Start of Uwe Reinhardt’s guest blog
To provide a proper backdrop for my lecture on “The Government’s Role in
the Economy” in Econ 100, I always preface it with the question: “Who in
this class has a mother?” In a good year, as many as 25% of the students
raise their hand. The rest won’t admit it, because regulating mothers,
like regulating government, are the ultimate buzz kills in the human
experience.
If enterprising children are out in the yard, researching how hard a
snowball can be before breaking a window, who usually kills that
experiment? Mom, of course. When, after attending a rock concert, a
fully mature 15-year old wants to stay overnight at the Waldorf Astoria
with her boyfriend or his girlfriend, who usually kills that
enterprising initiative? Mom, of course. Why evolution has not done away
with these enterprise-stifling-and-human-development-arresting Moms is
an intriguing question. Perhaps they have survived because, when
teenagers get into trouble, mothers usually are the source of instant
succor. Click on http://www.youtube.com/watch?v=x1fVfcv3vHc,
there to
see a rugged, All-American teenager accidentally breaking his fish tank
with his bar bells and promptly emitting the universal, primeval teenage
scream “Mom! Mom!” That is typical for teenagers.
What mothers are to teenagers, government is to the adults who run the
private sector of our economy. While teenagers chafe under Mom’s
regulations, these free enterprisers sit in their offices, clubs or golf
carts, wringing their hands over the mindless regulations issued by
politicians and government bureaucrats who “cannot walk and chew gum at
the same time.” Yet, like troubled teenagers seeking succor from Mom,
when the going gets tough, these same free enterprisers frequently run
to the government for instant succor.
Watch, for example, as our investment bankers on Wall Street, a.k.a.
Masters of the Universe, now run to our government for help, after the
mess they have made of their companies, of our economy and, indeed of
global finance. One can cloak what they did in technical jargon such as
“under-pricing risk.” One can even write sycophantic apologias on their
behalf, as did New York Times columnist David Brooks when he opined that
the current calamity on Wall Street is just a byproduct of “financial
innovation.” The fact is that what happened on Wall Street was much less
innovative than reckless and ill advised (in the vernacular, “stupid.”)
The bankers’ new, new thing was persuading investors around the world
(and ultimately themselves) that if dodgy mortgages –technically known
as sub prime mortgages –were packaged and repacked several times over,
the risk inherent in them would somehow miraculously eva****ate. By
skillfully marketing that belief, it was possible to suck sheiks in
Dubai and town governments as far away as Narvik, Norway into financing
millions of dodgy home mortgages in the U.S., extended to borrowers
unlikely to make the mortgage payments on them over the longer run.
The foundation of this game was a set of incentives that would have been
judged misaligned by any freshman in economics. The dodgy loans were
originated by brokers who did not care about the borrowers’ credit
worthiness because they were paid commissions simply on bringing the
deals to local banks, which then made the loans. The local banks did not
care about the borrowers’ credit worthiness either, because they
immediately sold the right to the monthly mortgage payments at a profit
to the big banks on Wall Street. The latter bought these receivables
sight unseen, usually without checking the credit standing of the
original mortgagees, because they made their profits by bundling tens of
thousands of these dodgy mortgages to resell them the world over as
“collateralized debt obligations” (CDOs),” which are rights to the giant
but inherently uncertain cash flows from the dodgy mortgages.
In the end, the banks even booked huge profits on repackaging their
original CDOs into yet other bundles of CDOs, which were then peddled
around the world as well. Evidently believing themselves that thus
manure could be made to smell like roses, so to speak, the big banks
invested hundreds of billions of their own shareholders’ dollars in
these miracle bundles, usually with borrowed funds.
Eventually news penetrated even Wall Street that millions of the dodgy
mom-and-pop mortgages would be likely to default unless government came
to the rescue. Once that became obvious, the CDOs directly or indirectly
based on these mortgages plummeted in value, driving many heavily
indebted investors in them to the brink of bankruptcy, among them some
of the big banks. And thus we now hear from Wall Street the primeval
scream “Mom! Mom!” – with ”Mom” being dutifully played by former
Princeton colleague Ben Bernanke of the Fed and, ultimately, the U.S.
taxpayer.
