Wednesday, September 24, 2008

One Alternate Suggestion and a Freaking Long Side Note

Okay, I'm NOT an economist and complex mathematical calculations make me weep with frustration, so please don't think I'm any kind of expert. That said, one of the things that has been bothering me about this whole bailout idea is that it seems to address the symptoms, but not the cause. I'm trying to investigate to see what the root cause is. The way I'm seeing it we have a cascade effect going:

People in trouble with mortgates ---> Banks who speculate on mortgages in trouble

But it may be more than that:

Fiat economy based on credit ---> Increased incentives for credit ---> People who take the incentives in trouble with mortgages ---> Banks who speculate on mortgages in trouble.

I'm still researching that, trying to determine if the glitch here is systemic, or confined to this particular set of circumstances. But regardless, the bailout seems to focus on the endgame, bailing the banks. The earlier cause, people in trouble with mortgages, appears to be written off with an assumption that the people were either: a) too stupid to recognize "predatory" lending, or b) too irresponsible to give a damn that their credit was going down the toilet. Now, I do recognize that there are many people like that. But this many? We're either a nation of complete morons, or there may be something else at work (see my earlier post on how doubling credit card payments, closing off bankruptcy, allowing credit scores to raise costs for seemingly unrelated things like insurance and rent, etc., may have played hell with the American budgets).

So I was quite interested to see this alternative proposal, via Concurring Opinions:
So, instead of the massive moral hazard -- and general unseemliness -- of putting taxpayer money on the line to bail out Wall Street banks and brokers at the top end of the pyramid, why not aim at the broad BASE of the pyramid?

The money is there. I mean really, isn't it funny how when political leaders and powerful interests like Wall Street REALLY need cash, they somehow find a way to pull it out of the federal government's [ahem]?
To put it more politely: They just stick taxpayers with the bill.

Year after year, there's somehow never enough money to fund universal guaranteed health insurance (and whatever bailout is passed to deal with this crisis will provide yet one more excuse). But need to invade a foreign country on false pretenses, even in a time of huge deficits? No problem! Need to spend about a TRILLION to bail out Wall Street? Deficits be damned!

America's population is about 300 million. Divide by 4 (typical household size) and you get maybe 75 million households. Even that doubtless overstates the number of owner-occupied homes covered by bank mortgages, with a value less than, say, $1 million or so (we should exclude the very wealthy -- if the $5 million La Jolla mansion is about to be foreclosed, I say tough luck -- John McCain, of course, would make $5 million the cutoff, having suggested that anyone under that is middle class -- whatever). And remember, you have to exclude the homeless, renters, nursing home residents, all the dependents who live in each mortgaged home, etc.

Now, I'm NOT saying that's the solution. First, I'm not sure I understand the entire problem yet, much less which way to jump (which is why the bailout makes me nervous, I'd prefer to know what's going on before we act, thanks, particularly when we're talking about this kind of money, and WTF is up with the whole no oversight thing? Second, it's still a bailout without discussing fixing whichever policies f*cked this all up in the first place. But it's at least a step toward opening up the conversation into all the options.

Freaking LONG Side Note:
If you're wondering why I keep talking about the system, it's because of articles like this, and sites like this, and blog posts like this. Yes, the Kos post and the Libertarian site appear to be fringe. But they make a point that needs to be understood - which a bunch of you may understand, but I don't yet since I totally didn't take macro- or micro-economics in undergrad. Apparently, our economy is based on fiat money: Currency that a government has declared to be legal tender, despite the fact that it has no intrinsic value and is not backed by reserves. Historically, most currencies were based on physical commodities such as gold or silver, but fiat money is based solely on faith. Most of the world's paper money is fiat money. Because fiat money is not linked to physical reserves, it risks becoming worthless due to hyperinflation. If people lose faith in a nation's paper currency, the money will no longer hold any value.

