[Reader-list] Heavy Hitters Against US Bailout

[Amit Basole]

On this theme a short, succinct piece by UMass-Amherst expert on financial
markets.

Amit

The Great Switch: Banks Rob People
Professor Jim Crotty
Dept. of Economics, UMass, Amherst and Center for Popular Economics
September 24, 2008

The US government is on the verge of making an unprecedented financial
commitment, likely to cost $700 billion, to buy the bad securities held by
large US and foreign financial institutions. Having driven our economy to
the edge of financial destruction, the Lords of Finance now want the public
to put up the money needed to save them and their firms from collapse. Maybe
men don't bite dogs, but banks do rob people.

*How did we get here?*
In response to the collapse of unregulated financial markets in the early
1930s, the American people decided to tightly regulate the financial system
so that it could never again threaten the US economy. The Depression-era
regulations worked effectively until the late 1970s, helping to create the
best economic performance in US history. When our financial system was
buffeted by high inflation in the late 1970s, it became necessary to reform
the regulatory process so it would be effective in the new economic era. But
instead of reform, the rise to power of anti-government, right wing forces-
reflected in the election of President Reagan in 1980s – led to a radical
deregulation process. By the end of the Clinton presidency, radical
deregulation was completed. A similar process of financial deregulation
occurred in other industrialized countries as well.

Deregulation, in concert with rapid financial innovation that made complex
financial products such as derivatives and mortgage backed securities
possible, created a volatile pattern of financial booms and crises. Each
crash led to bailouts by affected governments, which only increased
incentives to financial firms to expand further and take greater risks,
since there were massive profits to be made in the upturn while the public
paid to limit their losses in the downturn. The new era thus saw an
explosion in the size and profits of financial firms. Financial assets were
less than five times larger than US GDP in 1980, but over ten times as large
in 2007. In the US, the share of total corporate profits generated in the
financial sector grew from 10% in the early 1980s to 40% in 2006. As
financial markets grew larger and thus more dangerous, the pressure on
governments to bail them out increased proportionately.

*The Housing Bubble*
The recent boom was driven by the rapid rise in home prices in the decade
ending in 2006. Home buyers and mortgage lenders assumed that housing prices
would never decline. This sustained the boom, but the fact that banks and
mortgage brokers were paid large fees to originate and service mortgages
added fuel to the fire. Since most of these mortgages were not held by their
originators, but rather sold to others, it made sense for banks and brokers
to maximize the flow of mortgages, even if that meant selling mortgages that
were likely to default if home prices stopped rising or interest rates rose
substantially. Investment banks received similar fees to package the
mortgages into mortgage-backed securities that were then sold to banks,
hedge funds, pension funds and insurance companies around the world. These
securities were essentially highly leveraged risky bets that housing prices
would keep rising. They were so complicated that no one knew what their
price should be. Thus, they could only be sold because credit ratings
agencies such as Fitch and Moody's gave them AAA ratings. The agencies
provided overly optimistic ratings only because they were paid by investment
banks to do so.

Why did so many large financial institutions borrow so much money to invest
in such risky securities? The answer lies in the way their top people are
paid. Financial firm 'rainmakers' get most of their compensation in the form
of bonuses tied to the profits of their enterprise. When markets are
booming, profits and bonuses are maximized by borrowing lots of money –
investment banks borrowed $32 for every $33 of assets they owned in 2007 -
and taking high risks with it. For example, in 2006 Goldman Sachs had a
banner profit year and the average bonus for its 25,000 employees was
$650,000. But most of this money was paid to those at the top, with key
traders taking home $50 million. Everyone knew that such risk-taking would
eventually lead to disaster when markets turned down, but they would not
have to give back the big boom-time bonuses.

