Tuesday, 30 September 2008

Good news: The 'bailout' has crashed

Good news this morning: it looks as if America's trillion-dollar nationalisation of bad assets won't be going ahead. As readers of my earlier posts on this should realise, this is good news. Investor Jim Rogers encapsulated last week the bad news at the heart of the now-dead bailout plan:  "This is madness, this is insanity, they [want to] more than double the American national debt in one weekend for a bunch of crooks and incompetents."  Ain't that the whole truth.

Quite aside from the absolute irresponsibility of printing $700 billion of bailout cash to further inflate the money supply -- more of the same rocket fuel that caused the problem in the first place -- the plan to keep prices high is precisely the opposite of what's needed in a depression. 

Herbert Hoover's plans to keep prices high after the 1929 stock market crash was an object lesson in what not to do after a crash -- as Fed Chairman Ben Bernanke conceded last week to House Republican Ron Paul (see the video here). Hoover's plans, continued by Roosevelt in 1932, did precisely the opposite of what he intended: instead of protecting failing businesses and providing the funds necessary for recovery as he hoped, the failure to let the market contract and flush out the dead wood and malinvestments as is necessary for recovery merely prolonged the pain.

Today's American bailout plan made the same mistake, and would simply have prolonged the pain (and with that cash injection, even enhanced it).  Allowing the market to cut its losses and cut out the dead wood -- which is what a contraction consists of -- is painful for a year or two, but prolonging the contraction only ensures it's going to be painful for a whole decade (just as it was for Japan when it applied the same medicine in the early nineties, ensuring their necessary recovery was delayed for a decade, a point made on Morning Report this morning by Jim Rogers) with good money being poured after bad long after the time to cut the losses is over. 

How long must the necessary contraction take?  "Until," says Ludwig von Mises, "the illusions of the boom have been dispelled and economic activity has readjusted to the realities of the existing conditions. Attempts to interfere with free and flexible prices, wage and interest rates prevent recovery and prolong the depression period."

Let's repeat: you can't fake reality.  The contraction and both recovery need to happen; they can't be avoided.  The only choice is whether that takes a year or two, or whether the process is prolonged for a decade. 

Which of the two would you prefer?

And, too, by bailing out the assets of incompetent banks, it would have punished the shareholders and directors of competent banks and businesses.  As John Allison of North Carolina's BB&T Bank said late last week, the Paulson Plan is aimed at helping poorly run banks -- it has nothing at all for competently run banks:

    U.S. Treasury Secretary Henry Paulson's proposed $700 billion bank rescue aims to help ``poorly run'' companies and the primary beneficiaries would be Goldman Sachs Group Inc. and Morgan Stanley, said BB&T Corp. Chief Executive Officer John Allison in a critique of the plan.
    Treasury ``is totally dominated by Wall Street investment bankers'' and ``cannot be relied on to objectively assess'' the impact of government policy on the financial industry...
    ``There is no panic on Main Street and in sound financial institutions,'' Allison wrote. ``The problems are in high-risk financial institutions and on Wall Street'' ... 
    The market should be allowed to eliminate ``irrational competitors,'' he said. ``There were a number of poorly managed institutions and poorly made financial decisions during the real estate boom,'' Allison wrote. ``It is important that any rules post-`rescue' punish the poorly run institutions and not punish the well-run companies.'

You can read the full statement from John Allison here.

UPDATE 1:  The always astute Frank Shostak affirms the argument: "The Rescue Package Will Delay Recovery," he says.

UPDATE 2:  In An Open Letter to My Friends on the Left, Steven Horwitz answers the many critics who say this is a crisis of free markets; people like the two US presidential candidates who say erroneously it's a result of "shredding regulations" (as if!) and a "lack of regulatory oversight"; or local Marxist Matt McCarten, who says "the US example puts paid to the free market idea":

In the last week or two, I have heard frequently from you that the current financial mess has been caused by the failures of free markets and deregulation. I have heard from you that the lust after profits, any profits, that is central to free markets is at the core of our problems. And I have heard from you that only significant government intervention into financial markets can cure these problems, perhaps once and for all. I ask of you for the next few minutes to, in the words of Oliver Cromwell, consider that you may be mistaken. Consider that both the diagnosis and the cure might be equally mistaken.

Consider instead that the problems of this mess were caused by the very kinds of government regulation that [were] now proposed...

