Monday, 8 September 2008

Can't fail, won't fail, must fail

The world woke up Monday to what's being billed as one of the biggest nationalisations ever: the bailout by taxpayers of US behemoths Fannie Mae and Freddie Mac. These two bloated government-created panjandrums, something like NZ's SOEs, are repositories of around fifty percent of America's "secondary" mortgage market -- of the cheap credit that 'The Fed' printed and Fannie and Freddie then doled out so would-be home-owners could make up the difference between what they wanted to pay, and what they could really afford.

Someone had to pay the bill eventually for the decade-long bubble this created. That someone is us.

The chickens represented by this middle class welfare for house-buyers have now come home firmly to roost. The delusion of inflationism -- the process by which prosperity is 'assured' by expanding the money supply while strangling production -- which allowed everyone to believe this was sustainable, has been demonstrated by this collapse (and be every previous bust) that pumping up an economy with the government's counterfeit capital never can be sustainable, but in paying for the bailout with more of the counterfeit capital that caused the problem it's clear the chickens haven't yet landed in the homes of those who most need the lesson.

It's as if they still think that the magic salve of printed money will still be able to turn stones into bread, and snatch miracles out of disaster.

This is not good sense; it's throwing good money (yours and mine) after bad.

And let's get something straight here: creating these behemoths in the first place was not an example of capitalism at work -- that was the ' New Deal.' And bailing out these behemoths now is not capitalism at work either-- it's just more middle class welfare whose bill will eventually have to be paid. But letting them fall would be capitalism at work -- a long-overdue and urgently necessary creative destruction that will do more to stabilise the situation than any amount of dollar bills dropped on the world's economy by Fed chairman Ben Bernanke and US Treasury Secretary Henry Paulson.

Or else let it be said as it was said some generations ago: "They saved the banks, but destroyed the economy."

UPDATE 1: The Financial Times summarises the 'deal':

The US government’s decision to place Fannie Mae and Freddie Mac into “conservatorship” came without a specific cause ...
The government is using a belt and braces to hold up the show ... It will recapitalise the government-sponsored enterprises by gradually buying preferred stock – a plan that will also massively dilute existing shareholders. It will lend the GSEs what they need to continue, before slowly reducing their operations from 2010. And it will buy their mortgage-backed securities directly itself. All this is bullish for credit markets. As for the future structure of the US mortgage market – that is a problem for the next guy. [In other words, it will be a drain on everybody's future productivity.]
How much might it cost taxpayers? The Treasury can inject as much as $100bn into each GSE to help support their combined $5,400bn portfolio of bonds – although it is unlikely to need to do so. It may even make a profit from the GSE mortgage-backed debt that it buys directly and then holds to maturity.
Even so, the bailout is potentially huge, although it will probably not be the US’s biggest: the cost to the taxpayer from the savings and loan crisis was $300bn in today’s money... drastically extending the role of the state cannot be what Paulson imagined he would be doing when he joined the Treasury from Goldman Sachs in 2006. But perhaps he is simply behaving like any good banker – he is expanding his balance sheet. The US government’s, after all, is pretty much the last one left in town.

UPDATE 2: "This is just socialism for the rich," says Jim Rogers. America is now more communist than China." See him here on YouTube.

UPDATE 3: Paul Walker rounds up some reactions around the economics blogs.


  1. "one of" the biggest bail-outs? I actually think this would be the biggest bail-out by a government ever. correct me if i'm wrong, but i can't think of a bigger whopper than this!!

  2. " of the biggest nationalisations..."

    I figure the post-war Soviet take-over of Eastern Europe might come first. Just.

  3. Does anyone else snort when they hear those two ridiculous terms?

    Don't know what's sillier: the terms themselves, or the local newsreaders who you know only heard of them today.

    Washington was never going to let them fall over - ever - election year or not. But the timing's about as predictable as the next nasty Palin story on the front page of the NYT.

    (Probably the only thing to move her off the front page!).

  4. I am somewhat embarrassed by this entire matter..*blushes*

    I happened to buy ANZ shares on Friday just before the market closed when they were looking rather cheap at $16-24/25....intending to sell today for about $16-40(ish) ...and imagine my astonishment when the share price soared on this news to hit $17-96!

    So yes..gosh...just sold them for $17-77 and..eeekkkk...have profited considerably from 'corporate welfare' and 'nationalisation'..but yes, notwithstanding that, I think the this move is a disgrace.

  5. touche!! hmmmm. in nominal dollar terms it's probably even bigger than that (hehe)

  6. These two rorts are fine examples of cronyism in practice. For example, they were a source of endless funding for various politicians.

    This govt act of shoring up failed pyramid schemes up with a guarantee of a guarantee is going to be extremely expensive indeed. At best it will only buy a little time. Shoring up these institutions is no solution to the faulty premise and ideas that spawned them. A reckoning is looming.

    Points to note: govt rorts of this type are variants of Ponzi or pyramid schemes. Eventually they collapse.

    Govt interventions and protections and thefts allow these pyramid schemes to get so titanic that when they finally do collapse the results are a general impoverishment for participants and non-participants alike. Everyone has wealth confiscated and destroyed.

    In the mid-term the US government is going to be facing collapses of some really large pyramid schemes including,
    - govt debt mountain
    - central banking and fiat money
    - social security

    Every person will be affected one way or another.

    It is important to understand that governments are not a source of solutions to problems generated by the very same governments getting involved with activities they should not be undertaking in the first place. All of the looming collapses are of organisations and institutions set up by governments to solve "problems". They end up making larger troubles than what they were supposedly set up to address.

    The lesson is to let govt pyramids collapse and be destroyed as soon as possible. Allow private arrangements to develop and deal directly with what people want.

    Unfortunately that is unlkely to occur. Politicians and bureaucrats and selected cronies will clamour about "market failure"- how capitalism has "failed" them. Rescues and bail-outs and guarantees will be proposed and applied to deal with the "shortcomings" and "imperfections" of the market. Each series of legislative and regulatory patches will cost more than the last. Each will lead to greater instabilities and problems than the last. More wealth and productive activity will be consumed. All that will be achieved is to keep the rorts alive for a little more time.

    Inverted pyramids eventually fall over.

    The bigger the rort the bigger the mess!


  7. lgm,

    could you please elucidate on "private arrangements to develop"

    after all the Fed was founded on the back of the private arrangements of Mr J.P.Morgan and developed quite nicely from there.

  8. RAF

    Private arrangements means exactly that. It excludes government involvement. It excludes the granting of monopoly powers to a central bank by government. It excludes special arrangements between cronies and government, backed up and enforced by government power.

    The best discourses I've found on this are contained in the writings of Von Mises and Reisman. It is worth getting a copy of Reisman's "Capitalism". Anpother excellent essay on this is Rothbard's "What have they done to our money."



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