Wednesday, October 29, 2008

The Bail Out and Rate Cuts

For a bit of a change of pace, but still with a focus on science - the science of economics. OK, that isn't science any more than astrology is, but they do get a semi-Nobel in economic science. A bunch of Swedish bankers would never make a mistake. Here is my reaction to the rate cut.  :-)

The Federal Reserve cuts interest rates by only half a percent to 1.0% - WIMPS!

One of the really cool things about the bail out, is that rate cuts do not have to stop at ZERO. We can use the government to subsidize borrowing. If the interest rate is minus 5 percent, the government will reimburse the bank for the amount of money they are paying you to borrow money. 

If the original bail out plan did not appeal to the Huey Longs of the world, this one will. Of course, they will have to come up with some sort of needs testing so that it does not benefit the really rich, but it can put money in the hands of the poor. 

If you structure the loan just right, the interest rate you receive for borrowing the money could cover your payment on the principal and you would never have to pay anything out of pocket.

Sign me up for a few million in loans. I don't want to overdo it, so I will not ask for more. I will then quit my job, so that the unemployment numbers improve. This is clearly a Win-Win-Win situation. The more money the government gives away, the better for everyone.

Instant Recovery! FDR would be proud.


Wednesday, October 15, 2008

Smaller Banks Resist Federal Cash Infusions

An article in the Washington Post points out some of what is wrong with the Great Bank Bailout of 2008. Smaller Banks Resist Federal Cash Infusions.

A few quotes -

At Evergreen Federal Bank in Grants Pass, Ore., chief executive Brady Adams said he has more than 2,000 loans outstanding and only three borrowers behind on payments. "We don't need a bailout, and if other banks had run their banks like we ran our bank, they wouldn't have needed a bailout, either," Adams said.

The first $125 billion will be divided among nine of the largest U.S. banks, which were forced to accept the investment to help destigmatize the program in the eyes of other institutions.

Officials said they expected thousands of banks to participate.

But both the American Bankers Association and the Independent Community Bankers of America said that they knew of few banks that planned to participate.

Participating banks cannot increase the dividends they pay to shareholders without federal permission, they must accept some limitations on compensation for their executives, and Paulson said the government would press companies to limit mortgage foreclosures.

Not to defend the limitation of the compensation for executives, but that is not the role of government. We should not be paying out trillions of dollars, just so some redistribution of the wealth types can say, "We kept those dirty rich from making too much." They will always be making too much. The government even set up businesses that do this - Fannie Mae and Freddie Mac.

The sensible way to do this is to educate the stock holders, since they are the ones who pay the money to the executives. Let the stock holders take responsibility for their responsibilities. It is not the responsibility of the government.

As far as encouraging risky investments, this is a spectacular incentive to the irresponsible members of the banking community. Go forth and make bad loans, but do not worry. We will be there to bail you out. Then we will use that as an excuse to put more regulations on those, who behave responsibly.

Fannie Mae and Freddie Mac, corporate/government chimeras were part of the problem. Completely private financial institutions were just as bad. The ordinary solution to these excesses would be bankruptcy, firings, lay offs, foreclosures, and other misery. Fortunately, much of this would fall on those responsible. Many executives will have made fortunes out of this. The bailout will not change that. Regulations might have minimized that, or delayed it, but the regulations seem to have been encouraging sub-prime loans.

Free markets are more of a concept than a reality, since there are regulations on almost everything. The value of free markets is that they allow people to take risks. Many of these will fail, but some will prosper. This is what gets economies going. The government incentives and punishments have nothing to do with a free market and only pander to those with power.

The only guidance the government seems to have is the stock market. If the stock market goes up, they must be doing the right thing. If the stock market goes down, they just need to do more.

I was wrong about the market being near the bottom. Maybe it will bottom here (DJIA at 8578). Maybe.

They have already decided it is the right thing. There is no possibility they will consider that they are already doing too much. I was not expecting that I would be missing Mr. Greenspan, ever. He would probably keep everyone too confused to go along with such a plan.