And in an older article Frank Shostak, again, points out how regulations allowing banks to inflate their own money supply (what's known as "fractional reserve" banking) accelerates both booms and busts, and how under fractional reserve banking (in which all banks are inherently bankrupt) , the various means by which their "reserves" are met are inherently flawed, and when the ineveitable crisis does come "the collective attempt of banks to improve their solvency actually runs the risk of making them less solvent, thereby deepening the liquidity crisis."

In every sense then, we're now paying for the bad decisions of regulators and the government's central bankers.

UPDATE 3:  On the question of this being a "failure of free markets," it's worth re-reading this article by George Reisman, in which he points out  both the ack of a free market, and the reason for there being "very little, if any, rise in real wages" in the recent booms:
    In contrast to the experience of the 1920s, in the two great recent credit expansions, i.e., the dot.com bubble of 1995-2001 and its successor the presently collapsing housing bubble that began not long thereafter, there has been very little, if any, rise in real wages. Most commentators appear to attribute this to nothing more than the unrestrained greed of businessmen and capitalists. They apparently go on the theory that if there is anything in the economic system that breathes or moves other than at the command of the government, or other than with the active supervision and control of the government, it is proof that we live in an era of “laissez-faire"...
    This alleged laissez-faire environment, such writers pretend, has enabled businessmen and capitalists shamelessly to enrich themselves at the expense of increasingly impoverished wage earners, to whom nothing any longer even “trickles down.” {Are you listening, Barack Obama?]  Increased free trade and “globalization,” of course, are attacked as part of the process and as greatly contributing to the stagnation or outright decline in real wages.
    In sharpest contrast to such blather, in the real world there are innumerable rules and regulations enacted by the Federal Government to control virtually every aspect of economic activity. They are contained in the more than 70,000 pages of The Federal Register. The overwhelming mass of government interference described therein, and in its counterparts at the state and local level, is a glaring refutation of claims about the existence of any kind of laissez faire in the present-day world. The very description of such interference, in tens of thousands of pages of official text, is a refutation of such size and literal weight as to render any claims about laissez faire or insufficient government controls or regulations utterly nonsensical.
    This truly massive body of material also suggests that the actual explanation of the stagnation in real wages is precisely an ever growing burden of government intervention in the economic system. The intervention is in the form of policies that undermine genuine saving and in numerous other ways undermine capital accumulation and the rise in the productivity of labor. Personal and corporate income taxes, the inheritance tax, the capital gains tax, and government budget deficits—all entail the taking away of funds that if left in the hands of their owners would have been heavily spent, indeed, overwhelmingly spent, in the purchase of capital goods and labor services. Instead, those funds are diverted into financing the consumption of the government and those to whom the government gives money.
    Inflation and credit expansion greatly exacerbate this diversion of funds, because their effect is artificially to increase the incomes subject to these taxes and to thus to deprive business firms of the funds required to replace assets at prices made higher by the same process that increases their taxable incomes. The progressive aspect of income and inheritance taxes also worsens their effects, because incomes tend to be saved and invested the more heavily the larger they are; at the same time, substantial inheritances are more likely to be retained in the form of accumulated savings and capital than are modest inheritances.
    Because of the reduced demand for labor that results from the taxation of funds that would otherwise have been used in employing labor and in buying capital goods, wages are substantially less than they otherwise would have been. At the same time, the buying power of those reduced wages is also sharply reduced in comparison with what it would otherwise have been.
UPDATE 4:  From Noodle Food:
Reading that NY Times article in full, I'm impressed by the seemingly principled opposition to the bailout. See these descriptions and quotes:
Jeb Hensarling, Republican of Texas, said he intended to vote against the package, which he said would put the nation on "the slippery slope to socialism." He said that he was afraid that it ultimately would not work, leaving the taxpayers responsible for "the mother of all debt."

Another Texas Republican, John Culberson, spoke scathingly about the unbridled power he said the bill would hand over to the Treasury secretary, Henry M. Paulson Jr., whom he called "King Henry."

A third Texan, Lloyd Doggett, a Democrat, said the negotiators had "never seriously considered any alternative" to the administration's plan, and had only barely modified what they were given. He criticized the plan for handing over sweeping new powers to an administration that he said was to blame for allowing the crisis to develop in the first place.
In contrast, consider what the supporters of the bailout are saying:
When it comes to America's economy, [Representative Steny Hoyer of Maryland, Democratic Majority Leader] said, "none of us is an island."

Representative Maxine Waters, a Democrat, said the measure was vital to help financial institutions survive and keep people in their homes. "There's plenty of blame to go around," she said, and attaching blame should come later.
UPDATE 5:  Jeffrey Tucker at the Mises Institute is cock-a-hoop!

