Some Thoughts on “The Big Socialist Bailout”
Posted by Rob Weigand.
There’s been an enormous divergence of opinion over the way the bailout of the U.S. financial system is being handled (or, more accurately, the way government officials are proposing to handle it). My question is, do any of the critics have a better solution to the problem? Probably not. And I certainly don’t have one, either. One thing we can all agree on is that it is a big, stinking mess of epic proportions.
What the critics don’t seem to realize is that there is a significant chance that the entire global financial system may suffer a liquidity run leading to mass insolvency — something that could trigger a deep recession, maybe even a global depression. Systemic contagion continues to spread at an increasing rate, and rather than run the risk that it will “work itself out” via widespread bankruptcy filings, the powers-that-be opted to cobble together a backstop program. And there’s still no guarantee the government plan will work, despite the almost trillion-dollar commitment.
And yes, this means the U.S. is taking steps towards instituting a European-style socialist solution. It’s probably best to just take a deep breath and let all that go for now. I would argue that one of the main factors that makes the socialist form of the bailout appear so humiliating is the way the ultra-conservatives have spent the last 25 years bashing the European style of capitalism. It’s time to wake up to the truth: The European way of doing things is no better or worse than the American way — it’s just different. U.S. politicians and business leaders should stop preaching to the rest of the world that we have better styles of capitalism and democracy. The collapse of our financial system is a national humiliation, and it would be refreshing to see our business and political leaders begin acting with an appropriate measure of humility over the mess we’ve all made — lenders, borrowers and politicians are all partly to blame. This financial crisis is a by-product of, and harsh commentary on, the American way of life and its focus on profligate consumption.
To make the socialist bailout somewhat easier to swallow, allow me to point out that the U.S. has always practiced subtle forms of socialism. The big bailout is just another (albeit much larger) move in that direction. Public services like K-12 education and police and fire protection are all forms of socialism — our society pools tax dollars and provides everyone with access to the same services regardless of the magnitude of their contribution.
I am also of the opinion that conservatives are trying to focus public attention on the “socialist” smoke screen to take our mind off the role big business has played in creating this crisis. Large financial institutions behaved in a predatory fashion when they loosened lending standards and saddled millions of American households with unsustainable amounts of debt. And, these institutions were aided and abetted by the semi-“socialist” GSAs (Fannie and Freddie), whose existence made possible an explosion of mortgage debt that is now smothering our financial system. Of course, consumers deserve an equal share of the blame — they flagrantly overborrowed and overconsumed. And the failure of regulators to curb excessive leverage in the financial system is another notable cause of the crisis. Everyone shares in the blame.
The U.S. led the world into this mess — we have to accept that, it’s inarguable. We haven’t been practicing a better form of capitalism all these years, just a different form. And the way we practice capitalism will be permanently changed by this bailout. It’s going to be impossible for the ultra-conservatives to claim a rational basis for their Europe-bashing going forward (although they’ll probably continue bashing Europe from an irrational stance). The U.S.’s beloved free-market system has created the biggest financial mess of all time, and the Secretary of the Treasury and Chairman of the Federal Reserve Bank believe we need a socialist mop to clean it up. Let’s get over it and move forward.
For those of you who would like to read some of the more intelligent dissent on the topic — none of which offers an alternative solution to the global systemic contagion that is spreading by the day, I’d like to point out — I offer the following links below.
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Financial Market Commentary 
Rob: I am not convinced that the long term solution to failed socialism is more socialism. Fannie and Freddie are perfect examples of well-meaning government programs (“help make housing affordable”) that over time evovled into disasters. We knew years ago FandF were suspect, but the proposed reforms never made it through the political process. Wall street, the Fed, and the government have tried for months now to soften the blow, but when it comes down to it, you can’t unpop the sub-prime real estate bubble. Best to get it it over with and start anew. Socialism rarely corrects its mistakes, markets are ruthless in correcting theirs. So here is a question: if FandF had not ramped up the demand for subprime and Alt-A in the last few years, would we be in the pickle we are today?
