Tuesday Highlights

Good morning.

  1. The upside to the reaction to TARP, which I think is naive in that the negative reaction will not last long enough to serve as a moral hazard.
  2. What COIN looks like up close.
  3. Jews and Nebraska.
  4. Defending Ms Rand.
  5. Mr Lindzen and AGW.
  6. Comparing two rallies, why is it that the ostensibly green democrats never manage to police their own trash?
  7. Knowing your partner was “the one.”
  8. Hell.
  9. Cinema.
  10. Porcupine.
  11. Darwin, doubt and God.

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  1. Boonton says:

    The upside to the reaction to TARP, which I think is naive in that the negative reaction will not last long enough to serve as a moral hazard.

    Several things:

    1. TARP initially cost $700B but is now down to $50B because a lot of the money has been paid back and interest and dividend income has partially offset the remaining funds that either won’t get paid back ever or are still outstanding.

    2. A common argument about TARP at the time went with the efficient markets hypothesis. It basically went like this. If you think these various financial assets are under valued then go raise $700B privately and buy them. The fact that you can’t indicates that the market knows better. If this was true then TARP should have produced massive losses. It didn’t. Cosidering a cost of $50B on a $700B we can clearly see TARP could have been profitable if the Treasury was concerned about making money like Mr. Buffet and was a bit more aggressive. The clear implication was that the market was behaving inefficiently & the gov’t intervention countered that partially or in whole.

    The moral hazzard argument has some real flaws in this light:

    1. If the assets were really worth $700B or so then an efficient market would have ‘bailed out’ Wall Street as well. ‘Moral hazzard’ would still be there!

    2. It was the system that got bailed out. If you were a stock holder of, say, AIG, Bank of America, GM, etc. you took a massive hit. There was punishment aplenty in the meltdown. The primary risk takers were wiped out, the bailout primarily benefited risk takers that were secondary and beyond. In other words, the risk taker was less Bank of America writing/buying dubious loans, the risk taker who got bailed out was YOU who kept some of your money in a BoA account! (Or more accurately the counterparties on many of the trades)

    3. If you had asked people two or three years ago what they thought the odds were of Congress passing a spending bill of nearly a Trillion dollars in less than a week to loan and buy up troubled Wall Street assets they would have said less than zero. Then why was the risk undertaken to begin with? The argument is absurd, now that Wall Street was bailed out once they’d take risks thinking they could get bailed out again, why did they take risks when no one thought a bailout like that would ever happen?

  2. Boonton says:

    Defending Ms Rand.

    It’s a fair point in that Galt did not actually cause society to collapse, it collapsed because of its own stupid mistakes but I think that misses the author’s original point about Atlas Shrugged, it is basically nerd revenge porn.

    Over my years of working I’ve encountered more than a few people who had been fired, downsized or laid off. A quite common perspective falls along the lines of “wait to they see how hard it is without me! They’ll rue the day when the XYZ report has to be run and none of them know how to do it”. What almost always happens, though, is that nobody much notices. Maybe the XYZ report was totally unneeded so when it takes a day of head scratching they shrug and say ‘let’s not run it and see if it causes any problems’. Or maybe people who hadn’t bothered to learn about the XYZ report will be forced to figure it out. Invariably, though, it doesn’t take too long after losing the ‘essential people’ for things to get along pretty much the way things were getting along before. Yes the world existed before you got here and it will exist after you depart. As entertaining as it is to think no one will ever laugh or love or have fun again after you’re gone, they will. In fact don’t be surprised if your departure doesn’t even register a full 24 hours of departure from ‘business as usual’.

    Rand’s schema, though, is essentially genocidal. The world is mae up of a few smart, worthy people like Galt and everyone else is simply a waste of space. Hence the National Review quite correctly when zeroing in on a scene where a train enters a long tunnel and the fumes start killing the passengers because society’s freeloaders had insisted on sending the trian thru despite the fact that it wasn’t designed for that type of engine. Rand gleefully delights in the deaths of innocent people, including a mother and her child, who in her schema are not innocent because they failed to know their place relative to the GREAT PEOPLE of society.

    Reality is a bit more nuanced, though. Galt and the freeloaders exist inside the same people. Sometimes we carry the world on our shoulders and other times we freeload off others who are carrying the weight. IMO to get too caught up in this, esp. keeping score, is pretty deadly to the soul and should be avoided. In reality if some people got tired of carrying the world and ‘shrugged’, what would happen is that some other people would start carrying it. That’s it, the trains would still run on time and the world would go on.

  3. The moral hazard argument is a specious one anyway, because the problem was that everybody underestimated the probability of risk, not that they underestimated the cost of the risk. Just another example of libertarianism’s underlying problem — it’s based on the false premise that people will behave rationally.

  4. …and when I say “underestimated” I mean “ignored.” It’s not like they were thinking, “Oh, we’ll just get bailed out anyway.” They were thinking “the housing market’s never going down!” It’s insane and irrational, but that’s what it was.