I heard someone (Alex Blumberg) on NPR talking about a paradox of the bond market. With most countries, when there are bad financial times, the interest rate goes up. This is because the currency is considered to be more risky. With the US, as the demand for treasury bonds goes up, the interest rate goes down. The conclusion was that the worse the economy gets, the lower the interest rates. This is true, but only up to a point. There will be a bubble in bonds. At some point the US will owe enough money, that it will be seen as wiser to default on the debt, than to pay it back. This was considered back in the inflationary times of the recent past.

Why is a US bond default unthinkable?

Is the US so responsible with its money, that they have surpluses of cash and bullion to back up the currency?

Will the US be again, faced, with high interest rates to borrow money?

This guy seems to think so.

Picture from NPR (the web site, not the radio) that provides a giggle.


Friday, October 3, 2008

Something that should amuse the short term panic people

Some people pointed to the record drop of 777 (and change) points on the DJIA (Dow Jones Industrial Average) on the day the House of Representatives rejected the original Encouraging Reckless Activity Bill as evidence of the decision being a bad decision. If you use their logic, the market should be up today. Up a lot. The market should be up this week. Up a lot. Here is a chart of .DJIA for the week. This is what a lot of people refer to when they discuss the market.

Today, Friday 10/03/08, is not showing up on the chart, but I expect that will change later on. Today's close of 10,325.38 is 40 points lower than the close for Monday of 10,365.45 - the lowest point for the day. If that was a justification for listening to the market and passing the bill, what does this mean?

Maybe it all means that paying attention to the short term fluctuations, even when alarming, is a bad idea. Not that a bad idea would stop Pelosi and The Bush.

Pelosi: "Gee Bush, what do you want to do tonight?"

The Bush
: "The same thing we do every night, Pelosi—try to take over the world."

I still am continually amazed at the ability of the Speaker of the House to refrain from saying Narf on TV.

Addendum 17:26 10/03/08 -

The market will probably bottom out about here, but not because of this action by Congress.


The Encouraging Reckless Activity Bill

If you want proof that Congress does not understand finance/economics/money management, watch C-SPAN. While there are some good things in this bill, they overestimate their ability to make a positive difference.

The road to hell is paved with good intentions.

I have only listened to a part of the discussion. It continues as I type. I was out of the room and did not catch the name of the representative speaking. This comment was not something unique to this speaker. I am not fond of redundancy and I am paraphrasing -

We need to do this to guarantee that average Americans will be guaranteed a return on their investment in the stock market.

Well, that average American should buy bonds. They are guaranteed by the American government. The more people buy, the lower the interest rates go, but the interest rate will always be positive.[1] Of course, the government may default on these. US government default was seriously considered a few decades ago. The funny thing is The Encouraging Reckless Activity Bill increases the chances of a government default.

The argument from many of the speakers seems to be for the ability to guarantee investment return. This is a bad idea. This is already available with bonds, but if interest rates climb, the bonds may lose value .

A note on the screen listing some of the features of this bill listed Mental Health Benefits. I love irony.

Representative Jeb Hensarling made an amusing comment. Again I am only paraphrasing -

How can we have Capitalism on the way up, but Socialism on the way down?

This does capture a significant part of the problem. The idea that government can protect us from risk is Socialism. While many companies do a poor job of money management, the ability to take risk is the important part of having free markets (Capitalism is not the right term).

Too many people think that free markets will provide for survival of the fittest. This is usually a misunderstanding of how survival of the fittest works. Survival of the fittest depends on the circumstances of the environment - in the short term. Sometimes this includes criminal activity. Enron is one example of a company that was the darling of the market. Enron started out as a good company, but began to lie and cheat, in order to satisfy the expectations of the market analysts for ever increasing profits and projections. Should the government have bought Enron to keep people from losing money? No. If the government does that, it is subsidizing this criminal behavior. Were people hurt by this? Absolutely. A lot of innocent people.

What about the internet bubble? Should the government have bailed out the investors/speculators in the stocks that lost, in many cases over 90% of their value. Hey! I lost some money in that. I am not a great trader. I want my government bailout. On the other hand, I don't want the government to control how I can invest/speculate.

Representative Christopher Shays gave an excellent example of the misunderstanding of how markets work. He stated that the market dropped by a trillion plus dollars on Monday. He blames the lack of passage of the bill for this. That may be what many investors/speculators were thinking. He is using the open market behavior, which is usually wrong in the short term, to justify a removal of market forces and the introduction of greater political control of the markets. I guess he has never read Catch-22.[2] Maybe he read it and never understood it. When I write that the market is usually wrong in the short term, I don't mean that the reaction of the market is exactly opposite of the correct response. I mean that the extremes of the markets are usually wrong. The time of greatest panic is the time to buy. The time of greatest optimism is the time to sell.

