The Great Bank Robbery of 2008

[competentone]

The Great Bank Robbery of 2008
Daily Article by Robert P. Murphy | Posted on 9/30/2008

The Paulson bailout failed in the House. If it isn't a death blow to the plan, it should be. This is not an economic plan: it is a heist.

It will go down as The Great Bank Robbery of 2008.

The economics behind it are nonsense, but we are naïve if we spend much time even considering the "arguments" for it. This is a money and power grab, pure and simple.

Just as magazine covers today feature scantily clad women that would have been scandalous a generation ago, in the same manner Paulson's proposal -- made in broad daylight and on national TV! -- is almost naked in its audacity.

Austrian economists tend to be libertarians in their political views, and they are often chided for not keeping these systems hermetically sealed and separated in their minds. Fortunately, this alleged vice is a virtue in our present situation. Because of all the mumbo jumbo thrown around to show why the plan is necessary, some very sharp academic economists are in a tizzy trying to treat this as an extra-credit question, rather than a crime scene. That is a waste of time.

In this article, we will of course cover why the Keynesian justifications -- coming from a "free-market" administration -- are nonsense. But in the grand scheme, that's not entirely relevant. People didn't seriously consider the testimony of the tobacco company CEOs about the nonexistent dangers of smoking, because everyone knew those executives stood to lose billions from the settlement. So by the same token, no one should pay much attention to the official statements made by Henry Paulson, since he stands to personally be put in charge of doling out hundreds of billions of dollars to some of the most powerful people on the planet.

The Keynesian Fallacy: The Paulson Plan Won't Create Wealth

In very simple terms, the Paulson Plan is a straight-up transfer of $700 billion -- and counting! -- from the taxpayers to a few big financial institutions. (Some smaller banks are complaining that they don't own the exotic mortgage-backed derivatives, but rather simple mortgages. They do not believe they will see a dime of the Paulson money.) It's easy to get all twisted around, but just remind yourself of this: the Paulson Plan has the federal government borrow $700 billion (through issuing Treasury debt) in order to buy assets from Wall Street banks. (We are neglecting the time delay in the program; the entire $700 billion wouldn't be spent all at once.)

Some analysts think that the price paid for these "toxic" assets is important. No it isn't. The government officials running this operation will dole out the favors on both ends, when the mortgage-backed securities are coming and when they are going. Neglecting this insight, some people want to say that if the government pays $700 billion for a portfolio of assets that is really only worth $400 billion, then the taxpayers really only lost $300 billion, not the full $700 billion.

Yet this thinking is naïve. The taxpayers are not going to be treated as equivalent to shareholders of a firm that just acquired $400 billion in assets. The taxpayers are not going to get a cut of the monthly mortgage payments (less the servicing costs on the $700 billion in new debt) tied to the government's massive portfolio. Instead, the government will simply bump up its annual spending by a few billion dollars. Maybe it will have to spend the money on homeownership programs, or homebuilder job retraining, but the net income from those government-owned assets certainly won't translate into a dollar-for-dollar tax cut.

And then at some point -- during a future Republican administration, no doubt -- there will be a push to "privatize" the secondary mortgage market, and the government's portfolio at that time will be auctioned off at very generous prices to politically connected institutions. For example, maybe the $400 billion portfolio is auctioned off for $250 billion. (Perhaps the big banks have to set up subsidiaries owned by minorities and women who get preferential treatment in the bidding process. But whatever the ruse, they will find a way to justify the low prices.) When all is said and done, the government will have played hot potato with the MBS, and the national debt -- borne by taxpayers -- would be $450 (=$700-$250) billion higher. The favored financial institutions would be "up" roughly the same amount, collectively. (Throughout, we are ignoring the timings of the payoffs and the effect on present discounted value.)

It is the crudest Keynesianism to view the Paulson Plan as an injection of capital or "liquidity." That money has to come from somewhere. If it is taxed or borrowed, then it is just a shell game; the liquidity is drained from elsewhere, to be injected into Wall Street.

