Friday, November 12, 2010

Congress Fears the People? Please....

A few days ago CWD commented,
I still haven't figured out why everyone gives the Fed a pass when they are deliberately setting a policy that hurts a substantial number of Americans (anyone living on a fixed income/relying on savings and investments... like retirees). Don't get me wrong, there is an argument for the Fed's position, but no one even bothers acknowledging that the issue exits and that the costs should be considered...
The underlying point is that when interest rates are at or near zero, people who are relying upon their investments to help pay for their retirements have to either cut their spending or dig into their equity in an amount greater than they anticipated. The long-term consequences of overspending equity are self-evident, and are magnified when you're no longer earning wages.

The easy response to that is, "Who's paying attention"? The population that is largely identified as comprising the Tea Party movement, upper middle class, mostly white, largely male, would be a population you might expect to be attuned to the issue. But even if we assume that some tried to raise the issue, the supposedly Tea Party-friendly media - Rush Limbaugh, Fox News, etc. - ignored it. Glenn Beck was on the case well in advance, of course, but in a different way. He was paid handsomely to shill for overpriced gold coins as an investment. Yes, you too can undermine your retirement while lining his pockets.

Here's something that Matt Yglesias proposed as a serious argument for why we have this massive, poorly publicized subsidy of the financial industry that's hurting pretty much every wage earner who is trying to save for retirement, and pretty much every senior who is living in part on retirement assets affected by the return on those investments. You're asked to imagine that you're a public official who is terrified of letting even a single bank fail (presumably here we mean one of the handful of large banks, because small banks are allowed to fail with some regularity). You're presented with two choices:
One choice is that you force the banks in question to accept capital injections from the public sector. This will “bail out” the bank and save it as an institution. It’s also obviously better for the bank’s owners than the alternative of letting the bank fail. But for the owners it’s also not ideal since it means the value of their shares is being diluted. Indeed, if raising extra capital were a bailout of the shareholders they would have avoided this problem long ago by simply raising capital from private investors. But their reluctance to do this has helped bring us to the crisis point. They’d rather get public equity than fail, but they’d rather avoid getting public equity.
If the issue is that a bank will fail and wipe out its investors, but we're to accept that the bank could simply raise money from capital investors, it's going to choose not to fail. The bank only needs to be bailed out if its management was so incompetent that it chose bankruptcy over raising money, or if it's anticipating that the government will shovel money in its direction if it claims that it's going to otherwise fail. So we're in the position of being asked to bail out banks that are either led by incompetents who have destroyed the business they run, or to pay hundreds of billions of taxpayer money to banks run by people who planned to loot the treasury in exactly that fashion.

Further, if we look back at when we did inject money into those banks, the arrangements were made in a manner that protected shareholders and bondholders, even though that meant at best minimizing the return to taxpayers who were saving the banks from failure and potentially losing part or all of that money. So no matter what the public does, the bank and its investors come out just fine, thank you very much. And let's gloss over the fact that the taxpayer was asked in some cases to inject money meeting or exceeding the market capitalization of the financial institutions at issue - we can talk all we want about private investors, but if a private investor comes up with that type of money you can expect that when the transaction is done they'll own their investment, lock, stock and barrel.
A different option is to refuse to give “the banks” extra money. Instead you perform stress tests and proclaim that the banks are secure, implicitly signaling the existence of government guarantee of their operations. You have the Federal Reserve start paying interest on banks’ excess reserves, giving them a zero risk profitable investment parking cash with the Fed. Then you hunker down and wait for the regulatory forbearance to allow the profit-making process to generate sufficient capital to resolve the situation.
Wait - I have an idea! Why not do both - in fact, we did do both. Seriously, why is this being presented as a choice of options?

It's argued that the second approach, probably better described as "phase two" of the financial industry bailout, will take longer to work, prolong the suffering on Main Street, and is "wildly more favorable to the people who owned the banks, in a way that creates a massive problem of injustice" - that third point being what CWD noticed. But it's argued that this second approach may seem preferable because you don't need to get approval from Congress and the public would view it as "superior to a soft-on-bankers 'bailout'". Well, whose fault is it that this isn't being repeatedly and accurately characterized on by the media as a bailout?

Tim Fernholz at Tapped characterizes this argument as follows:
The long and short of it is that we ended up choosing a less optimal policy, because people were so angry about bailouts, and because Congress - and the incentives of political actors therein - drastically increased the challenges of implementing a better policy.
Except as is patent from the description Yglesias provides for the first option, the anger is justified. We made oversized investments in financial institutions that were designed to deliver undersized returns (or obscene losses), to bank managers whom Yglesias tells us could have prevented the need for a bailout had they been willing to dilute the value of their shares, and who forged ahead in apparent anticipation that they would be able to use a doomsday scenario to get that public bailout money. Now we have a disguised bailout in the form of low interest rates for those banks, because they still prefer to be undercapitalized than to dilute the value of their shares. I'm sorry, but if the private money is there to be invested as Yglesias suggests and Fernholz accepts, this is not a case of taxpayer anger causing Congress to fear making the better of the two choices - because there's a third choice that would also keep the banks from failing. It's another round of banker greed, incompetence, or both causing the economy to languish while taxpayers pick up the tab.

It's interesting, isn't it, that wiping out shareholder value was not such a big deal when the auto industry was involved. How Congress and the President had no problem demanding that, in return for being bailed out, auto makers come up with plans for long-term sustainability in down markets. How they insisted that worker wages be slashed and contracts rewritten. And, whatever people may have thought about the bailout itself, all of that was largely popular. But when it involved the oversized compensation packages and absurd "retention bonuses" of the people whose greed and/or incompetence caused the economic collapse, we were lectured on "the sanctity of contracts".

The reason we have a backdoor bailout is not because Congress is afraid of a direct bailout due to popular anger. It's because it knows that it can't get away with another "no strings attached" - no, that's too charitable - another open giveaway of taxpayer money without making some demands on the financial industry. So sure, you can get me to blame Congress for not approaching this in a way that brings a faster, more cost-effective and fairer end to the bailouts - but let's put the rest of the blame where it belongs, on the financial industry itself. It's fear of their wrath, not mine, that cows Congress.

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