If we want the government to guarantee that people do not experience financial hardship, where do we stop?

Should the government guarantee that you will not lose your job, when your employer is going to go out of business, regardless of the reason?

Should the government step in and take over these businesses?

Should the government establish more regulations to control that business, even if the regulations were a significant contribution to the failure?

Read this article, Fannie Mae Eases Credit To Aid Mortgage Lending,[3] from the New York times. It was written 9 years ago and points out the problems that were coming. Problems that have arrived. Problems that were encouraged by the government. The government that is now the solution to the problem.

And the example of Representative Chaka Fattah -

I request unanimous permission to revise and extend my remarks.

This is the way those in Congress make it seem as if they gave a literate speech, while not actually giving any speech. They add something, maybe ghost written, to the official record of the debate. Imagine if a presidential candidate were able to go back to revise and extend my remarks from a presidential debate. Just another example of how Congress isolates itself from reality. these are the saviors of the market.

I am waiting for the bill that will prevent injuries, because it is unfair for people to be injured. They try to legislate safety, and claim success, but when will they actually make rules that forbid activity that might put an individual at risk? We need to limit everyone to prevent the lowest common denominators. Read Harrison Bergeron.[4] A very short story by Kurt Vonnegut.

Then, the Speaker of the House, Representative Nancy Pelosi finishes up with -

(This is) only the beginning of our work to protect the American people

But is being saved by Nancy Pelosi a fate worse than death?

Even Paul Krugman is for it in his article Edge of the Abyss.[5] Could there be more convincing evidence that this is a mistake? Should we let him push us off of the edge of the abyss? He fancies himself standing on the abyss, pushing us away from the abyss. This is a good metaphor for the kind of footing he is accustomed to.

This mistake has now passed both the House (263 to 171) and Senate (74 to 25).


^ 1 If you have more demand for an item, in a market with open bidding, the price will go up. Buying a bond means that you are paying X dollars today for a fixed amount of dollars in the future. I use one year and round dollars for ease of explanation. If there are not many people bidding for the product, the price might be $96 now, for $100 in a year. A profit of $4 on a $96 investment. The interest rate would be 4/96 - just over 4% per year, since this is only for one year. If there are more people bidding for the product, the price might be $97 now, for $100 in a year. A profit of $3 on a $97 investment. The interest rate would be 3/97 - just over 3% per year, since this is only for one year. If there are a lot of people bidding for the product, the price might be $98 now, for $100 in a year. A profit of $2 on a $98 investment. The interest rate would be 2/98 - just over 2% per year, since this is only for one year. You are paying different amounts now, for a fixed amount in the future. The more you pay, the lower the interest rate.

At the end of that year, the interest rate could be higher, lower, or even the same. Even with bonds there is a risk of the interest rate being lower than inflation. Back in the 1970's this was common, since the interest rates rose very quickly. If you owned a long term bond before the interest rates started going up, you probably would not be able to sell that bond for as much as you paid for it, because the value of the money you paid has been eroded by inflation. At the end of the loan, the money you are paid is in current dollars. Dollars which have been devalued by inflation. You paid for it in earlier, pre-inflation dollars. Dollars that had more value than the current value of the loan. We do not currently have high inflation. Few predict it. This bill encourages it, because it decreases the confidence in the ability of the American government to manage its money competently. America becomes a greater credit risk. I do not base this on the current reaction of the of the bond market, because the market is usually wrong in the short term. The long term will tell us where interest rates will go. In the short term, the government sets some interest rates. In the long term, the impotence of the government to control interest rates is demonstrated by the markets.

^ 2 Catch-22
From The Straight Dope.

^ 3 Fannie Mae Eases Credit To Aid Mortgage Lending
New York Times Business section
September 30, 1999

^ 4 Harrison Bergeron
From Welcome to the Monkey House
By Kurt Vonnegut (1961)

^ 5 Edge of the Abyss
New York Times Op-Ed
October 2, 2008