Historically, I guess it fits in like this:

1926-1931 - FIXED Gold standard, 5 years
The gold exchange standard was established wherein each country pegged its currency to the US dollar and British pound which were then supposed to be backed by the dollar. When the depression began countries tried to cash in their pounds and dollars for gold. That "run" on gold forced the end of the gold exchange standard.
1931-1945 - FLOATING Fiat currency, 14 years
Fiat currencies reign worldwide leading to huge economic imbalances from country to country and was of the major contributing factors to the beginning of WW2.
1945-1968 - FIXED - Gold standard, 26 years
1944 Bretton Woods Accord (similar to gold exchange standard of 1926-1931) Two main currencies again, the US dollar and British pound. A run to convert pounds to gold collapsed the pound and began the end of the Bretton woods accord. It took 3 years while governments tried to salvage the system and also to determine what to do next. Kind of like having one leg on the boat and the other on shore. 1963 - New Federal Reserve notes with no promise to pay in "lawful money" was released. No guarantees, no value. This is also the year of the disappearance of the $1 silver certificate. Once again, a subtle shift in plain view.
1965 - Silver is completely eliminated in all coins save the Kennedy half-dollar, which was reduced to 40 percent silver by President Lyndon Johnson's authorization. The Coinage Act of 1965 signed by Lyndon Johnson, terminates the original legislation signed by George Washington 173 years earlier (carrying the death penalty) enabling the US Treasury to eliminate the silver content of all currency.
1968 - June 24 - President Johnson issued a proclamation that all Federal Reserve Silver Certificates were merely fiat legal tender and could not really be redeemed in silver.
1971 - FLOATING - Fiat currency, 5 months
August of 1971 President Nixon ended the international gold standard and for the first time no currency in the world had a gold backing.
1971-1973 - FIXED - Dollar standard, 2 years
The Smithsonian Agreement was passed pegging world currencies to the dollar rather than gold as a fixed exchange rate.
1973-? - FLOATING - Fiat currency, 30 years
The Basel Accord established the current floating exchange of currency rates we are operating under today.

As I'm understanding it so far, and my grasp is tenuous, the economy is kinda sorta controlled by the government. An abstract of an article in World Economics: Journal of Current Economic Analysis and Policy: Fiat money is a creation of both the state and society. Its value is supported by expectations which are conditioned by the dynamics of trust in government, the socio-economic structure and by outside events such as wars, plagues or political unrest. The micro-management of a dynamic economy is not far removed in difficulty from the micro-management of the weather. However, money and the financial institutions and instruments of a modern economy provide the means to influence expectations and bound behaviour. The control of the fiat money supply, together with rules on the granting of credit and the bankruptcy, default and reorganisation rules are public services. They provide lower and upper bounds for the price level in the economy. They also determine the innovation rate of the economy. An innovation may be regarded as an economic mutation; the less costly failure is, the more likely an innovation will be risked. Basically, the dollar appears to be backed by the Government's ability to pay out. It's ability to pay out appears to be backed by it's ability to tax us. It's ability to tax us appears to be backed by our ability to grow and develop businesses, products, etc. So far, so good. But it gets complicated: our ability to grow and develop stuff depends on our credit - one very libertarian-leaning site suggests we should supplant the term capitalism with creditism. (I'll give you two guesses whether it supports the idea of a fiat economy or not . . . yep, you got it in one.)

The Daily Kos post extends the argument to bringing in oil dependence (not surprising from a left-leaning blog):
The new basis then, was the value of developed land. The incentive was for Americans to develop their cities and towns, and reap the rewards of increased home values and stability of their communities. This, in turn, created the ability of the government to print more dollars, relatively confident that if there was a dollar, then somewhere there was economic activity underneath it. There was, at least, someone with an address who could be taxed. The model that we used for development was the automobile, and we saw the rise of the automobile city, which was far more sprawled out than the old industrial city.

. . . .