David: Thanks for your thoughts and interacting with us on the site. Regarding your comments, notice that the article doesn’t say I like or endorse this move towards socialism, just that, in my opinion, the financial system is running such a high risk of disastrous systemic contagion that some form of bailout has become inevitable. I also believe that bemoaning the “socialist” aspect of the bailout based solely on ideaology is of no use as the powers-that-be try to enact the most efficient solution. For example, in his Tuesday a.m. testimony, Bernanke introduced the idea of using auction markets to price some of the most toxic finacial contracts — an intriguing (and market-based) idea.
In answer to your specific question, without FandF there would undoubtedly have been fewer subprime and Alt-A mortgages. But consumers and financial risk modelers share quite a bit of the blame for the mess as well.
Also notice that the consensus that is emerging from both Paulson (the former head of Goldman Sachs!) and Bernanke (a career academic at heart) is that re-regulation is going to be a key part of the solution to this enormous mess. I am of the opinion that this crisis is going to generate a new respect for the role of regulation in a free-market economy.
For the life of me I cannot see how the bailout is socialism. Socialism would be the administration and congress nationalizing all Wall Street firms, stressed or not. Socialism would be the government using $700 billion to create a bank whose sole purpose is to lend money to investment projects located in the US. This is run of the mill political cronyism. And the problem, as you allude to, was exacerbated by government action in the past and the problem is also being exacerbated by government action in the present. A couple of points:
1. To what extent is Paulson’s “plumbing problem” caused by the government itself? It should be noted that the problem has gotten significantly worse with each subsequent bailout. While this does not prove causation, why in the world would a firm sell an asset for $0.22 if they believe the government will buy it for $0.65? If a homeowner purchases a home for $200,000 and needs to sell it but can only find a buyer for $125,000, what can they do but sell. But now if the government is discussing bailing out homeowners and may pay the full $200,000 for your home what would a homeowner do? Wait for the bailout.
2. If the purpose is to inject needed capital into the system how wise is it to put the capital into the hands of financial intermediaries in direct proportion to the said intermediaries’ proven incompetence at efficiently allocating capital? A wiser approach would be for Paulson to loan $700 billion to all the banks that are NOT crippled with toxic assets and take a box of pencils as collateral.
3. Nobody has clearly explained how this specific plan is actually going to benefit the US economy. Capital markets are global. If I have $100 million to build a factory, will I choose to build it in a country whose economy just took on a couple trillion dollars of debt which MUST be offset by higher taxes (probably on capital, fairly so) and decreased spending or another country that not only did not take on debt but actually had some of their debt transferred to the US economy in the GSE bailout.
4. There is no action the government can take to undo the massive losses caused by the housing bubble. The losses WILL be felt in the economy. All they can do is shift those losses around. This is, of course separate from any liquidity problem. But it is important to note since I believe that this is primary reason for the political actions being taken, action that I think would be unlikely to occur if this were 2009.
5. I am told over and over again that this is a massive failure of free markets. But the crisis is a massive shift of capital AWAY from building houses that cost more than they are worth to buyers as actual places to live. There is a massive shift AWAY from making loans to people with bad track records of paying bills to purchase homes their incomes (if they bother providing incomes) would indicate they can not possibly pay off. All of this capital is instead chasing safe investments. Aren’t these all reasonable things? Aren’t these things we want the market to do? Aren’t these the things that people have be spending the last decade perplexed over the fact that it wasn’t occurring sooner? Let us remember that the Case-Schiller index was created for the primary purpose of figuring out a way in which homeowners, who know their homes are overvalued could diversify their assets and risk. Since selling their overvalued homes is of limited use since they would have to buy homes in the same overvalued market.