*The Bubble Pops*
When housing prices began to fall in 2006, the game was up, though it took
another year before the crisis broke out. Once it did, the gravitational
pull of "reverse leverage" accelerated the downfall. Firms that borrowed
heavily to buy assets used the value of the assets as collateral for their
loan. When asset prices started to fall, so did their collateral value.
Their creditors demanded that they put up additional cash, which forced them
to sell assets. Of course, this made asset prices fall faster. Soon
financial firms across the globe found the value of their assets and the
value of their capital plunging along with the price of their stock. As
usual, they rushed to government agencies to save them.
*
Bailouts and More Bailouts*
In the US, the Federal Reserve Bank (referred to simply as the Fed)
responded to the crisis by extending massive loans to commercial banks, and,
for the first time since the Great Depression, to investment banks as well.
In addition, the Federal Home Loan Bank increased its loans to banks by
almost $300 billion between June 2007 and June 2008, a rise of 43%. In the
Bear Stearns rescue, the Fed in effect bought $29 billion worth of devalued
securities from the failing investment bank. The collapse of Fannie Mae and
Freddie Mac, two firms that own or insure almost $5 trillion in mortgages
(and made their top executives fabulously rich by investing in shaky
mortgage-backed securities in the boom) led to their nationalization; the
taxpayer is now liable for their losses, which could hit $100 billion. The
US government, which the Lords of Finance told us should stay out of
financial markets, now owns the largest financial companies in the world.
The Fed then effectively nationalized AIG, one of the largest insurance
companies and biggest financial speculators in the world, at a cost of $85
billion, even though it does not regulate and has no responsibility for
insurance companies. The rout was on.
Finally, in mid September, when even these unprecedented interventions
proved unable to calm financial markets, Fed Chair Ben Bernanke and
Secretary of the Treasury Henry Paulson, former CEO of the top investment
bank Goldman Sachs, proposed that the government put up an additional $700
billion of taxpayer money to buy most of the bad assets held by financial
corporations. This would be the largest bailout in history. At the same
time, the government announced a blanket guarantee of the $3.5 trillion
money market mutual fund industry. By this time, Paulson (or Goldman?)
seemed to be in control of the bailout process. His initial proposal stated
that all decision making power over the dispersal of this enormous amount of
money was to be in his own hands. Neither the courts nor other government
bodies would be able to exercise oversight of Paulson's handling of the
money. Since the proposal said nothing about which securities would be
purchased, or which firms would receive payouts, or how the prices of
securities would be valued, Paulson (or Goldman?) was actually proposing
that the President and Congress simply give him up to $700 billion to
distribute to his cronies as he saw fit. As economist and New York Times
columnist Paul Krugman put it: "Mr. Paulson is demanding dictatorial
authority, plus immunity from review 'by any court of law or any
administrative agency'."
*
Scare tactics*
Adding insult to injury, Paulson planned to privatize the bailout process.
Wall Street firms hired by Paulson would decide how much to value the bad
securities the public had to buy from Wall Street firms. These firms would,
of course, be paid hundreds of millions of dollars of public money to
provide this service. Moreover, Paulson and Bernanke tried to panic the
Congress into accepting their Trojan Horse by arguing that if Paulson's
proposal was not accepted without revision within a few days, global
financial markets would collapse. Congress was to be stampeded by fear into
rubber stamping legislation that would complete the process of a virtual
government takeover of a huge share of the country's financial system by one
man. This was reminiscent of President Bush's successful effort to get
Congress to quickly authorize his war in Iraq. And there were no penalties
for financial firms or their rainmakers in the proposal, and no new
regulation to prevent this fiasco from recurring a few years down the road.

This is, literally, unbelievable. As recently as spring 2007, Paulson argued
that excessive regulation was crippling American finance in its battle for
global financial supremacy: the government should stay out of financial
markets. And Goldman Sachs along with other large investment banks played a
key role in packaging and selling the mortgage backed securities that led to
the crisis – the same securities they now want to pawn off on the taxpayer.
Paulson is a representative and charter member of the Lords of Finance who
foisted this corrupt and absurd system of deregulated financial markets on
the American public, a system that created financial instability and rising
inequality, pressured the public time and again for money to clean up the
messes they made, and used their ill-gotten money and power to corrupt the
political process. Having done this, the Lords of Finance now want total
control of $700 billion public dollars to allocate to themselves. New York
Times liberal columnist Bob Herbert put it nicely. "Does anyone think it's
just a little weird to be stampeded into a $700 billion solution to the
worst financial crisis since the Great Depression by the very same people
who brought us the worst financial crisis since the Great Depression?" No
doubt the outrage over this destructive proposal that has been building
since its announcement will eventually lead to amendments that change its
form, though perhaps not in substance. The American people should inundate
Congress with a demand to stop this insanity. There should be no bailout
unless there is a concurrent and dramatic increase in the regulatory
restraints on financial firms that will prevent a rerun of this catastrophe.


