Friday, September 19, 2008

My impressions on the financial mess

Since January, when I realized that something ahistoric was happening with nonborrowed bank reserves, I have been examining our country's financial situation with much more than my usual attention. I realized something very dire was happening, and after then studying the matter for a week or so I came to the conclusion I still hold today, namely that there is only one reasonable way out of the mess. And the solution is not at all complicated or otherwise than straightforward. The banks loaned out too much money, as they have done numerous times in bubbles before, and so they should pay the consequences; more specifically they should be left alone, most of them (among them the worst of them) going bankrupt. This will destroy a great deal of fictitious wealth, making people less willing to spend, and thereby causing the threat of a deflationary spiral leading to horrendous depression. But President Wilson created the Federal Reserve and Roosevelt took us off the gold standard precisely so such depression would not be inevitable. All we have to do to cancel the deflation is replace some of the fictitious money created by debt with real money by turning on the printing presses (as we started out trying to do with the tax rebate stimulus checks, a wonderful idea that didn't go far enough). And of course, this money created will in a short while end up being deposited at banks, thereby lessening the banks' problems somewhat, though not sufficiently that many won't fail, probably. So some of the money the government will print would end up being printed to reimburse those with money in failed banks who have insured accounts. That's fine, this money will also go toward avoiding the deflationary spiral.

Houses and mortgage-backed securities (the latter being the fundamental investments created as a result of bundling mortgages together to create investments so banks can more easily unload loans in order to make or process new loans) were overpriced. It is rather like the tulip bubble in Holland; the owners of tulips at the height of the tulip-frenzy never really collectively had the wealth corresponding to the prices of the tulips; the tulip bulbs were not worth nearly as much as they were priced at; it was just a bubble. The same thing is true of today. Those who thought they were wealthy because they owned houses, mortgage-backed securities, stock in Wall Street banks, etc., were not actually as wealthy as they thought, for the prices of these items were all inflated as a result of the bubble, and more particularly, incorrect expectations that they would rise in price. The government should bail out those who deposited their money in federally insured bank accounts, and should let the others suffer for their folly. There is a reason some people put their money in bank accounts and treasury securities, etc., even though in boom times their return on investment is low. They know that when booms end, as they are ending now, they don't want to risk losing their money. It is not fair to those who put their money in safe investments to change the rules when the more risky investments are in a good way to fail.

What is really sinister about propping up mortgage-backed securities and the financial institutions, as our government disturbingly seems to be attempting, is that the average not particularly wealthy person does not invest in mortgage-backed securities, money market funds, hedge funds, investment banks, etc. Propping up financial institutions amounts to taking money from the average taxpayer and giving it to those (usually wealthy people) who have investments in the financial sector. It would be like the government of Holland after the tulip bubble burst buying all tulips at their peak prices, something they couldn't do in those days because money was tied to gold in those days, which kept them from printing it. It should be very revealing to naive people who have grown accustomed to hearing over-and-over like a broken record from the pillars of finance of the evil of government interfering with the financial system just how quickly these so-called pillars are willing to change their tune. What happened to laissez-faire? All of a sudden government interference in the economy is not communist anymore. Government redistribution of wealth apparently turns out to be just fine when the redistribution is to the wealthy people with stakes in the excessively influential real-estate and financial sector. There is talk of the government buying up mortgage-backed securities. This would possibly be a piece of legislation never exceeded in both its regressiveness and unjustness. Those who aren't heavily invested in real estate, investment banks, etc., including all poor people, will endure great hardship as a result of this. Fortunately, I'm inclined to think the government can't pull it off. Mortgage backed securities are largely owned by those overseas. Unless our government is so stubborn and clueless as to want to impoverish our entire country so much as to turn it into third-world status, there is no way they can bail out all the owners of mortgage backed securities, etc., just a subset of the American owners of mortgage-backed securities (e.g., those owned by certain banks and American investment funds). And I don't think foreigners are going to stand for just the American investors getting bailed out. We really do have a global economy, and I am hoping China, Russia, the Middle East, etc., will use the economic powers at their disposal to force our government to do the right thing (exactly what these powers might be, I am not entirely clear, but I believe they have them).

What our government should do:

1. Let investment prices, real estate prices, etc., reach their natural values. In particular, be fair and stop bailing out what the government hasn't promised to bail out. As banks and credit unions fail, reimburse those depositors with FDIC or NCUSIF insurance.

2. Print money to avoid deflation and the concomitant deflationary spiral. Technically, the way the government does this is that the Treasury Department issues bonds, and the FED keeps or buys them (crediting the treasury with money) rather than selling these bonds on the open market. Distribute the money created to ordinary people (and to those with Federally insured accounts which have failed), e.g., in tax rebates or temporary tax reductions.

3. For the rest of eternity, require banks to keep much larger reserves so this sort of vile thing doesn't happen again, and so that the underlying cause of the bubble is eliminated (and eliminate loopholes that allow banks to skirt reserves, e.g., as with banks selling loans for securitization). Actually, for many years it has been my belief that low bank reserves have been a huge drag on our economy. Low bank reserves amount to the same thing as easy credit. As long as banks lend like crazy, the amount of money people have in banks will be a little less than the amount they are in debt, and the average person (who is more likely to have his money in banks than in the stock market) is therefore destined to be poor. True, there should be some low level of bank lending. Loan sharks probably would arise when there are no banks lending. And I will admit that there is an advantage to encouraging people to buy houses rather than rent. But the financial industry has so manipulated the public and our government by extolling home ownership, that home ownership has become an idol. As those who haven't studied Economics 101 in college unfortunately don't tend to realize (along with politicians who were more concerned with drunken revelry in college than with learning), banks create money when they lend it. Most money that is created is created by banks lending it, and this money impoverishes the poor people even in economically stable times--every such dollar is a dollar someone in debt has to pay interest on. At least with ordinary busts there can be a kind of catharsis after the bust as lending gets contracted. Now it seems that our government is using its cleverness mainly just to avoid this catharsis. I am not inclined to think they will be able to put Humpty Dumpty (the fictitious financial capital) back together again or increase personal debt to former levels or beyond, but I do believe their efforts will cause great misery (more a prolonged torture-like misery than an all-at-once one), at least to those who are not wealthy and are without a stake in real estate or financials.

The best blog I have found discussing the current financial mess is naked capitalism; even the comments are usually insightful(and eclectic as one would expect from people necessarily on the fly trying to figure out what is going on as new rules get enacted most every day).

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