Besides taxing or borrowing, the government has a trump card: it can have the Federal Reserve simply create the new money out of thin air, by engaging in some "Open Market Operations." Yet even in this case, real wealth still hasn't increased. Certain nominal figures, like "aggregate asset values" might go up. But that's not very relevant, because the economy isn't really richer. After all, there aren't more tractors or office buildings just because Bernanke allows the monetary base to grow more rapidly. So what happens in this case is that prices rise; people find it harder to buy milk, bread, and gasoline. But the Wall Street fat cats are fine with the general price hikes, because they got their hands on the newly injected funny money early in the game.

But Won't the Credit Markets Collapse?

Some observers would admit the legitimacy of my analysis above. "However," they might say, "the Paulson Plan, or something like it, is necessary to avert a total meltdown of the financial system. We're not trying to boost aggregate investment, so much as clearing out a clogged pipe."

This talk of a breakdown in the financial system is a bogeyman. Steve Landsburg does such a great job of exploding this myth that I will simply quote him:

So what's special about banks [that they deserve a bailout]? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.

Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.

… [A]s any user of match.com can tell you, the technology for finding partners has improved since [the 1930s]. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

… I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.

Conclusion

The Paulson Plan is a heist. It is a grand scheme in which the public will end up owing hundreds of billions of dollars to holders of new debt claims issued by the US Treasury. The plan won't "prop up" asset values and it won't provide any real stimulus to the economy.

Despite the dire warnings -- coming from the same folks who brought you the Iraq invasion to remove WMD -- there is no threat of a financial meltdown. If Goldman Sachs failed, the sun would still rise the next morning.

Far from providing stability and confidence, the Fed, Treasury, and SEC's recent moves have ensured that US capital markets will now function with the same efficiency as public education in this country. The Paulson Plan is one more step in the socialization of America, but it is also a great bank robbery.

[rammstein]

Its a decent write-up, although I don't know what possesses people to take what was a reasonably argued position and finish it with:

"Despite the dire warnings -- coming from the same folks who brought you the Iraq invasion to remove WMD -- "

WTF is wrong with people. What does one have to do with the other?

[Carrman]

I'd mostly agree with you, but in this case, I can see a bit of a relationship: Both Iraq and the Heist are/were bad ideas brought to you by the same incompetent people, for the purpose of serving special interests, and by making the same type of fear/hype arguments.

The point would be: Be suspicious.

[Zeke]

Originally Posted by rammstein

Its a decent write-up, although I don't know what possesses people to take what was a reasonably argued position and finish it with:

"Despite the dire warnings -- coming from the same folks who brought you the Iraq invasion to remove WMD -- "

WTF is wrong with people. What does one have to do with the other?

He could have done worse. It's all so complex that I don't think anyone but the actual perpetrators of the sub prime loan schemes really understand how to fix it.

That's why I said in a previous post that we should hire them just as Las Vega casinos hire cheats as soon as they get out of prison. Except in this case, I'd give immunity to the likes of Countrywide execs with the promise that if they don't come to work for the gov't and steal it back, they DO go to prison.

Oversimplified, I know, but the idea is there. Where is Professor Milken? He could sell the whole shebang right back to the banks.

I know, I know....... don't start.

[BertBeagle]

Walter Williams said this morning when asked if he supported a bailout:
"If the building across the street was on fire would you call the arsonist who started the fire to come put it out?"

[Shaun @ Tru6]

Why don't they just rewrite all the ARM's so that people can afford them? This may be simplistic, but wasn't it when the rate went through the roof that people started defaulting?

Seems that if people could keep their initial lower rate and continue to pay their mortgage, there would be no crisis.

yes? no?

[rammstein]

Not just the rate. People also bought properties at inflated prices, and when they saw the value of their assets fall down by more than their current equity into the property, they realize they lose less money by defaulting and walking. This happens particularly with speculative purchases where the buyer doesn't need to keep a roof over their heads on their investment property. They just default.

My business is in bulk purchasing of distressed condos. Often times, a building can have 50 or more buyers simply walk from their deposits for the very same reason. They put $40k down on an $800k property which is now only worth $550k. Much less painful to lose $40k than $250k.

