Things learned during an economic crisis

Ah, McSweeney’s:

This brings us to the housing crisis, for which you and you alone, Pamela, are responsible. When you choose a Chance card and Rich Uncle Pennybags orders you to pay taxes on your houses, then, damn it, Pamela, you pay taxes. Instead, you decide you’re not going to pay, because you only have $7 left. It’s just a game, you say. Stop taking it so seriously, you tell me. Well, maybe that’s what the millions of Americans caught in the subprime-mortgage crisis should have done.

Then you offered a solution—that we dole out my money and resume play. When I heard you suggest a redistribution of wealth in front of the children, I thought my head would explode. What type of example are you setting during Monopoly night, Pamela? Next, you’ll encourage Warren to smoke dope. Or Brittany to get a liberal-arts education.

I realize that, since the layoff, I’ve been obsessed with the economic crisis. Admittedly, I’ve been watching too much CNN. Which is, perhaps, what led me to suggest a government bailout of our Monopoly crisis. I figured we needed about 40 Monopoly games to accrue the necessary funds. I don’t know where you thought that kind of liquidity would come from, but I believe you overreacted to my suggestion of going door to door and borrowing all the neighbors’ Monopoly money. Perhaps you’d had too much wine. Or perhaps you are against foreign investment, although I happen to think the Chinese are saving our asses.

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“We Did This To Ourselves”

An article in today’s Guardian by John Lanchester provides a useful summary of the current credit crisis, which I will quote as an introduction to some more fundamental issues raised later in the article:

Financial institutions in the US lent money to people with poor credit histories. This wasn’t a bad thing in itself … The invention that made it possible for the lending to become reckless was securitisation: the process by which loans were added together and sold on to other institutions as packages of debt. This had the effect of making the initial lender indifferent to whether or not the loan could be repaid. These packages of debt were then resold in the form of horrendously complex financial instruments, and it is these that are the basis of the global jamming-up of capital markets. The overlapping loans are so complicated that no one knows who owns what underlying debt, and, furthermore, no one knows what these assets are worth. The mechanism for assessing the value of these assets is the market: they are worth what someone is prepared to pay. At the moment, because no one is buying, no one has a clue what they’re worth, if anything. Because of an accountancy practice called “mark to market”, requiring that assets be listed at their current values, this fact had to be reflected in the companies’ balance sheets – so these balance sheets suddenly looked disastrous. As a result, banks are reluctant to lend to each other, and the entire financial system has ground to a halt: such capital as is moving in the markets is supplied by the central banks, which have to date pumped in hundreds of billions of dollars to generate some liquidity.

After going into some of the details about what individual banks and countries did, the article ends with a summary of the bigger picture:

So: a huge unregulated boom in which almost all the upside went directly into private hands, followed by a gigantic bust in which the losses were socialised. That is nobody’s idea of how the financial system is supposed to work. It is just as much an abomination to the free marketeer as it is to the social democrat or outright leftist. But the alternatives don’t seem to be forthcoming: there is a theoretical vacuum where the challenge from the left used to be. Capitalism no longer has a global antagonist, when it has never needed one more – if only to clarify thinking and values, and to provide the chorus of Schadenfreude that at this moment is deeply appropriate.

Having fully indulged their greed on the way up, and created the risks, the bankers are now fully indulging their fear on the way down, and allowing the system to seize up. But it wasn’t just the banks. One thing that has been lacking in public discourse about the crisis is someone to point out that we did this to ourselves, because we were greedy and stupid. We grew obsessed with the price of our houses, felt richer than we should, borrowed money we didn’t have, and now that the downturn has happened – as it was bound to do – we want someone else to blame.

Other than that, it’s too early to draw general conclusions from this amazing crisis. What must die is the mystical belief in the power of the markets that has dominated political and economic discourse in most of the western world for the past several decades. The markets have, so flagrantly malfunctioned that we can’t go back to the idea of unfettered liberal capitalism as a talisman, template or magic wand. Unquestioned Cityphilia is gone, I hope for ever. Unfortunately, we have no model of where to go from here, apart from a more heavily regulated form of growth-based liberal capitalism.

