October 14, 2008
Is It Adios to Capitalism - or Only Au Revoir?
With the long-expected decision today by President George W. Bush, Treasury Secretary Henry Paulson, and Fed Chief Ben Bernanke that Treasury will spend $250 billion of the $700 billion buying equity stakes in nine top banks, thus injecting "liquidity" directly into the industry, we stand at a crossroads. The question is whether this is "goodbye" to Capitalism or just "see you soon"... whether this is a permanent break from free markets or just a necessary but temporary bank holiday.
I believe Bush when he says it's the latter:
"The government's role will be limited and temporary," Bush pledged. "These measures are not intended to take over the free market but to preserve it. He said these steps and other related actions echoed similar bold moves made overseas in an effort to prevent a global recession. Bush said that by restoring confidence in the system, the hope is to "return our economy back to the road of growth and prosperity."
He said that the efforts to rescue the nation's battered financial sector was a short-term move to help banks to be able to begin lending again.
Alas, it's not up to him, is it? Bush has only three months left in office, and surely this direct-equity program will last longer than that (more likely a year or eighteen months). The question is what the next president will do... whoever he is.
The original plan, recall, was for Treasury to buy (through a resolution corporation) toxic assets themselves; the reason for the change is twofold:
- The financial situation deteriorated at warp speed, much faster than expected, and it appeared that the world financial markets were headed towards a Great Depression-level collapse; it seemed to the administration that action had to be taken immediately to inject capital directly into the institutions that otherwise could go under, taking the world economy with them.
- It became clear that it was impossible to set up the asset-purchase procedure (including creating a new government-sponsored or owned resolution corporation) quickly enough:
The $700 billion rescue program will continue to feature the purchase by the government of banks' bad assets, but the administration decided to place greater emphasis on the stock purchase program after doubts were raised about how long it might take to get the asset purchase program up and running.
Treasury officials said Tuesday that they still plan to buy troubled assets and that this program would start as soon as possible.
If in fact this turns out to be a temporary nationalization, I don't think it will be that bad. I agree with nearly every economist (though I am not one) that the free market alone cannot resolve this problem; but unlike them, I actually know why, or I think I do. Let me explain why the market is helpless here...
We've all been looking at this problem from the wrong perspective: We keep thinking of the rescue plan as injecting liquidity into the banking system and other credit markets; but the real need is to inject, not liquidity, but information; liquidity is just a seredipitous side effect.
The more I read about the current world fiscal crisis, the more I believe that it's not a market failure, not a credit failure, not a mortgage failure, and not a liquidity failure: Those are all symptoms of the real, underlying failure.
What has actually failed is the world information supply. Simply put, everything related to finance, to trade, to buying and selling -- in short, everything connected with any kind of a market -- depends upon access to timely, honest, accurate, and believable information (hereafter "THABI"). For an example I have used before, you cannot buy a car based solely on a grainy picture in a newspaper, because you cannot put a value on it; does it even have an engine?
You need THABI before you can make an offer. And the same is true for mortgages, mortgage-backed securities (MBS), credit default swaps (CDS), construction loans, business letters of credit (LOC), and so forth. Without sufficient THABI, no seller has any idea what price to ask the buyer, and no buyer has any idea what price to offer the seller. Buyers and sellers cannot come to a "meeting of minds," which means nobody can agree on any contract. And that means no market can exist.
That is exactly what has happened and is still happening today, all around the world: a global shortage of THABI, of timely, honest, accurate, and believable information.
This is caused by the lack of a particular kind of regulation, one that every economist, from Keynesian to libertarian (Austrian or Chicago-school), agrees we need: the THABI requirement. Like a fair, equitable, and trusted civil-court system, access to timely, honest, accurate, and believable information is a fundamental requirement for a market even to exist in the first place. This is why the market cannot itself correct for this problem: THABI is a lower, more fundamental "layer" than the market; the market sits atop THABI. Therefore, in the absence of THABI, the market cannot exist... hence cannot correct for the lack of THABI.
To put it into computer terms, no application software running on a computer can possibly fix the problem of that computer's processor being unable to communicate with the computer's memory: That communication is necessary to run any application at all; clearly you cannot run an application on a computer to fix the problem of being unable to run any application on that same computer.
As the market is unable to function without THABI, it cannot function to restore THABI. All that information must come from somewhere else; and the only "somewhere else" that can act quickly enough to stave off a global depression is the State. Because the State functions both within and without the market, it can force changes even when the market is stymied... just as it takes a State to enforce the decisions of a civil-court, because only the State can step outside the market to seize by force the bank accounts of those who flout the court's decision.