House rejects the bill. This is a magnificent repudiation of the Fed, the Treasury, Bush, Wall Street welfarists, inflationists, and stabilizers of all sorts. The costs of what the Fed has already done are going to be massive and felt for many years. But at least Congress has so far, and this time only, not participated in the evil.

It's a great birthday gift for Ludwig von Mises.

Whatever the case with stock markets--and we can be confident that whatever prices emerge are truer than they would be with a bailout--it is fantastic that oil prices have retreated so dramatically. Drivers cheer. May all commodities follow. How this can be spun as dreadful news is beyond me.


  1. ? Make that billion PC. The amount is so staggering that it is easy to make this typo.

  2. Oops. Thanks Dinther. It makes the eyes water just to type it!

  3. *blushes* ...ummmmm...another minor typographical error, Peter.

    Ron Paul is actually a member of the House of Representatives, not a Senator.

    One interesting aside, 1930s Great Depression-wise; Smoot, Hawley and Hoover (the chaps with the high tariff/high prices policies) were heavily defeated when they sought re-election, as their constituents were not as silly as expected - so various politicians should take note! ha ha!

  4. Oops again.

    Yes, Smoot, Hawley and Hoover were sacked by the electorate - but while Roosevelt ran on a ticket opposing Hoover's destructive interventions, and won on that ticket, he pretty soon made old Herbie look like a piker.

  5. Contrary to the outrage from the Left this debacle is is not the result of the free market. I suggest you read:

    And here is the executive summary of my report to the Reserve Bank in 1996. I hate to say “I told you so – but:

    The Principle Findings of this Report Are:
    General Principles
    • General economic theory, and international experience, strongly indicate that the regulation of the supply of land should be light-handed, for reasons of both equity and efficiency.
    • Policy makers must recognize, and must explain to their constituencies, that heavy-handed regulation of the supply of residential land carries a burden of significant economic and social costs. Such over-regulation affects prices, construction output and finally employment.
    • In New Zealand those same price rises make a significant contribution to the CPI, which, in turn, forces a response from the Reserve Bank, which means that these distortions impact on the competitive performance of New Zealand’s trading sector.
    • Many of these costs fall most heavily on those least able to deal with them. Those already comfortably settled, benefit from the increased capital value of their properties. Those struggling to become established, find themselves paying higher prices for housing, or are priced out of the market altogether. A large percentage of the population who have a mortgage on their home or who have borrowed to finance their business or other activities are paying higher interest rates that necessary.
    • Some increased costs associated with protection or enhancement of the environment are to be expected. As populations become wealthier, they demand higher environmental standards.

    Local Government and the Supply, Demand and Regulation of Land
    Local government has a responsibility to ensure that an adequate land-bank is available to meet rapid and unforeseen increases in demand.
    Unless sufficient sections are available and ready for occupancy, an increase in demand can lead to a vicious cycle, whereby, at the end of the cycle, the land-bank is no better supplied than at the beginning.
    Pressure on rural fringe land will increase rather than decrease over the next decade. Contrary to much planning mythology, economic efficiency and the need to make the best use of rural land, demand that the ‘lifestylers’ should be allowed to have their way. There is no shortage of agricultural land.
    The Impact of the Resource Management Act
    • The major change in the economic environment surrounding the residential property market in recent years has been the passing of the Resource Management Act in 1991.
    • The Act was genuinely intended to be light handed and to increase the individual choice in land use and resource allocation, provided there was no adverse impact on the natural and physical environment.

