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America's Financial Mess

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Wotan

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Isn't all this government intervention in the financial markets -- all these bail-outs, rescues, and "back-stops" in the past month -- just making things worse? It seems like this is exactly what happened to create the 1930s Great Depression! Some natural economic problem and decline of a year or two was extended to a decade due to government "help."

Would the economy really have a "melt-down" if Bear Stearns, Shearson Lehman, Freddie Mac, Fannie Mae, AIG, and all the rest were allowed to go bankrupt? I don't believe it. It seems to me like all these bad companies would just be sold off to good companies! Maybe they would then only be worth 80 cents on the dollar or so -- but the problem would be solved! As far as I know, the housing market is almost the only difficulty here, and it's just going to fall 20% or thereabout. So I say: Let it! "Hands off!" and "Laissez-faire!"

I think we desperately need a competent Objectivist economist here. I understand very little of what's going on today economically but...I have a truly sick feeling inside neither does anybody else. Especially not President George Bush, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Henry Paulson! The Three Stooges seem like they're gonna kill us. Help!

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When the government nationalizes anything, it makes it much worse. I guess it could be argued that it makes things better in the short term, but it will never work long term. Today's nationalization of an insurance company (AIG) is awful.

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Isn't all this government intervention in the financial markets -- all these bail-outs, rescues, and "back-stops" in the past month -- just making things worse?

Would the economy really have a "melt-down" if Bear Stearns, Shearson Lehman, Freddie Mac, Fannie Mae, AIG, and all the rest were allowed to go bankrupt?

I have a truly sick feeling inside neither does anybody else. Especially not President George Bush, Federal Reserve Chairman Ben Bernanke, and Treasury Secretary Henry Paulson!

1. Yes

2. No

3. The next time anyone thinks republicans are for the free market, just remember this administration. In not very much time, Bush and his ilk are going to make themselves look worse than Nixon, and are doing a better job of creating a socialized economy than the Demoncrats ever dreamed of. With friends like this, I'd vote for the enemy.

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The problem is that the government created this disaster and so it becomes a legitimate question as to whether the government should now have a role in helping to prevent the mess from spreading. As everyone knows, we have a mixed economy that is flush with unbacked paper money. Given that situation, we might see less economic dislocation from these failures if the government performed targeted bailouts and then sold off the assets to private companies as soon as possible. To the extent that they should be done at all, these bailouts should essentially be orderly liquidations. However, I doubt that will happen. I fear that the bailouts will continue and the government will decide to stay in the businesses of investment banking, insurance, etc... over the long term. That would be a disaster.

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Kendall, I was speaking with an economics professor yesterday who said that if there hadn't been bailouts, starting with Fannie and Freddie, and if AIG isn't bailed out, we would head into a worse depression than the Great Depression. His reasoning was that the payments system is the lifeblood of any economy, and if it goes kaput, so does everything else. I am just familiarizing myself with the financial industry right now, so I don't know enough about it to deny his claim. Though, this similar logic could be applied to something else, such as highways (ie, if the highway building industry failed, everything would go downhill, since they are such an important aspect of the economy), to which I would say things will happen just as they should when any business tanks: so-called 'vulture' capitalists can now obtain whatever is left at dirt-cheap prices and start anew, and probably more efficiently if they take into consideration the things that made the last system fail.

There is so much talk about the masses of people who are now going to be unemployed -- but one would think a fair amount of them would start boutique firms and things of that nature, with the skills they had acquired at their previous jobs. Is this why you don't think we'd experience a melt-down if they were all allowed to fail?

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His reasoning was that the payments system is the lifeblood of any economy, and if it goes kaput, so does everything else.

I am not sure what that means exactly. Notice when everyone talks about the doom and gloom scenarios, it's always some euphemism or slang, like "kaput", "fail", "goes under". It's meant to get you to think that all of this stuff just disappears. Poof!

Failure is a part of capitalism, and the system is actually quite robust at dealing with it. Free markets have reclamation, and garbage collection mechanisms that work quite well. Value will be destroyed in this crisis, but it is to the extent that govt interfered with the mortgage market in the first place. It will cause a recesion, a slow down, a correction. However, it will not cause the economy to "collapse". No "kaput", no "wipe-out".

The best thing the govt can do now is to get out of the way, let the market mechanisms chew up this blasted mistake the govt has made and get on the road to recovery.

If you want me to walk you through what happens in a bankrupcy like that I can, but it is not a complete wipe-out by any stretch of the imagination.