The direct injection of liquidity by Treasury buying equity is also outside the market, because that money is extracted from people by force, in the form of taxes. But at the core, even this direct investment is an attempt to buy time to complete the "transparentizing" (horrible neologism, I know) of the toxic assets -- the recreation of the information that was lost by multiple unregulated securitizations of massive collections of mortgages.
Once the THABI has been restored to the mortgage-backed securities and other instruments, the market can reboot itself:
- The assets can be valued;
- They will all have some nonzero value, because no mortgage is worth nothing (if nothing else, the land itself has value);
- All will be saleable, though often not at as high a price as the financial institution purchased them;
- Each institution will thus be able to figure out how big a write-down it must take... and whether it can even stay in business or needs to sell itself to another institution.
There... that's a market! With the restoration of the missing THABI information, the market can reboot, and the catastrophe will be averted. So long as partial-nationalization of the banking industry lasts only long enough to retransparentize the toxic assets, thus allowing the market to begin functioning again, it will be an acceptable, even necessary intervention.
Bush and Paulson have really worked hard to make it difficult for a future president to use this plan as the camel's nose poking its way under the big top; the plan is designed to sunset automatically, allowing the banks to buy back their equity in no longer than three years, but earlier if both they and the incoming administration agree:
“It is profound, and it is something of a shift back to the state,” said Adam S. Posen, an economist at the Peterson Institute for International Economics. “But is this a recasting of capitalism? I think what we’ll see is that the government acts as a silent partner and gets out as soon as it can....”
The package does call for the government investments to be in three-year securities that the banks can repay at any time, when markets settle and conditions improve. “This is clearly a crisis measure in crisis times, but it’s a good thing there is a sunset provision that limits the length of the government’s investment,” said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University.
The historical record of such equity-based interventionism is mixed; on the one hand:
The United States has a culture that celebrates laissez-faire capitalism as the economic ideal, yet the practice strays at times. Over the last century, the federal government has occasionally taken stakes in railways, coal mines and steel mills, and has even taken a controlling interest in banks when it was deemed to be in the national interest.
The corporate wards of the state typically have been returned to private hands after short, sometimes fleeting, stretches under federal stewardship.
But sometimes the shoe is on the other hand:
The traditional American reluctance for government ownership is not shared in other countries. After World War II, several European countries nationalized basic industries like coal, steel and even autos, which typically remained in government hands until the 1980s, when most Western economies began paring back the state’s role in the economy.
After all, we're talking about the federal government; the temptation is always to push far beyond necessity to the tipping point of no return... after which the partial-nationalization becomes permanent, aiming not to restore the market but supplant it.
I will tell you straight: If our next president is Barack H. Obama, then that tipping point is inevitable. Obama's instincts are all European, all towards nationalizing and socializing everything from banking to medical care to taxes; he proclaims over and over again that he will reduce income taxes for "95% of the American people"... knowing that 40% of them don't pay a dime of income tax.
That means at least a third of those whose "taxes" are "lowered" will instead get an annual check from the federal government -- a welfare scheme that will end up, ten years from now, costing more than one trillion dollars per year, according to the Tax Policy Institute; four times what ordinary cash-welfare would cost!
Obama is socialism, socialism is the One. If he is president, he will move heaven and high water to permanize all this federalization, wrenching America away from the Capitalism he hates and cannot understand (and has never, in his entire career, had to deal with) -- it's inevitable. But it's not inevitable that he will win.
We don't know for sure that a John S. McCain administration will know when to say "enough!" -- though that is strongly hinted by his newest economic plan to guarantee all deposits for their full worth, not just $250,000... but only for six months. Whether that's the perfect duration or just a convenient number, it indicates that he is thinking temporary; unlike Obama, all of whose proscriptions and prescriptions are permanent, transformative changes to American society and economy, away from Capitalism and towards socialism.
A "crisis," properly defined, is when the world holds its breath, and nobody really knows what will be. In that sense, we are truly at a crisis, a crossroads between freedom and socialism; we're riding a fast horse that has got the bit in its teeth, and none of us knows which way he shall finally turn his steps.
It is time we started yanking on those reins and leaning hard in the right direction. Now is not the time to close our eyes and abandon ourselves to our fate, to concede the game in the eighth inning. So let's all put on our manly gowns, gird our loins, and pull up our socks: The game ain't over until the last fat lady is hung.