On Mon, Sep 29, 2008 at 12:53 PM, Abhishek Hazra
<abhishek.hazra at gmail.com>wrote:

> >>PS - I really enjoy the articles etc. you post on the list. Helps clear
> some
> of that Kashmir air. . .
>
> same here.
>
> abhishek
>
> On Mon, Sep 29, 2008 at 10:18 PM, Isaac souweine <isouweine at gmail.com
> >wrote:
>
> > Hi Naeem -
> >
> > Well, I guess we're saying just about the same thing then, huh? As in -
> the
> > bailout probably isn't that sweet a deal for the common folk. Not that
> one
> > needs a fancy PhD to guess that much would be true ;-) As someone who
> pays
> > into the American treasury every April 15, I guess it's especially
> appaling
> > to see this year's misue of my funds, but when you think that a similar
> > amount went to the Iraq boondoggle, and when you consider the annual size
> > of
> > the defense budget - well, its hard not to feel a little fatalistic. . .
> >
> > As for Moore, I would say "don't get me started" but really it's a
> pleasure
> > to. Every time I read another open letter from that one-trick
> > "documentarian" turned folksy champion of the left, I marvel to myself at
> > how snugly Moore fits into America's system of cultural hegemony. Where
> > buffoonery and emotive populism hold sway, the rational discourse
> required
> > for real policy change fear to tread. Of course, Moore's politics are
> often
> > in the generally right direction, viz. gun control, health care, the Bush
> > years etc., and one could argue that his "gadflyism" opens up space for
> > cooler heads to actually do some thinking, but my guess is that every
> time
> > Michael Moore hits send, the powers that be chuckle to themselves.
> >
> > Cheers,
> > Isaac
> >
> > PS - I really enjoy the articles etc. you post on the list. Helps clear
> > some
> > of that Kashmir air. . .
> >
> >
> > On Tue, Sep 30, 2008 at 12:19 AM, Naeem Mohaiemen <
> > naeem.mohaiemen at gmail.com
> > > wrote:
> >
> > > > 1. Re: Michael Moore: The Rich Are Staging a Coup This Morning (Isaac
> > > souweine)
> > > > I too found Moore's rant difficult to follow. I think that's what we
> > call
> > > being out of your depth.
> > > ...
> > > > Shiller is a pretty heavy hitter <
> > > http://en.wikipedia.org/wiki/Robert_Shiller>
> > >
> > > Moore rants unapologetically because that's his style. Some may find
> > > it grating but it's who he is, and his focus is on winning over middle
> > > america's mass undecided. His style may irritate, and his
> > > footnote-less prose may dismay, but the core sentiments I find echoed
> > > in various shades by others-- not on healthcare, that's reflective of
> > > MM's singular focus since making SICKO the film; but on worries about
> > > the fundamental economic unfairness of this bailout plan.
> > >
> > > 1. Is the Bailout Needed? Many Economists Say "No"
> > > http://www.mcclatchydc.com/227/story/53107.html
> > >
> > > 2. Stiglitz on a Better Bailout
> > > http://www.thenation.com/doc/20081013/stiglitz
> > >
> > > 3. Economists see need for a penalty
> > > http://www.iht.com/articles/2008/09/23/business/23skeptics.php
> > >
> > > 4.Ferguson-Johnson: Bridge Loan to Nowhere
> > > http://www.thenation.com/doc/20081006/ferguson_johnson
> > >
> > > 5. Economists Petition to House of Representatives
> > >
> > >
> >
> http://faculty.chicagogsb.edu/john.cochrane/research/Papers/mortgage_protest.htm
> > >
> > > To the Speaker of the House of Representatives and the President pro
> > > tempore of the Senate:
> > >
> > > As economists, we want to express to Congress our great concern for
> > > the plan proposed by Treasury Secretary Paulson to deal with the