Now, on one level, this quote is somewhat disturbing, borderline terrifying. But, as a scientist, I can’t help but note the similarity to a scientific revolution. There is a crisis in the old model – its shortcomings have been made apparent by its failure to account for a novel situation. The search for new models is underway – will it just be a patch on the old model, or a complete overhaul? It will be interesting to see if the field of theoretical economics has a very productive decade in the aftermath of the credit crunch as bright young minds are drawn to the exposed problems of capitalism.

Still, it must be extremely difficult to model a phenomenon whose most basic element is “greedy and stupid” humankind. It makes astrophysics look comparitively straightforward.

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Things are getting worse

Luke’s recent LHC post has goaded me into making sure other important events do not pass without appropriate comment.

The talk about town is all of the US government’s proposal to nationalise (or ‘go all European on,’ as I predict it will soon be derided) the parcels of extremely bad debt owned by important financial companies; my mother, for instance, describes it as ‘bad’ in her most recent weekly letter. It seems to me that the text of the legislation becomes more penetrable if one replaces the phrase ‘mortgage-based assets’ with ‘chocolate’.

Sec. 5. Rights; Management; Sale of Chocolate.

(a) Exercise of Rights.–The Secretary may, at any time, exercise any rights received in connection with chocolate purchased under this Act.

(b) Management of Chocolate.–The Secretary shall have authority to manage chocolate purchased under this Act, including revenues and portfolio risks therefrom.

(c) Sale of Chocolate.–The Secretary may, at any time, upon terms and conditions and at prices determined by the Secretary, sell, or enter into securities loans, repurchase transactions or other financial transactions in regard to, any chocolate purchased under this Act.

(d) Application of Sunset to Chocolate.–The authority of the Secretary to hold any chocolate purchased under this Act before the termination date in section 9, or to purchase or fund the purchase of a chocolate under a commitment entered into before the termination date in section 9, is not subject to the provisions of section 9.

Dire stuff; if you are reading this post, you are affected by this proposal. Though the market reaction to the announcement of the plan on Friday was extremely positive, the American political-economic blogaxis (too polar to warrant the term ‘sphere’) has now metastasised in a unified bloc of opposition, with each end trumpeting objections along their idealogical fault lines.

Of course, it is not the place of this blog to editorialise, especially when there is chocolate to be bought; the purpose of this post is to direct attention to a lengthy and cogent discussion of the legislation and reactions to it, though I do not endorse their opposition whole-heartedly.

Update (ca. 9pm BST) An off-blog dispatch from B. M. Jackson spurs me to sketch out those fault lines a little more; he suggests Greenwald, who unsurprisingly (and understandably) zeroes in on the ‘no-oversight’ clause:

Put another way, this authorizes Hank Paulson to transfer $700 billion of taxpayer money to private industry in his sole discretion, and nobody has the right or ability to review or challenge any decision he makes;

one of Greg Mankiw’s friends makes the same point with a bit more outrage:

Has more money ever been given with fewer restrictions on how it is used? Ever?

Greenwald also quotes Atrios, who seems to have assimilated his Chomsky without difficulty. One could go on, and indeed Sullivan does. But all one needs to know is contained inside the fresher-level summary from Jim Manzi, followed by the comments of an allegedly well-placed reader of Yves Smith:

[JBJ: This is Smith, then her reader indented below] Yet as we discussed, the plan makes no sense unless the Orwellian “fair market prices” means “above market prices.” The point is not to free up illiquid assets. Illiquid assets (private equity, even the now derided CDOs were never intended to be traded, but pose no problem if they do not need to be marked at a large loss and/or the institution is not at risk of a run). Confirmation of our view came from a reader by e-mail:

…Anyway, I wanted to let you know that, behind closed doors, Paulson describes the plan differently. He explicitly says that it will buy assets at above market prices (although he still claims that they are undervalued) because the holders won’t sell at market prices. Anna Eshoo pressed him on how the government can compel the holders to sell, and he basically dodged the question. I think that’s because he didn’t want to admit that the government would just keep offering more and more.

Photo by Flickr user ansy used under a Creative Commons license.

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