The intermediate steps, such as abandoning Bretton-Woods and creating a floating currency regime, deregulating the airlines, attempts to save gasoline, were all stopgaps until a new basis for the global economy came into being. That basis was the paper for oil economy. In this economy the United States generated paper based on development arbitrage and technology, which Arabs bought, and in return they sold us oil for that paper which we were to turn around and use to create more paper.

Seems a bit one-sided and leaves out the Chinese factor, however, so I'm not positive I'm totally buying that. Plus, these posts also seem rather reactionary - one could easily jump to the conclusion that all non-real money is bad. According to this site, which is apolitical and educational, that's not exactly so:
There will be no economic growth without the virtual money. Exact mathematical proof could be quite long, so here is a short (very simplified) descriptive substantiation:

As every economist know, there is a closed circulation of money in a country economy: Firms pays households for means of production (as work, capital, knowledge), and then households are buying goods and services from firms paying with money earned before.

Lets try to build an simple example: there is only one factory manufacturing 100 cars a month, and all people work in this factory. Let say that this factory gains a new technology, and is able to increase production to 150 cars. But we have a problem. Households have money only to buy 100 cars (money earned last month), so if the factory increase its production, it will gain exactly the same amount of money as for 100 cars a month before. So, board of directors will see no reason to increase production. An thus there will be no economic growth...

Solution of this problem are the virtual money. Money that are completely fictional, taken from nowhere. Money to buy that extra 50 cars. Using a metaphor, we can say that the virtual money are borrowed from the future (I mean: we are hoping that our GDP grows, and we will be able to repay our debts). Simple speaking virtual money are nothing more than a credit.

There are two basic ways to generate virtual money:

Government could print some paper (fiat) money (or spoil the metal coins), spending more money that gains from taxes, and thereby borrowing money from citizens. In this case growth is government-stimulated.

Financial institutions like for example banks could lend more money that they have deposits or give credit too easy. In this case growth is stimulated by financial institutions (government could help here with low interest rates).

Which of those stimulation is better? It depends.

But there will be no economic growth without any stimulation (or the growth will be slow).

And sometimes because of other factors, no mater as strong, and well-constructed it is, none of methods of economic stimulation is effective.

And moreover, this is a very simplified classification of methods used to produce virtual money. Some others include: credit cards, stock market options (and other derivatives), overvalued national currency rate, etc.

So some virtual money is good, it appears, but we've screwed up our ratios badly. According to the same site:
At the beginning, when economy is in growth phase, growth is financed using virtual money. (Today’s debtors are borrowing money that have to repay tomorrow.) When the base for the economic growth is firm, debts made today will be repaid without any problem in the next period from the new, bigger GDP (income). Volume of virtual money is matching the expected future growth of income quite good (compare with the model of rational expectations).

But sometimes the parameters of economic environment (and thus the conditions for economic growth) could change in an unpredictable way. There are many reasons for these changes, but generally speaking most of them spring from politics, and political changes, or from changes in the volume of available resources.

When the change happens, such a high rate of growth, (as we expected before the change) will be no longer possible. However because of virtual money, there are debts that were made, when the expected rate of growth was higher. Because of natural inertia of political, and economic institutions, the rate of growth is still high for a some period of time, but it creates an extra cost of rapidly increasing debt. Publicity still believe in the virtual money. We can observe some symptoms of increasing market unbalance. This is the hidden phase of crisis.

Then comes a shock. It could be some unpredictable event or even a gossip. Publicity loses its belief in virtual money. This launches a rapid fall of prices of money, assets or goods, whose prices were partially created by the virtual money. We can observe a great fall of stock market prices, rapid fall of national currency value (inflation, and even hyperinflation) or rapid changes of currency exchange rates (when the growth was stimulated by money borrowed abroad).

Then comes the crisis - because the possible rate of growth is lower than before - and even the recession - because of the debt that must be repaid. When debts are repaid, or reduced by some political means, and there are natural conditions for growth, the crisis ends.