Alas, it is a safe bet that a year or so after the federal “Mom” will
have brought succor to these swash-buckling free-enterprisers, they once
again will sit in their offices, clubs and golf carts, cursing the
government and its “mindless regulation.” And therein lies the essential
difference between teenagers and the adults on Wall Street. Eventually
teenagers learn to appreciate their Moms.
© Uwe E. Reinhardt 2008
reinhardt@[EMAIL PROTECTED]
commentary does not explain how we might get out of the mess into
which the i-bankers have pushed us.
Here we must distinguish between insolvency and illiquidity.
Insolvency occurs when a firm’s assets are worth less than its
liabilities. With asset-to-equity ratios among investment bankers in
excess of 30, it can easily happen. Illiquidity means that there is
insufficient cash on hand to meet current cash obligations. When that is
widely suspected, it can trigger a classic run on the bank. Some
investment banks find themselves momentarily illiquid but, if that could
be overcome, would remain solvent. Others are basically insolvent, if
not yet illiquid. And some are both.
Ben Bernanke of the Fed has been busily working on the liquidity
problem. Knowing him as well as I do, he must be holding his nose doing
so — especially as he is forced to forget about inflation for the moment.
In the meantime, the White House (Treasury) and the Congress are likely
to work on the solvency issue by pumping subsidies into the mortgage
market (disguised as loan guarantees by the FHA). The aim here probably
will be not so much to help stricken home owners — the ostensible reason
likely to be given for such a move — as compassion for the balance
sheets of Wall Street’s bankers, who, we must remember, are major
shareholders, so to speak, in the Wa****ngton-based businesses called the
White House and the Congress. (I may sound cynical here. But I just
can’t imagine that a White House that has never shown much compassion
for uninsured Americans who go bankrupt over medical bills caused by
cancer would have any genuine compassion for low-income homeowners who
signed on to dodgy mortgages).
If tax payers can be made to guarantee the mortgage-payment streams of
mom-and-pop mortgages, the value of the structured securities based on
them is likely to be enhanced even if the lenders had to take a small
hair cut on the principal due on the mortgages. On balance, a bail out
of homeowners probably would address the solvency problem of the i-banks.
This bailout will cost US taxpayers some money, to be sure, but probably
not more and perhaps not even as much as a year’s worth of Iraq, so it
is not that big a big deal in the sweep of American things. Since any
federal outlay must be financed by borrowing abroad, however,(the net
national savings ratio of the US being 0) these added federal outlays
may well have a slight negative impact on the value of dollar, but
probably not nearly as much as has the loss of confidence abroad in what
was once thought to be the great American capitalist model, with
virtually omniscient i-bankers at the helm. From being the Masters of
the Universe of yore they have morphed into pitiful and pitiable
supplicants of sheiks in the Mideast and Communists in China. Mao Dze
Dong must be smiling at seeing what he called “capitalist running dogs”
repairing now to Beijing, hat in hand.
All told, this too is likely pass somehow. My point in the commentary
was that, when the wounds have mended, the swashbuckling free
enterprisers who got us into this mess will once again whine that
nothing good ever comes from government (I once heard Peter Ueb*****h
actually say that during an after dinner speech to venture capitalists)
— keeping silent only momentarily, when government has to play the
shovel brigade once again, cleaning up the do-do left behind by whatever
next asset bubble the swashbucklers will concoct. Perhaps it will be
credit derivatives or something not yet dreamt about. A good parlor game
would be to guess what that next mess will be. It’ll come within the
decade.
Evidently, at this very moment the swashbuckling free enterprisers do,
indeed, not reject government involvement in the private sector. On the
contrary, they beg for it, as a teenager begs for succor from Mom.
However, the free enterprisers normally want to be free to make the very
messes that causes government to get involved. Perhaps it is the
government’s role to be the shovel brigade behind the private sector —
although textbooks in economics never quite put it that way — just like
Moms see it as their role to clean up messes left by teenagers.
So it goes.
|
