aren't stupid political demands like “Green” this or that, or preservation of a decades-failed business and labor model. But we'll have to see — Detroit is a specific case, whereas the Fed's and Treasury's acts are of a more general sense (favoritism for Wall Street excepted, naturally).
Detroit's new, latest case for, ahem, government intervention is to be presented tomorrow.
Note that I distinguish between Ned and Mikkel above even though I was unclear about it.
Now that I have more time let me clarify. I just thought it was hilarious that anyone could actually say this
with a straight face. Seriously.
Nothing will happen? How many millions of jobs would it take to count as something happening? Make no mistake, we are talking millions of jobs vanishing. In just the auto industry there are no companies making the kind of DIP loans that normally allow a company the size of any of the Big 3 to continue operation while re-organizing under Chapter 11. Even with Chapter 11 there will be a lot of misery. Is that nothing? Who are these solid banks that have enough liquidity to buy the assets of monsters like Citi, Chase and all the other huge institutions that are in trouble? Lack of regulation is what led to the creations of institutions so large, complex and intertwined that too big to fail happened. That got us here far more than the government interfering with capitalism.