Hatched by Dafydd on this day, October 14, 2008, at the time of 8:05 PM
TrackBack URL for this hissing: http://biglizards.net/mt3.36/earendiltrack.cgi/3287
Listed below are links to weblogs that reference Is It Adios to Capitalism - or Only Au Revoir?:
» Obama's State-Ownership Society from Big Lizards
Back in the precambrian era -- in fall of 2008, I of course mean -- we warned in several posts that when the federal government takes an "equity interest" (ownership in whole or in significant part) in private companies, it... [Read More]
Tracked on March 19, 2009 7:02 PM
» Déjà Vu About Vujà Dé from Big Lizards
I once crafted a neologism, vujà dé, bouncing off of the psychological term déjà vu -- the false feeling that something you are now experiencing happened before. My new word vujà dé means -- the false feeling that something that... [Read More]
Tracked on March 23, 2009 3:31 PM
» Once Again, Lizards Proven Smarter Than Democrats! from Big Lizards
Aeons and millennia ago -- almost a year ago, actually -- we published a piece purporting to explain just what had happened to bring the financial heads to their knees. We discussed sub-prime mortages, how they were repackaged into Mortgage... [Read More]
Tracked on September 12, 2009 10:48 PM
The following hissed in response by: Dick E
Simply put, everything related to finance, to trade, to buying and selling -- in short, everything connected with any kind of a market -- depends upon access to timely, honest, accurate, and believable information (hereafter "THABI")….
Without sufficient THABI, no seller has any idea what price to ask the buyer, and no buyer has any idea what price to offer the seller. Buyers and sellers cannot come to a "meeting of minds," which means nobody can agree on any contract. And that means no market can exist.
Amen and agreed. (although “everything” might be a bit of an overstatement.)
…in the absence of THABI, the market cannot exist... hence cannot correct for the lack of THABI.
As the market is unable to function without THABI, it cannot function to restore THABI. All that information must come from somewhere else; and the only "somewhere else" that can act quickly enough to stave off a global depression is the State.
There I must beg to differ. I’m not an economist either, but what you say here clearly does not apply to markets in general.
Take the simplest possible case: You have a widget for sale, and I want to buy one. You provide information about your widget, and I decide whether it meets my definition of THABI. I provide information about how I will pay for the merchandise, and you decide whether I have met your definition of THABI. (We exchange other information too, but the same principle applies.)
The State may provide some information -- the condition of the economy, the value of currency, etc. -- but that kind of information is strictly tangential to our transaction. The State may even regulate some of the information we exchange -- what information must be provided and the penalties for failure to comply with the regulations. But still, we are exchanging information with one another, not with the State.
THABI is a lower, more fundamental "layer" than the market; the market sits atop THABI.
No. Information (whether THABI or not) is a commodity that has value, and it is exchanged for value received. If someone else has an apparently identical widget for sale, I may very well decide whether to buy from you or from them based on the information each of you provides. The information may also affect the price I am willing to pay.
And the market does, in fact, correct itself for incorrect or insufficient information. If I trusted you, but you gave me bad information about your widget, I’ll either sue or spread the word or rat you out to the Feds if you didn’t follow the regs.
I can’t think of a single business transaction I have witnessed where these principles do not apply.
The market may, indeed, be helpless in dealing with the extremely complex situation we now face. And it may be true that the root of the problem is a failure of information supply. And it may also be true that the State is the best source for information in resolving this crisis. But that is not how markets in general work. Nor do I see how we, as non-economists, can determine that the rules applicable to simple transactions somehow apply differently to very complicated ones.
(If you intended for your analysis to apply to the current crisis only and not to markets in general, then it would have been useful had you indicated where the “general” comments ended and the “crisis” comments began. However, the computer analogy sure makes it sound like you are referring throughout to markets in general.)
The following hissed in response by: Dafydd ab Hugh
I am referring to markets in general; and your response in fact argues for my point, not against it... as every ameliorative action you posit is a State action -- or a market action in an environment where State action controls:
"You have a widget for sale, and I want to buy one." You describe information exchange in a functioning market built upon THABI.
"Information (whether THABI or not) is a commodity that has value, and it is exchanged for value received." What is the value of information that is untimely, dishonest, inaccurate, or unbelievable? You cannot set a value, either as buyer or seller. Its value is a coin flip.
"If someone else has an apparently identical widget for sale, I may very well decide whether to buy from you or from them based on the information each of you provides." But his widget offering is as bereft of THABI as is mine. Not only can you not evaluate my offering or his, you cannot compare them either!
"And the market does, in fact, correct itself for incorrect or insufficient information. If I trusted you, but you gave me bad information about your widget, I’ll either sue or spread the word or rat you out to the Feds if you didn’t follow the regs."
- Lawsuit -- you will rely upon the force of the State to get your money back.
- Spread the word -- if the information about the product is absent, and there is no functioning THABI in that arena, you cannot (by definition) convey that information to anyone who matters. If you could, we wouldn't be in the non-THABI situation we posit.
- Complain to federal regulators -- no comment!
"I can’t think of a single business transaction I have witnessed where these principles do not apply." I agree completely: Every market transaction is predicated upon the existence of several layers deeper than the market itself: Civil and criminal courts, a functioning currency (barter is too unwieldy for a civilized society), a transportation system, a police force to prevent rampant banditry... and THABI communication.