> > > financial crisis. We are well aware of the difficulty of the current
> > > financial situation and we agree with the need for bold action to
> > > ensure that the financial system continues to function. We see three
> > > fatal pitfalls in the currently proposed plan:
> > >
> > > 1) Its fairness. The plan is a subsidy to investors at taxpayers'
> > > expense. Investors who took risks to earn profits must also bear the
> > > losses.  Not every business failure carries systemic risk. The
> > > government can ensure a well-functioning financial industry, able to
> > > make new loans to creditworthy borrowers, without bailing out
> > > particular investors and institutions whose choices proved unwise.
> > >
> > > 2) Its ambiguity. Neither the mission of the new agency nor its
> > > oversight are clear. If  taxpayers are to buy illiquid and opaque
> > > assets from troubled sellers, the terms, occasions, and methods of
> > > such purchases must be crystal clear ahead of time and carefully
> > > monitored afterwards.
> > >
> > > 3) Its long-term effects.  If the plan is enacted, its effects will be
> > > with us for a generation. For all their recent troubles, America's
> > > dynamic and innovative private capital markets have brought the nation
> > > unparalleled prosperity.  Fundamentally weakening those markets in
> > > order to calm short-run disruptions is desperately short-sighted.
> > >
> > > For these reasons we ask Congress not to rush, to hold appropriate
> > > hearings, and to carefully consider the right course of action, and to
> > > wisely determine the future of the financial industry and the U.S.
> > > economy for years to come.
> > >
> > >
> > > Signed (updated at 9/25/2008 8:30AM CT)
> > >
> > > Acemoglu Daron (Massachussets Institute of Technology)
> > > Adler Michael (Columbia University)
> > > Admati Anat R. (Stanford University)
> > > Alexis Marcus (Northwestern University)
> > > Alvarez Fernando (University of Chicago)
> > > Andersen Torben (Northwestern University)
> > > Baliga Sandeep (Northwestern University)
> > > Banerjee Abhijit V. (Massachussets Institute of Technology)
> > > Barankay Iwan (University of Pennsylvania)
> > > Barry Brian (University of Chicago)
> > > Bartkus James R. (Xavier University of Louisiana)
> > > Becker Charles M. (Duke University)
> > > Becker Robert A. (Indiana University)
> > > Beim David (Columbia University)
> > > Berk Jonathan (Stanford University)
> > > Bisin Alberto (New York University)
> > > Bittlingmayer George (University of Kansas)
> > > Boldrin Michele (Washington University)
> > > Brooks Taggert J. (University of Wisconsin)
> > > Brynjolfsson Erik (Massachusetts Institute of Technology)
> > > Buera Francisco J. (UCLA)
> > > Camp Mary Elizabeth (Indiana University)
> > > Carmel Jonathan (University of Michigan)
> > > Carroll Christopher (Johns Hopkins University)
> > > Cassar Gavin (University of Pennsylvania)
> > > Chaney Thomas (University of Chicago)
> > > Chari Varadarajan V. (University of Minnesota)
> > > Chauvin Keith W. (University of Kansas)
> > > Chintagunta Pradeep K. (University of Chicago)
> > > Christiano Lawrence J. (Northwestern University)
> > > Cochrane John (University of Chicago)
> > > Coleman John (Duke University)
> > > Constantinides George M. (University of Chicago)
> > > Crain Robert (UC Berkeley)
> > > Culp Christopher (University of Chicago)
> > > Da Zhi (University of Notre Dame)
> > > Davis Morris (University of Wisconsin)
> > > De Marzo Peter (Stanford University)
> > > Dubé Jean-Pierre H. (University of Chicago)
> > > Edlin Aaron (UC Berkeley)
> > > Eichenbaum Martin (Northwestern University)
> > > Ely Jeffrey (Northwestern University)