    • Most local bodies have been determined to add the control of environmental effects to their long standing right to control land-use, and to allocate resources. They have shown considerable ingenuity in using the new Act to make the allocation of resources a necessary means of controlling effects.
    • The “omnibus” nature of the Act has improved the project planning environment for major players. On the other hand, the costs of the Act fall more heavily on the smaller players, if only because they have fewer resources, both monetary and political, with which to deal with them, while they are not receiving the same benefits.
    • Local Authority officers claim that the necessary policy statements and standards are taking a long time to appear and those that have been published (such as guidelines for water and air standards) are of little use to those operating in urban areas, and residential sectors in particular.
    • A general lack of direction front central government means that local authorities have either failed to provide guidelines to applicants, or have been quite inventive in developing their own.
    • The RMA, as it has been, and is being, implemented, has imposed massive extra costs on the residential housing market in the Auckland Region, in terms of both time and money. These costs could be greatly reduced without diluting the environmental objectives of the Act.
    Specific Centres of Increased Costs -
    • Subdivision is now subject to a more complex process, and is more frequently subject to notification, with associated increases in costs, delays and risks.
    • Applicants are required to pay both for the work of their own consultants and then again for checks carried out by the Councils’ own consultants.
    • Unexpected and broad definitions of terms such as “environment” and “heritage” have led to an explosion of controls and costs which impact on areas such as building design, colour, clearance of vegetation, choice of planting, and even the right to occupy land at all, without first gaining a Resource Management consent. Many owners have lost any clearly defined ‘right to use, and yet are not eligible for compensation. Such properties are increasingly difficult to value.
    Performance of the Private Sector
    • The land development/subdivision industry has been able to deliver the increased environmental standards demanded by the Act without increasing its own costs of construction. The industry has been aided by increased productivity, and the benefits of deregulated capital and labour markets.
    The High Cost of “Providing for Growth by Containment”
    The ARC policies of containing growth
    The major cause of ongoing increases in housing costs is the ARC’s policy that Auckland’s growth should be managed by a policy of containment which restrains growth outside the present urban limits, (which are currently under review) while concentrating development within the present urban limits. These policies rest on the unfounded assumption that the present city form is unsustainable. These arguments are without foundation both in fact and probably in terms of the Act. Opinion surveys and Census Data, indicate that the Regional Policy Statement seeks outcomes which the majority of Aucklanders do not want, and are likely to resist, and are contrary to present practice. Such a massive re-direction of preferences must introduce high costs with downstream effects on the whole economy.

  6. Fancy Radio NZ hosting Jim Rogers! That's most interesting.

    Thanks for the two RP clips. I wonder how many people were exposed to that good, solid 10 min rant and actually thought about what he said: that the prescribed 'medicine' would actually prolong the disease.

    And when did you last hear somebody on mainstream TV quote the Austrian school? Actually defending the free market?

  7. "Fancy Radio NZ hosting Jim Rogers"

    I must confess I was pretty surprised to hear his voice. But good on them, eh? :-)

    "Thanks for the two RP clips..."

    Yes, isn't it a shame that he's so good on monetary issues, and so ... well, so not-good-at-all on almost everything else.

  8. Fear not! They'll scurry back to their pork dealing & create a new consensus- one that has a little more dripping for all the representatives and their cronies. Then they'll pass the bail-out but on a different form, one that they can claim was not tainted by the Bush Administration. That'll make it right, see?


  9. "Yes, isn't it a shame that he's so good on monetary issues, and so ... well, so not-good-at-all on almost everything else."

    'Almost' everything else? Bit harsh, PC. I realise you disagree with him re Iraq, etc, but he's not called Dr No for nothing. I admire his consistent voting record against measures in favour of govt expenditure.

    (Easy?!)credit where it's due. ;)


  10. And when did you last hear somebody on mainstream TV quote the Austrian school? Actually defending the free market?

    the scum are just trying to stave off privitisation!

    frankly: fuck privitisation: I'd close the lot down and just give all the frequencies to FOXS news.

  11. What's more --- even monbiot has come out against the bailout, in the Granuiad no less:

    Campaign finance is the best investment a corporation can make. You give a million dollars to the right man and reap a billion dollars' worth of state protection, tax breaks and subsidies. When the same thing happens in Africa we call it corruption.

    European governments are no better. The free market economics they proclaim are a con: they intervene repeatedly on behalf of the rich, while leaving everyone else to fend for themselves. Just as in the US, the bosses of farm companies, oil drillers, supermarkets and banks capture the funds extracted by government from the pockets of people much poorer than themselves. Taxpayers everywhere should be asking the same question: why the hell should we be supporting them?


  12. I found that link from the previous poster fascinating.

    One of the things that bothered me was how quickly they were able to put a 700b plan on the table.

    But it seems it is routine, just the amount is a bit higher.

  13. Not sure Allison's position is strictly Objectivist ...
    "This is a housing value crisis. It does not make economic sense to purchase credit card loans, automobile loans, etc. The government should directly purchase housing assets, not real estate bonds. This would include lots and houses under construction."

    Also, Owen, the increase in house values due to restricted land contributed to the boom but the expansion of the money supply (which built upon itself) was the key factor. Same goes for the tech boom - sure, tech & increasing use of the net offerred some productivity benefits which implied equity should be invested in it's development but not as much as was ultimately invested in those stocks. That kind of investment could only be underpinned by easy money policies and the same goes for housing - people clambered onto the bandwagon with heaps of newly minted money and the rising prices attracted still more idiots.


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