Thus, every society must, at this stage of human and technological development, include a State that does, at a minimum, these things. This is true whether we're talking about Hong Kong under the British -- or the Soviet Union under Josef Stalin.
Some are better at them than others, but no society can function without them. When one or more of these lower layers disappears (Rwanda-Burundi a few years ago, Calcutta a few decades ago, or the Palestinian territory at any time) that is an operational definition of a "failed State"... and there you do not find markets as we conceive them, only tribalism, thugocracy, exotic diseases, and wholesale slaughter.
The above hissed in response by: Dafydd ab Hugh at October 15, 2008 1:54 AM
The following hissed in response by: hunter
The question will be answered by the next President.
And that is a scary thought.
The following hissed in response by: Dick E
OK, so in some cases the State sets the environment for defining when someone has violated the rules on information -- the consequences being either a lawsuit or being hauled before a regulatory authority.
But there are many transactions where neither of those consequences is likely or is even a reasonable possibility. And remember (as I’m sure you do) that THABI is rarely perfect -- information is usually shades of gray, not black and white.
Example: I’m currently talking to several people about repaving our driveway. I don’t fully trust any of them -- after all, they’re businesspeople, working in their own best interests to support their own families. They may “shade” the truth, as do all salespeople. It is up to me to evaluate which company is offering the best deal for me. If I hire one of these people, it’s not because I trust everything they’ve told me -- any more than you would trust everything you were told by the used car seller.
But what are the consequences if the information provided is not accurate? In an extreme case, a lawsuit may be threatened or may actually occur. (If the Bozo takes my deposit and never shows up again, for example.) But lots of other information components of the transaction may not happen as promised, but no legal or regulatory action is reasonable. Let’s say he promised to finish my driveway in two weeks, but it takes him three. Or he promises to personally supervise the job, but after he takes my money I never see his scraggly hide again. Legal action is very unlikely in these cases. (If the delay is significantly longer than the agreed-upon time, I may have cause for legal action, but how long is that? Four weeks? Five? Eight? And if the job is ultimately done properly, what are my damages? Both parties know that a lawsuit under such circumstances, while possible, is very unlikely.)
So what force of nature causes most businesses to act properly under these circumstances? The marketplace. If treated badly, I, of course would not do business with the scoundrel again -- I wouldn’t hire him to repave the driveways at my other mansions, for example. And I would, in fact “spread the word”. Anyone I tell about my experience with the shady contractor has information (whether they believe it or not) that they can use when they make a decision about repaving their driveway -- or their shopping center parking lot. This is not irrelevant, and is in fact an important part of how we make business decisions: Networking
Another example: Some countries have a very different legal environment than we do, where lawsuits and regulatory action concerning private transactions are so rare as to be considered impossible. Think of the country on our southern border as an example. People still transact business, and they evaluate information as part of the process, but they must make their evaluation without the threat of government action or rules. If you get screwed, you turn counter-clockwise to remove, then lick your wounds. Then you tell your friends and business associates. (Lawsuits may occur in egregious cases: Say someone made off with a couple hundred thou in a real estate transaction. But that is very rare.)
That’s the market at work. And it does work. After all, a business’s most important asset is its reputation -- its goodwill (non accounting definition).
Before there were even governments to enforce regulations and maintain courts, commerce did, in fact, occur. People relied on information to decide which transactions made sense, and the force regulating that information was word of mouth.
The following hissed in response by: Dick E
Information is not a “layer”. It is a commodity traded in the marketplace, sometimes bundled with other real, personal or intellectual property, sometimes sold on its own.
When you hire a lawyer, for example, what you are buying is information. The decision to hire a particular attorney is governed by your assessment of whether he has provided you with THABI. But the product itself is actually nothing but THABI.
The following hissed in response by: MNotaro
Our economy is in turmoil and I haven't heard any of those left wing illuminati's in Washington come up with any ideas to help out the American people! Do any of them care people are losing their homes, their jobs, and their retirement accounts?
The following hissed in response by: Xpressions
What could happen depends on you and I. Do we trust the liberal illuminati to clean up this mess? Or do we put in politicians that can make it right?
The following hissed in response by: Xpressions
I believe it's hello socialism. The Ivy-League illuminati politicians are trying to spread our wealth. It's not enough we have to pay for this bailout, but the left-wing is going to give them more, watch and see.
Post a comment
Thanks for hissing in, . Now you can slither in with a comment, o wise. (sign out)(If you haven't hissed a comment here before, you may need to be approved by the site owner before your comment will appear. Until then, it won't appear on the entry. Hang loose; don't shed your skin!)
© 2005-2009 by Dafydd ab Hugh - All Rights Reserved