> > > Eraslan Hülya K. K.(Johns Hopkins University)
> > > Faulhaber Gerald (University of Pennsylvania)
> > > Feldmann Sven (University of Melbourne)
> > > Fernandez-Villaverde Jesus (University of Pennsylvania)
> > > Fohlin Caroline (Johns Hopkins University)
> > > Fox Jeremy T. (University of Chicago)
> > > Frank Murray Z.(University of Minnesota)
> > > Frenzen Jonathan (University of Chicago)
> > > Fuchs William (University of Chicago)
> > > Fudenberg Drew (Harvard University)
> > > Gabaix Xavier (New York University)
> > > Gao Paul (Notre Dame University)
> > > Garicano Luis (University of Chicago)
> > > Gerakos Joseph J. (University of Chicago)
> > > Gibbs Michael (University of Chicago)
> > > Glomm Gerhard (Indiana University)
> > > Goettler Ron (University of Chicago)
> > > Goldin Claudia (Harvard University)
> > > Gordon Robert J. (Northwestern University)
> > > Greenstone Michael (Massachusetts Institute of Technology)
> > > Guadalupe Maria (Columbia University)
> > > Guerrieri Veronica (University of Chicago)
> > > Hagerty Kathleen (Northwestern University)
> > > Hamada Robert S. (University of Chicago)
> > > Hansen Lars (University of Chicago)
> > > Harris Milton (University of Chicago)
> > > Hart Oliver (Harvard University)
> > > Hazlett Thomas W. (George Mason University)
> > > Heaton John (University of Chicago)
> > > Heckman James (University of Chicago - Nobel Laureate)
> > > Henderson David R. (Hoover Institution)
> > > Henisz, Witold (University of Pennsylvania)
> > > Hertzberg Andrew (Columbia University)
> > > Hite Gailen (Columbia University)
> > > Hitsch Günter J. (University of Chicago)
> > > Hodrick Robert J. (Columbia University)
> > > Hopenhayn Hugo (UCLA)
> > > Hurst Erik (University of Chicago)
> > > Imrohoroglu Ayse (University of Southern California)
> > > Isakson Hans (University of Northern Iowa)
> > > Israel Ronen (London Business School)
> > > Jaffee Dwight M. (UC Berkeley)
> > > Jagannathan Ravi (Northwestern University)
> > > Jenter Dirk (Stanford University)
> > > Jones Charles M. (Columbia Business School)
> > > Kaboski Joseph P. (Ohio State University)
> > > Kahn Matthew (UCLA)
> > > Kaplan Ethan (Stockholm University)
> > > Karolyi, Andrew (Ohio State University)
> > > Kashyap Anil (University of Chicago)
> > > Keim Donald B (University of Pennsylvania)
> > > Ketkar Suhas L (Vanderbilt University)
> > > Kiesling Lynne (Northwestern University)
> > > Klenow Pete (Stanford University)
> > > Koch Paul (University of Kansas)
> > > Kocherlakota Narayana (University of Minnesota)
> > > Koijen Ralph S.J. (University of Chicago)
> > > Kondo Jiro (Northwestern University)
> > > Korteweg Arthur (Stanford University)
> > > Kortum Samuel (University of Chicago)
> > > Krueger Dirk (University of Pennsylvania)
> > > Ledesma Patricia (Northwestern University)
> > > Lee Lung-fei (Ohio State University)
> > > Leeper Eric M. (Indiana University)
> > > Leuz Christian (University of Chicago)
> > > Levine David I.(UC Berkeley)
> > > Levine David K.(Washington University)
> > > Levy David M. (George Mason University)
> > > Linnainmaa Juhani (University of Chicago)
> > > Lott John R.  Jr. (University of Maryland)
> > > Lucas Robert (University of Chicago - Nobel Laureate)
> > > Luttmer Erzo G.J. (University of Minnesota)
> > > Manski Charles F. (Northwestern University)
> > > Martin Ian (Stanford University)
> > > Mayer Christopher (Columbia University)
> > > Mazzeo Michael (Northwestern University)
> > > McDonald Robert (Northwestern University)
> > > Meadow Scott F. (University of Chicago)
> > > Mehra Rajnish (UC Santa Barbara)
> > > Mian Atif (University of Chicago)