Unfortunately, I just underwrite the assets, I don't get the profits. For buyers with SERIOUS capital (like hundreds of millions of dollars) things are close to perfect right now. The only thing holding us up is leverage (or more specifically the total lack of it). Sure, we can make money on 100% equity, but not the kind of returns that are exciting. So on the one hand, a buyout would loosen the lending markets and funds like us could buy more, further easing things. Problem is, the government would be taking $700Billion off the market that we are circling. The government will overpay for these assets, and then the issue becomes how will they dispose of them? This is where I am most suspicious. I think they are claiming that they will "make money" on it. I guarantee, right now, that they will do no such thing. Their best hope is to maybe, through a selloff, lose only $500Billion instead of $700Billion. I'd LOVE to get my hands on the kind of financial modeling they are doing, although a part of me doubts a group of lawyers is going to have any such analysis done.

[rammstein]

Originally Posted by BertBeagle

Walter Williams said this morning when asked if he supported a bailout:
"If the building across the street was on fire would you call the arsonist who started the fire to come put it out?"

I want to remember that quote. It is useful on SO many things.

[Zeke]

Originally Posted by BertBeagle

Walter Williams said this morning when asked if he supported a bailout:
"If the building across the street was on fire would you call the arsonist who started the fire to come put it out?"

Originally Posted by rammstein

I want to remember that quote. It is useful on SO many things.

No, that's not a good anecdote. Would you call a thief to catch a thief? Yes. Would you call a thief to protect your property? No.

Let's understand the roles people play and their motivation.

[targa911S]

The senate will push it through. They all know the same thieves the house knows.

[jyl]

Originally Posted by Shaun 84 Targa

Why don't they just rewrite all the ARM's so that people can afford them? This may be simplistic, but wasn't it when the rate went through the roof that people started defaulting?

Seems that if people could keep their initial lower rate and continue to pay their mortgage, there would be no crisis.

yes? no?

Not all foreclosures have been triggered by ARM resets, though many were. Default and foreclosure rates are much higher for ARM mortgages than fixed rate.

http://www.mbaa.org/NewsandMedia/PressCenter/64769.htm

For prime loans, foreclosure starts on fixed rate loans were 0.34 percent, an increase of five basis points, while prime ARM foreclosure starts were 1.82 percent, a 26 basis point increase. For subprime loans, fixed rate foreclosure starts increased 27 basis points to 2.07 percent and subprime ARM foreclosure starts increased 31 basis points to 6.63 percent.

[widebody911]

One aspect of the bailout that is getting very little press is all of the little unrelated tidbits being added that have nothing to do with the bailout; I heard some of them enumerated on NPR this afternoon.

Here's a link containing the full text of the bill
http://www.huffingtonpost.com/2008/09/28/bailout-legislation-full_n_130063.html

[competentone]

Originally Posted by widebody911

One aspect of the bailout that is getting very little press is all of the little unrelated tidbits being added that have nothing to do with the bailout; I heard some of them enumerated on NPR this afternoon.

Here's a link containing the full text of the bill
http://www.huffingtonpost.com/2008/09/28/bailout-legislation-full_n_130063.html

With the Senate Bill that passed this evening, it was actually the bailout portion which was "tacked on." The original bill was some "Mental Health" Bill -- which I thought was pretty appropriate!

The bailout is "madness."

[widebody911]

Originally Posted by competentone

The bailout is "madness."

Well, it's definitely not Sparta...

[Hugh R]

The only "up" side to the bail out that I personally see is that it MAY buoy the economy where my personal 401K and other retirement funds MAY rise enough to sustain me into retirement ten years from now. I'm 54 and expect that in another 40 years I'll be dead. I feel sorry for my kids. That's the ONLY upside that I see.

[Jim Richards]

Edited - personal attack removed. -Z-man

[widebody911]

Mad about power. There is a new power center growing in our Federal Govt. and the quasi-governmental Fannie and Freddie are funding fronts for those in the house and senate who are part of that new power.

The bailout is the financial equivalent to the Patriot Act.

[Jim Richards]

Edited - unnecessary comments removed. -Z-man.

[Z-man]

This pissing match thread is now closed.

-Z