  5. Mark says:

    I don’t get it, are you saying that the argument that there should be a chance of companies failing or not when they undertake tail risk? Or are you denying that the Fed signaled strongly to the banking community throughout the late 90s and oughts that they would cover in the event of failure (which they ultimately did), which was one the big reasons that the banks were willing to ignore those same said risks (and because of those signals their decision was actually rational).

  6. I’m saying only what I said — that moral hazard didn’t even come into play here and probably wouldn’t the next time it comes up either. I don’t agree at all that the banks were willing to ignore the risks because they thought they would get bailed out, but even if that’s true, it doesn’t mean that it would have been better to not bail them out. They were so big and so important that we HAD to bail them out, so it’s just a game of chicken that we can’t win.

    If I believed in God, I’d say thank God no Tea Partier was at the helm when a bailout was needed.

    There are only 2 solutions that I’m aware of to this problem: break them up into smaller banks and don’t let them get so big and important again or regulate them well so that they can’t get away with gambling the economy and taking absurd risks with the nation’s economy. This notion of forcing them to act rationally by convincing them they won’t be bailed out is ridiculous because it can only be either a bluff or completely self-destructive. If they’re as big as they are, creating a moral hazard is a lesser evil than bailing them out repeatedly, not least because the moral hazard turns out to not even be a factor.

  7. In other words, not every problem has a free market solution. This one specifically doesn’t.

  8. Mark says:

    So then you’re screwed, or at least committing us back to the same path. Because avoiding “too big to fail” is not going to cut it because its not size but infiltration and dependence that is more the issue. Secondly, increased regulation is likely to make us more not less vulnerable is (as it is likely to be the case) if done wrong. More regulation will likely result in more conformity in banking practices, which means those banks are all vulnerable to exactly the same weaknesses and shared assumptions held by the regulators.

    I’m sorry with the Fed spending almost two decades signalling that they would indeed bail out the banks is a significant problem. Taking on tail risk is not necessarily a bad thing. In fact much the reverse it is good and necessary. It just has to be not hidden and the assumption that the government will bail out the banks if that risk is called in, which means the cost of the risk doesn’t have to be paid for by the investor, is one of the primary causes of the problem.

    If you’re interested Rajan has some good recommendations for going forward and avoiding the problem which suggest that there are not just “two” solutions.

  9. Boonton says:

    I think you’re confusing the issue here. Most Wall Street firms were not banks and were never given a clear signal of being bailed out. Bear Sterns, Lehyman Bros. and others are not banks in the sense that Bank of America is. They do not accept deposits but instead borrow their funds and invest as they please (as well as provide brokerage accounts to other investors). Likewise AIG was a finance firm selling insurance like products (it’s auto and life insurance is done in separate companies since state regulators require auto/life insurance hold a critical mass of reserves to fund claims).

    Now the fact is there was no clear signal that they would be bailed out if they got in trouble. In fact the impetus of the bailouts was the collapse that happened after the Fed announced that Lehyman Brothers would NOT be bailed out. What’s interesting is that this all went down not so much in the regulated area of the finance world but the unregulated one. The normal ‘moral hazard’ insurance that covers the ‘boring banking’ sector, the FDIC, was not hit all that hard until the recession hit with full force.

    The problem here with the moral hazard issue is that it just doesn’t work. Put it from the point of view of a Gordon Gekko type who wants to play it risky and get bailed out if things go bad. It only works if everyone does the same thing, if so many people are at risk that ‘the world will blow up’ if a bailout doesn’t happen. If, however, everyone else doesn’t play it risky and you blow up there’s no push for a bailout for you. In fact, its just the opposite. Without a bailout you go down in flames and the vultures get to pick up your valuable assets at firesale prices. The rest of Wall Street will be *against* your bailout.

  10. Mark says:

    No. I’m not confusing the issue. I’m giving you the conclusion of two longish chapters in Rajan’s book in brief sans the supporting arguments. And yes, I’m mixing the notion of bank and investment bank, and other firms involved in investing freely.

    Yes, there were in fact 15 years of strong signals from the Fed that they would indeed be bailed out. These signals preceded the crash so the Lehman Bros. not being bailed out was irrelevant. How could these firms unwind billions of off-sheet tail risk after the Lehman non-bailout?

    It only works if everyone does the same thing, if so many people are at risk that ‘the world will blow up’ if a bailout doesn’t happen. If, however, everyone else doesn’t play it risky and you blow up there’s no push for a bailout for you. In fact, its just the opposite.

    Actually, in light of the bailouts the firms that did the worst (except for the signal examples that weren’t bailed out) were the ones which didn’t (like JP Morgan for example) invest heavily like the rest in tail risk. Firms like Citibank and so on made billions during the boom and subsequently got bailed out. Their managers made out better (bonus-wise) than the conservatives that chose not to join the party.

  11. Boonton says:

    What about institutions outside the US? Were they counting on the Fed or Congress as well? What about Iceland whose bank achieved debts several times the country’s entire GDP? Did they assume they were getting bailed out by their gov’t issuing a 200% tax rate or that other country’s taxpayers would vote to bail them out?