The problem is that the government created this disaster and so it becomes a legitimate question as to whether the government should now have a role in helping to prevent the mess from spreading.

There is something about this particular premise that doesn't seem right, but I don't know what it is just yet. Let me noodle on it.

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The problem is that the government created this disaster and so it becomes a legitimate question as to whether the government should now have a role in helping to prevent the mess from spreading.

Well that's just it, the government can't prevent it from spreading. Layer after layer of government regulations, buy outs, bail outs, etc., may slow the spread for awhile, but it's never going to fix anything.

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What will happen, is quite simple.

Past:

1. Government promises bailouts.

2. Places screw up, and receive bailouts.

Present:

3. The bailouts start to pile on each other.

Future:

4. The government needs more and more money to pay for the bailouts, and the government:

a. takes it from other branches of government, and/or

b. raises tax-payer money.

5. As they start to pile on, the tension in the government rises. Funds become tight, and taxes on the populous increases drastically.

6. Eventually, people will be seeing taxes over 2/3 of their income.

7. As the numbers rise, depression spreads.

8. "Atlas Shrugged America" -esque ensues. Will people learn from this mistake? Hopefully.

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I saw a CBS poll online today that showed that nearly 70% of responders think the government should not have bailed out AIG. I have no idea of how accurate a representation of the general population that is, but at least people aren't overwhelming for this this type of crap.

Does anyone know if GM, Ford and Chrysler got their bailouts yet?

When do I get mine? :D

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There is something about this particular premise that doesn't seem right, but I don't know what it is just yet. Let me noodle on it.

I'm trying to figure out what advantages or disadvantages these bailouts will have when compared with normal Chapter 11 filings. As you well know, if the companies file they will continue to operate. Is there something I don't know about the insurance industry that would have caused AIG to stop writing policies if they were in Chapter 11? Even if this happened, it seems that competitors would pick up the business. Perhaps there's some greater level of customer confidence one could exepct to be associated with the government bail-outs vis a vis a Chapter 11 filing.

I'm also thinking about my original statement and trying to decide what's wrong with it. It makes me a bit uneasy as well.

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Does anyone know if GM, Ford and Chrysler got their bailouts yet?
With Michigan somewhat of a "swing state", McCain suports it and so does Obama. It's probably going to be guarantees for about $25 billion of loans.

When do I get mine? :D
Remember that stimulus check!
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I'm trying to figure out what advantages or disadvantages these bailouts will have when compared with normal Chapter 11 filings. As you well know, if the companies file they will continue to operate. Is there something I don't know about the insurance industry that would have caused AIG to stop writing policies if they were in Chapter 11? Even if this happened, it seems that competitors would pick up the business. Perhaps there's some greater level of customer confidence one could expect to be associated with the government bail-outs vis a vis a Chapter 11 filing.

I've never said -- or even thought -- this before in my life but: I have good confidence in the current US bankruptcy laws and courts! I wish all of those companies had been allowed to go bankrupt (yes, Fannie and Freddie too). As far as I can understand it, they would have then been sold off to the highest bidder and ipso facto a superior and fairly competent competitor would take over. All the old employees would be fired (good riddance to bad workers). Many would then go to work at a superior company. These new hires would be the best of the lot, and they would also probably be forced to raise the level of their game a bit. To me, this sounds like the perfect solution. Good companies and good workers throughout the economy!

But maintaining the bad companies in business seems to give us the worst of both worlds. All the old money is lost under government "rescue", but now new money will be lost too, as the incompetent companies and CEOs continue to do a bad job and lose money probably.

As I read everybody's comments above, and try to think this through in my head: In my view, even if all those financial companies above went into Chapter 11, the American and worldwide economy would NEVER have a "melt-down" or systemic collapse. We would never even come CLOSE to a doomsday or long Depression.

Government intervention is 100% bad in theory and 100% bad in practice, folks. Laissez-faire, damnit!

Edited by Wotan
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How many of those responders know:

1.) What "AIG" is.

Ha ha! Still, the good thing is, even if people don't know who AIG is or what they do, the point is, they don't want them bailed out. At least they recognize the bail out for the bad thing it is.

When you lose your job and sign up for unemployment.

Won't happen. People need financial planners whether the market is good or bad, and fortunately, I work for a great one who properly prepares and updates our clients for/about situations like this. We're also independent and don't sell for any of the poorly managed brokerage houses that are in trouble right now. We don't need no stinkin' handout! :D

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When LIBOR doubles overnight, this is getting serious:

The Libor surge was most striking, with the overnight dollar rate more than doubling from 3.10625 percent to 6.4375 percent, a record jump....