I am neither a conservative nor liberal, so I have no dog in this election fight and I am absolutely certain that the person I vote for in November will not win. But as for assigning the greatest weight of political blame clearly the biggest culprit of this mess is Fannie & Freddie’s massive moral hazard design that fed massive risk-taking in the housing market. These two institutions have been two of the favorite targets of economists on BOTH sides of the political spectrum for over a decade. It has been primary DEMOCRATIC politicians (notice I did not say socialist since the only thing socialized in these schemes are the massive losses) that had offered the political protection that have allowed these institutions to survive and expand into riskier and riskier markets. We should also recognize that this past summer, when it had already become apparent that the sub-prime market was in the midst of a massive train wreck, that the Democratic Congress allowed these GSE to rush headfirst into the market putting taxpayers at even greater risk. They also saw the wisdom in allowing Fannie/Freddie to start guaranteeing mortgages for homes valued between $400K and $700K, very affordable housing indeed.
While I am an ardent believer in free-markets, I do not for one minute believe that markets are perfect. However, I believe that they are better than the alternatives. Paulson and Bernake are certainly smarter, more experienced and possess far more information than me. But they are not smarter than markets. Markets are amoral. Markets are subject to volatility unpredictability. But markets are not random. Markets are volatile because the billions of people and trillions of decisions that aggregate into those markets are volatile and often irrational. Bernake said there was no need to lower interest rates on a Friday and then lower interest rates on a Monday. Paulson said that there was adequate liquidity in the markets and then a few weeks later said that the mother of all bailouts was a necessity. This is not a sign of incompetence, but a sign that no individual or committee can possibility take into account the trillions of atomistic decisions that come together to create market outcomes, such as prices. The primary role of government in a free-market is to protect property, enforce contracts and to solve informational problems. The FDIC and other regulations in insurance and finance industry are clearly a part of this role. Government laws and oversight is the most efficient way for consumers to ensure that when you buy insurance or put money in a bank that the said company is as safe as they say they are. What differs between this crisis and the Great Depression is that the heavily regulated bank industry is a safe haven for capital in which the taxpayer’s guarantee comes with significant oversight of risk taking. Perhaps the market taking us back to good old fashion banking with capital allocation decisions being made by bankers as opposed to astrophysicists with supercomputers is not a bad thing after all.
Perhaps I am nothing more than a cynic to question the benevolence of our esteemed leaders. But I will offer a solution to such cynicism. If taxpayers are on the hook for this necessary bailout, then let’s put Congress on the hook as well. Since everyone is so certain that there will be a positive payout to this investment, why not require that members of Congress, the Bush Administration and Federal Reserve committee members put 100% of their wealth into the fund. Let us also put a tax on campaign contributions to the Democratic and Republican parties of 90% to purchase equity in the Great American Bailout Corp. Let’s also allow the public to get in on this deal more than the $2,000 per capita stake currently forced upon us. Since it is clearly such a great long-run investment this would allow more of taxpayers’ money to be put to other uses.
It is a part of human nature to tend to view the lack of centralized decision making as anarchy. And it is just as human for society to rush towards those of offer security in times of fear and uncertainty. But when we relinquish our freedoms (economic or otherwise) in exchange for security the question remains “Who will watch the watchmen.”
And finally, as for the US leading the world into this mess, I will note that progressives blame the financial mess thrust upon sub-prime borrowers on the banks, lenders and credit card companies providing them with too much debt. By this logic the US economy is nothing more than a victim of the rest of the world immorally providing us with too much debt as opposed to saving us from our own conspicuous consumption.
Says Sollars “…the political reforms never made it through the political process…” and then he suggests that the best thing to do is start anew. Why should we believe that the political process, in the long term, will not repeat the same (or some variation thereof) the same mistakes?
The efficient, rational, ruthless market exists in the minds of some economists and there, when appropriate, it perfectly disciplines greedy, foolish, and intemperate individuals as well as predatory institutions but, as long as politicians are loose in the land looking for votes, exchanging promises for votes, no such market in reality will exist.
Nicolas Sarkozy has recently said: “The idea that the markets are always right was a crazy idea.” He might have been closer to the truth had he said: “The idea that political leaders in ordinary times (let alone a crisis) will rely upon markets is a crazy idea.” The point being that none of this discussion matters much if we are not willing to visit the intersection of day-to-day political behavior in a democratic form of government and economic principles. One does not work without the other and the two are often (perhaps inherently) incompatible. That, in my opinion, is the problem we are confronting presently.