> > > Middlebrook Art (University of Chicago)
> > > Miguel Edward (UC Berkeley)
> > > Miravete Eugenio J. (University of Texas at Austin)
> > > Miron Jeffrey (Harvard University)
> > > Moretti Enrico (UC Berkeley)
> > > Moriguchi Chiaki (Northwestern University)
> > > Moro Andrea (Vanderbilt University)
> > > Morse Adair (University of Chicago)
> > > Mortensen Dale T. (Northwestern University)
> > > Mortimer Julie Holland (Harvard University)
> > > Muralidharan Karthik (UC San Diego)
> > > Nanda Dhananjay  (University of Miami)
> > > Nevo Aviv (Northwestern University)
> > > Ohanian Lee (UCLA)
> > > Pagliari Joseph (University of Chicago)
> > > Papanikolaou Dimitris (Northwestern University)
> > > Parker Jonathan (Northwestern University)
> > > Paul Evans (Ohio State University)
> > > Pejovich Svetozar (Steve) (Texas A&M University)
> > > Peltzman Sam (University of Chicago)
> > > Perri Fabrizio (University of Minnesota)
> > > Phelan Christopher (University of Minnesota)
> > > Piazzesi Monika (Stanford University)
> > > Piskorski Tomasz (Columbia University)
> > > Rampini Adriano (Duke University)
> > > Reagan Patricia (Ohio State University)
> > > Reich Michael (UC Berkeley)
> > > Reuben Ernesto (Northwestern University)
> > > Roberts Michael (University of Pennsylvania)
> > > Robinson David (Duke University)
> > > Rogers Michele (Northwestern University)
> > > Rotella Elyce (Indiana University)
> > > Ruud Paul (Vassar College)
> > > Safford Sean (University of Chicago)
> > > Sandbu Martin E. (University of Pennsylvania)
> > > Sapienza Paola (Northwestern University)
> > > Savor Pavel (University of Pennsylvania)
> > > Scharfstein David (Harvard University)
> > > Seim Katja (University of Pennsylvania)
> > > Seru Amit (University of Chicago)
> > > Shang-Jin Wei (Columbia University)
> > > Shimer Robert (University of Chicago)
> > > Shore Stephen H. (Johns Hopkins University)
> > > Siegel Ron (Northwestern University)
> > > Smith David C. (University of Virginia)
> > > Smith Vernon L.(Chapman University- Nobel Laureate)
> > > Sorensen Morten (Columbia University)
> > > Spiegel Matthew (Yale University)
> > > Stevenson Betsey (University of Pennsylvania)
> > > Stokey Nancy (University of Chicago)
> > > Strahan Philip (Boston College)
> > > Strebulaev Ilya (Stanford University)
> > > Sufi Amir (University of Chicago)
> > > Tabarrok Alex (George Mason University)
> > > Taylor Alan M. (UC Davis)
> > > Thompson Tim (Northwestern University)
> > > Tschoegl Adrian E. (University of Pennsylvania)
> > > Uhlig Harald (University of Chicago)
> > > Ulrich, Maxim (Columbia University)
> > > Van Buskirk Andrew (University of Chicago)
> > > Veronesi Pietro (University of Chicago)
> > > Vissing-Jorgensen Annette (Northwestern University)
> > > Wacziarg Romain (UCLA)
> > > Weill Pierre-Olivier (UCLA)
> > > Williamson Samuel H. (Miami University)
> > > Witte Mark (Northwestern University)
> > > Wolfers Justin (University of Pennsylvania)
> > > Woutersen Tiemen (Johns Hopkins University)
> > > Zingales Luigi (University of Chicago)
> > > Zitzewitz Eric (Dartmouth College)
> > > _________________________________________
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>
> --
> - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
> does the frog know it has a latin name?
> - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
> _________________________________________
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-- 
Amit Basole
Department of Economics
Thompson Hall
University of Massachusetts
Amherst, MA 01003
Phone: 413-665-2463
http://www.people.umass.edu/abasole/
blog: http://thenoondaysun.blogspot.com/