A high Libor — the rate that serves as a benchmark for interest rates on so many kinds of debt — has the potential to impact the entire U.S. economy. But specifically for companies, a spiking Libor can curtail profits and make it costly to refinance corporate loans. The Libor is the interest rate that banks charge to each other for short-term loans, and usually falls in line with the overnight federal funds rate managed by the Federal Reserve.

http://www.cfo.com/article.cfm/12259999?f=alerts

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Would the economy really have a "melt-down" if Bear Stearns, Shearson Lehman, Freddie Mac, Fannie Mae, AIG, and all the rest were allowed to go bankrupt? I don't believe it. It seems to me like all these bad companies would just be sold off to good companies! Maybe they would then only be worth 80 cents on the dollar or so -- but the problem would be solved! As far as I know, the housing market is almost the only difficulty here, and it's just going to fall 20% or thereabout. So I say: Let it! "Hands off!" and "Laissez-faire!"

It's really sad to me that anyone in this country could possibly think that this bail out is a good idea. I have watched famous financial analyst after famous financial analyst on all the news programs say "There was no alternative. AIG is too big to fall and the ramifications would have been so profound," and I am amazed at how non-capitalistic these people are in their thinking. Do they really not understand that the ramifications of this bailout are far worse for our economy than the fallout of a major company would be? This is just yet another dangerous precedent to be added to the list of te government's justification of stiffling any last remnant of free-market thinking that may xist in this country. AIG is big, yes, and if it had fallen --on its own dumb accord -- then yes, people would have seen their mutual funds drop in value, people would have lost their jobs, and some people would have had some serious questions if they held variable life insurance policies with AIG. But I say it should have been allowed to fall. I don't care how old and prestigious companies are; if they've become idiotic and have provenover the course of time that they are no longer capable of making wise business decisions for themselves and their investors, then let them fail! It is unfortunate that lots of people would suffer financial hardships, but that is part of the risk of investing. People complain about how bad business practice has become in this country, but what incentive is there for companies to avoid bad business practices if there is no consequence for their ill action? If they know that the government would step in with taxpayer dollars to bail them out after all their bad decisions made them lots of money but cost their investors thousands. It's liek the teenager who never learns to value their car or take care of it properly because if they wreck it, daddy will buy them a new one. Who wouldn't drive wrecklessly if there were no consequences? I am not surprised then, that there are so many scandals emerging among these big companies because the natural consequences of bad business decisions are being prohibited from coming to realization. These companies are not being allowed to fall... and the consequences of proping up ill-performing businesses with billions of taxpayer dollars is absolutely sickening.

I think one of the biggest underlying problems in our ecomony, and maybe I'm being idiotic in this assumption - so feel free to correct me if I am out of line here, is that people have this ridiculous sense that they are entitled to profits on their investments; that they DESERVE to make money whenever they toss some money in a stock or mutual fund. No one seems to understand that there is risk involved anymore. Sometimes companies make money, sometimes they lose money: that's why you should make informed purchases of stock and make sure you're not dumping all your money in one place (diversification is key to ptotecting your assets; it will never protect all of your assets, but it helps shelter you from a total financial fallout). You as the investor made the choice to purchase that stock (or gave such consent to your mutual fund, or 401k, etc to make investments with your money for you) and you always have the choice to sell. If companies were allowed to fail when they were making failing decisions, then people would be able to make more informed purchases because the value of these stocks would be more accurate (ie, bad businesses on the verge of collapse would not be carrying a deceptively valuable stock value). If people lose all their money then I would contend that they are partly to blame for not spreading out their money enough. Now I am FULLY aware that AIG is a stock that is carried in nearly every mutual fund out there so it's downfall would have had a deep impact on more than just people who had a lot of their stock or their employees. But let it fail, and let a better business take its place. Let people see that better business for what it is and choose to take their money there, and please, let them remember that there is risk in stock investment (and variable life policies derive their value from stocks, so they need to keep that in mind too). If one finds that they are not comfortable with the idea that they may not be guaranteed a profit, then they need to do other things with their money: but some real estate, buy some boullion (oh wait, the government limits that... how convenient), stuff some money under the mattress, or whatever. In a free market, companies do lose money and they do fail and that is the only proper course for bad businesses to take. it is their failure that allows wiser companies to take their place. But how can we ever make room for ethical business practice in this country if bad business is so richly rewarded? How can good business earn consumers' dollars if all their dollars are being taken from them to prop up bad business. This whole situation is disastrous, but for reasons quite different from what all these commentators are saying on the news.