Which seems to bring the question full circle - which policies screwed up what? Are we bailing the correct end? We've had a decade or so of pro-business innovations: decreasing the ability of the individual to declare bankruptcy, increasing business' ability to use credit scores and charge customers more even if they've not done any direct defaulting to the company itself, increasing fees for banking and credit card use, raising the maximum allowable interest on individual's credit cards from 19.8 to thirty-something percent, changing loan terms to allow for the jump in interest rates that was once considered innovative and is now considered predatory. Some of these, like the "predatory" loans were consumer choice. We didn't have to sign up for them. Others, like the increased fees and credit scoring, were definitely not put up for a vote. We could theoretically switch companies if we don't like them, but to what company? They all use them now. In retrospect, I still support some of the changes, just not how they were implemented. Example: raising the minimum credit card payments. Yes, it's a good idea to have gotten those to the place where one could theoretically pay off the card in less than a lifetime. But did it have to double all at once? Right at the same time you closed off bankruptcy and allowed credit scoring and all the rest of it? And right when basic wages have stayed pretty well stagnant but the costs of things like gas have skyrocketed?

I want to make sure we're not bailing out the businesses, but leaving the policies untouched policies that could keep the homeowners in perpetual default. 'Cause if we do that, the loans are still nothing more than paper, and the trust in the system will continue to erode, and we're not going to have done anything but shuffle numbers from one column to another.

That said, I don't want to make such radical changes that it causes a backlash effect. What I'd examine:

Re-instilling some consumer protections against credit card interest, perhaps by setting maximum rates lower offset by upping the zero-percent introductories (five percent)? Yep, it ends that sweet way to rotate out of debt by transferring balances to zero and paying them off. But it also keeps those trying to climb out from under the maximum from completely drowning.

Reigning in some of the practices on raising rates based on a late payment to a different company, or a credit score, unless they've acually been late a few times to your own damn company? Would you rather have people juggling or going under altogether?

Keeping stricter standards for getting loans in the first place, or lowering the amount they can borrow? A $50,000 credit limit for an individual making about that per year is ridiculous - and I had one of those once, so don't tell me they don't exist.

Opening up some bankruptcy rules, so the bankrupt can go through the courts and get discharged instead of simply defaulting? Yeah, they get to keep their house. But companies aren't reduced to hunting down people and trying to attach non-existent assets (every try getting blood from a turnip?)

Giving some tax breaks to lower and middle class to alleviate some of the immediate problems?

Changing bankruptcy rules for corporations so that pensions are placed before golden parachutes? Nope, it doesn't seem fair, but 1) executives have more liquid assets to offset their loss, and 2) the economic impact of 400 employees losing their life savings is greater than that of a handful of executives losing theirs.

Yep, these are aimed at the little people. But if I'm right, they'll start fixing some of the problem of why the defaults occur in the first place, which will then benefit the businesses because the debts they own become more solid. Call it a trickle-up theory.

I don't know if any one or all of these will work. I'm open to suggestions. Maybe the idea of bailing out the base would be enough. Somehow my instinct says no, it's still just throwing cash, just at a more strategic spot. Without untweaking the tweaks we've made we're still in the same position. But I'm open to argument, counterproofs. Please god would somebody just explain this all in one massive essay? Maybe we could have Kermit the Frog do it, like we did for that one feel-good commercial back on the last crash (which beside this one feels like it was more of a gentle fender-bender).

I'm not running for anything, so it's a moot point, but this is what I'm trying to get my brain around right now, irrespective of the elections. I just don't think that simply pushing money at the businesses is going to be a long-term solution.

To bolster my point, this quote from the NY Times discussing one aspect of the bailout: "That might fail to fix the credit markets, because it would do relatively little to improve financial firms’ balance sheets. Firms might then remain unwilling to lend money to businesses and households, which is the whole problem the bailout is meant to solve."

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