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Here's a good summation of the potential fallout from AIG's collapse (subscription needed so I've posted the most salient part).

AIG's collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression.

A.I.G. does business with virtually every financial institution in the world. Most important, it is a central player in the unregulated, Brobdingnagian credit default swap market that is reported to be at least $60 trillion in size.

Nobody knows this market’s real size, or who owes what to whom, because there is no central clearinghouse or regulator for it. Credit default swaps are a type of credit insurance contract in which one party pays another party to protect it from the risk of default on a particular debt instrument. If that debt instrument (a bond, a bank loan, a mortgage) defaults, the insurer compensates the insured for his loss. The insurer (which could be a bank, an investment bank or a hedge fund) is required to post collateral to support its payment obligation, but in the insane credit environment that preceded the credit crisis, this collateral deposit was generally too small.

As a result, the credit default market is best described as an insurance market where many of the individual trades are undercapitalized. But even worse, many of the insurers are grossly undercapitalized. In one case in the New York courts, the Swiss banking giant UBS is suing a hedge fund that said it would insure nearly $1.5 billion in bonds but was unable to do so. No wonder — the hedge fund had only $200 million in assets.

If A.I.G. collapsed, its hundreds of billions of dollars of mortgage-related assets would be added to those being sold by other financial institutions. This would just depress values further. The counterparties around the world to A.I.G.’s credit default swaps may be unable to collect on their trades. As a large hedge-fund investor, A.I.G. would suddenly become a large redeemer from hedge funds, forcing fund managers to sell positions and probably driving down prices in the world’s financial markets. More failures, particularly of hedge funds, could follow.

Regulators knew that if Lehman went down, the world wouldn’t end. But Wall Street isn’t remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.

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Here's a good summation of the potential fallout from AIG's collapse (subscription needed so I've posted the most salient part).

I still don't think this justifies the government's bailout. Natural consequences need to play out; that is how learning, in any context, whether with children or in making investments, occurs. If big failures resulted from big mistakes, businesses would not only know to avoid those mistakes, but investors would know what to watch for when making their investment decision.

The demise of AIG would have been catastrophic yes, but I think the governments intervention in the matter will prove much more catastropic. (but people don't always get that because the damages occur more over the long run, where as a company fall-out is much more evident and has consequences that show up a lot faster). Every instance where the government assumes control -and part of this "loan" is the agreement that the Fed Gov now controls 80% of AIG- means that is one less instance in which free markets controls are allowed to function. (And if the gov now controls 80% og AIG, what % of the investment market does that amount to considering how widespread AIG is? Does anyone else not see how much leverage this is giving the gov?). When free market mechanisms are disabled, there is no way for capitalism to function. How can it when profits are inflated with subsidies, tax breaks, and all other sorts of government interventions that shouldn't be there either.

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Everyone of intelligence and virtue today seems to be crying out for "transparency" on Wall Street. Well, let's get it by making Big Finance much more honest! But don't regulate toward it. No more Sarbanes-Oxleys! That's coercive and doesn't work. Maybe just enforce the financial fraud laws much more closely. And let everyone learn to vastly mistrust all accountants and ratings agencies. And all those unreadable tissue-of-lies company financial statements and "prospectuses." Make these four institutions radically improve via new and radical public skepticism!

Edited by Wotan
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Publius -- You say:

AIG's collapse would be as close to an extinction-level event as the financial markets have seen since the Great Depression....Wall Street isn’t remotely prepared for the inestimable damage the financial system would suffer if A.I.G. collapsed.

I don't buy it. All this recent fantastic interventionism and government "help" seems wrong in theory and wrong in practice.

Does any competent Objectivist economist agree with your quote?

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I still don't think this justifies the government's bailout. Natural consequences need to play out; that is how learning, in any context, whether with children or in making investments, occurs. If big failures resulted from big mistakes, businesses would not only know to avoid those mistakes, but investors would know what to watch for when making their investment decision.

The demise of AIG would have been catastrophic yes, but I think the governments intervention in the matter will prove much more catastropic. (but people don't always get that because the damages occur more over the long run, where as a company fall-out is much more evident and has consequences that show up a lot faster). Every instance where the government assumes control -and part of this "loan" is the agreement that the Fed Gov now controls 80% of AIG- means that is one less instance in which free markets controls are allowed to function. (And if the gov now controls 80% og AIG, what % of the investment market does that amount to considering how widespread AIG is? Does anyone else not see how much leverage this is giving the gov?). When free market mechanisms are disabled, there is no way for capitalism to function. How can it when profits are inflated with subsidies, tax breaks, and all other sorts of government interventions that shouldn't be there either.

It's difficult to discuss economic issues here, where a "the way things should be" mentality pervades, versus the reality of the society we actually live in, which is not Objectivist-based (yet). Its tempting to apply free market solutions across the board but people aren't ready for it yet, and without whole-hearted support politically, free market policies can actually be counter productive; if they are not allowed to run their course, you never see the full benefits. Then people blame the market for any failures (see 1930's). Americans aren't ready for the ramifications of free market capitalism because most are operating on a completely different value system.

The primary concern for the economy now is stability. This is a much more motivating factor in inducing investment than even levels of taxation. That is what the bailouts are intended to do, ease people's minds that the economy isn't imploding, and that its still safe to invest and loan money.

Government helped create this mess but short sighted bankers and investors are to blame too. The government mandated that a certain percentage of mortgage loans go to poor people, but nobody forced banks to make so many bad loans, without even getting good documentation. And nobody forced investment banks to buy bad mortgage loans bundled as securities. And then there is the whole credit default swap mess. It was basically euphoric recklessness on Wall Street. Everyone was looking for the quick buck to make their year end bonus and not keeping their eye on long term growth.

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The primary concern for the economy now is stability. This is a much more motivating factor in inducing investment than even levels of taxation. That is what the bailouts are intended to do, ease people's minds that the economy isn't imploding, and that its still safe to invest and loan money.

Government helped create this mess but short sighted bankers and investors are to blame too. The government mandated that a certain percentage of mortgage loans go to poor people, but nobody forced banks to make so many bad loans, without even getting good documentation. And nobody forced investment banks to buy bad mortgage loans bundled as securities. And then there is the whole credit default swap mess. It was basically euphoric recklessness on Wall Street. Everyone was looking for the quick buck to make their year end bonus and not keeping their eye on long term growth.

Here's what I am optimistic about: I secretly hope "the collapse" happens despite the government's bailouts and that with all the publicity concerning the dollar amounts the government is throwing out there and the control they are assuming, that people might have a thought of skepticism toward government intervention in business matters. I know this is unlikely, but you know, in the decade prior or so to the American Revolution, a mass majority of the population was AGAINST any moves towards independence or rebellion. I know people won't see it right away, but my sincere hope is that they will see it over time, maybe in the next decade or so as the ramifications of all this play out. I saw an interesting figure on the Today show this morning. The recent -and we're talking just in the last few months - totals that the government has put toward bailing out these companies is around $1.1 TRILLION DOLLARS, and that's not even including the talk of the government giving millions of Americans loans to prevent them from losing their homes. That means each American is getting asked to pay around $3600, which they obviously won't collect from you all at once. They'll do it over years, so by the time it's said and done it will probably be more like $5,000 per American. And that's assuming no more bailouts are to come. Why bail out an investment firm if the money needed to do so deprives the American populace of so much money that they have no money to invest anymore? Their business won't recoup because their clientele and capital is going to go down.

These companies have part of the blame, the government has partof the blame, but let's not forget that individuals are to blame too. Someone who makes $35,000 a year had no business taking out a $400k mortgage. Was the company dumb for offering it, yes. Was the government dumb for making banks be more lenient toward lower income households, yes. But that person was pretty stupid, too. Many people are living beyond their reasonable means, just like many businesses (and governments) are spending beyond their incoming funds. A collapse would be devastating, yes, but maybe it would eb the first step in making the value of things in our economy (stocks, etc) more reality based.

I've been visiting some old economic theorists' works lately (goodness knows there's no sense to be found among most of the contemporary ones), and came upon a very insightful quote that made me smile to think how appropo it is right now regarding the "seen" and the "unseen" in economics:

"In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect;the good economist takes into account both the effect that can be seen and those effects that must be foreseen.

Yet this difference is tremendous; for it always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil." Frederic Bastiat

In other words, while it may seem that the government can stimulate the economy (and many Americans and economists hold steadfast to this belief), what many people in this country are failing to see is that the government cannot spend money that it does not TAKE first (via taxes). What each American gets back in return is bound to be only a fraction of what is stolen from them as these events play out. When we consider the long terms consequences of this, it's not a pretty picture at all.

An interesting theorist, this Bastiat. Does Rand ever reference him? I have only just begun to read his writings, but he seems to be very anti-government intervention in economics from what I've read so far, so I am certainly enticed to keep reading.

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