Roberts on the causes of the crisis and the consequences of the bailout
When Paul Craig Roberts, whose main field is economics, is not railing insanely against neoconservatives and Israel, he sounds like a rational being. His October 5
article at Vdare, “The Bailout Will Fail,” is rational and worth reading. I’ve excerpted several passages below. Notice how Roberts challenges the simplified explanations of the crisis that have come from both the Republicans and the Democrats.
The greatest mistake was made in 2004, the year that Reagan died. That year the current Secretary of the Treasury, Henry M. Paulson Jr., was head of the investment bank Goldman Sachs. In the spring of 2004, the investment banks, led by Paulson, met with the Securities and Exchange Commission. At this meeting with the New Deal regulatory agency tasked with regulating the US financial system, Paulson convinced the SEC Commissioners to exempt the investment banks from maintaining reserves to cover losses on investments. The exemption granted by the SEC allowed the investment banks to leverage financial instruments beyond any bounds of prudence.
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The 20th century proves that the market is likely to know better than a central planning bureau. It was Soviet Communism that collapsed, not American capitalism. However, the market has to be protected from greed. It was greed, not the market, that was unleashed by deregulation during the Clinton and George W. Bush regimes.
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The Paulson bailout saves his firm, Goldman Sachs. The Paulson bailout transfers the troubled financial instruments that the financial sector created from the books of the financial sector to the books of the taxpayers at the US Treasury.
This is all the bailout does. It rescues the guilty.
The Paulson bailout does not address the problem, which is the defaulting home mortgages.
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Initially, the House, but not the Senate, resisted the bailout of the financial institutions, whose executives had received millions of dollars in bonuses for wrecking the US financial system. However, the people’s representatives could not withstand the specter of martial law and Great Depression with which Paulson and the Bush administration threatened them. The people’s representatives succumbed as they did during the New Deal.
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If the $700 billion bailout is based on an estimate of the current amount of bad mortgages, as the recession deepens and Americans lose their jobs, the default rate will rise. The $700 billion might not suffice. The Treasury will have to go hat in hand to its foreign creditors for more loans.
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The US dollar is the world’s reserve currency. It comprises the reserves of foreign central banks. Bush’s wars and economic policies are destroying the basis of the US dollar as reserve currency. The day the dollar loses its reserve currency role, the US government cannot pay its bills in its own currency. The result will be a dramatic reduction in US living standards.
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Currently Treasuries are boosted by the habitual “flight to quality,” but as Treasury debt deepens, will investors still see quality? At what point do America’s foreign creditors cease to lend? That is the point at which American power ends. It might be close at hand.
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Some commentators are blaming the current mortgage problem on the pressure that the US government put on banks to lend to unqualified borrowers. The proliferation of privilege that bureaucrats pulled out of the Civil Rights Act led in 1993 to Shawmut National Corporation’s acquisition plans being blocked by federal regulators until its subsidiary entered into a consent agreement with the US Department of Justice to racially norm its mortgage lending. This agreement was quickly incorporated into the growing body of regulations. Next, Chevy Chase Federal Savings Bank was forced by the DOJ to open new branches in “majority African-American census tracts.” Chevy Chase had to provide below-market loans to preferred minorities at interest rates “at either one percent less than the prevailing rate or one-half percent below the market rate combined with a grant to be applied to the down payment requirement.” In 1995 the DOJ forced American Family Mutual Insurance Company to sell property insurance to preferred minorities on uneconomic terms. [See Roberts and Stratton, The New Color Line]
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Thus, it is true that it was the federal government that forced financial institutions to abandon prudent behavior. However, these breaches of prudence only affected the earnings of individual institutions. They did not threaten the financial system. The current crisis required more than bad loans. It required securitization and its leverage. [Emphasis added.] It required Fed chairman Alan Greenspan’s inappropriate low interest rates, which created a real estate boom. Rapidly rising real estate prices quickly created home equity to justify 100 percent mortgages. Wall Street analysts pushed financial companies to improve their bottom lines, which they did by extreme leveraging. The full story goes far beyond the propaganda videos put out by Republicans blaming Democrats.
An alternative to refinancing troubled mortgages would be to attempt to separate the bad mortgages from the good ones and revalue the mortgage-backed securities accordingly. If there are no further defaults, this approach would not require massive write-offs that threaten the solvency of financial institutions. However, if defaults continue, write-downs would be an ongoing enterprise.
Clearly, all Secretary Paulson thought about was getting troubled assets off the books of financial institutions.
The same reckless leadership that gave us expensive wars based on false premises has now concocted an expensive bailout that does not address the problem, which will fester and become worse.
- end of initial entry -
Jonathan W. writes:
Sure, the securitization and leverage played a role, but the but for cause is still the existence of those bad mortgages to begin with. But for the DOJ and special interest groups forcing banks to give loans to unqualified minorities, the leverage wouldn’t have caused the banks to fail.
LA replies:
But would it not also be true that but for extreme leveraging, the loans to unqualified minorities wouldn’t have caused the finance system to fail? That is Roberts’s point.
TWW writes:
I have been somewhat following your discussion of the deflationary depression upon us, but I don’t recall seeing a discussion of the root problem. Roberts addresses what eventually got us where we are today, but from your excerpts, I don’t see a discussion of said root problem. The current deflationary event, or bust, of the boom bust cycle inherent through use of a fiat currency, is explained quite succinctly by Vox Populi in a short letter to Rich Lowry regarding the Paulson Plan:
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Here is the entry by blogger Vox Populi:
This may sound familiar
The negligence and incompetence of the nominally conservative commentariat on economic matters has really been quite remarkable when one considers how much they write about the so-called “free market”. I wrote this email to Rich Lowry in response to his amazing assertion on NRO that the failure of the Paulson plan to “restore confidence” to the markets should not be taken as a failure of the Paulson plan.
Mr. Lowry, with all due respect, you’re missing the point. The Paulson plan cannot and will not work. It is hopeless and was from the very moment of its conception. It’s a Keynesian solution to an Austrian problem; all the Treasury is doing is ensuring that the crisis is exacerbated and extended in exactly the same way that Hoover and FDR did. This is the classic “pushing-on-a-string” problem that all the contrarians have been warning about for some time now. You cannot correct fundamental investment misallocations caused by cheap money by providing more liquidity. It’s spraying gasoline on the fire.
This is not about “a crisis of confidence” or “animal spirits” or all the usual Keynesian blather that is spouted by the half-educated in political economy. They’re only addressing the symptoms, not the disease which as they try to fight off the contraction that inevitably stems from previous inflationary expansion. It worked in 1996 when they inflated equities. It worked again in 2003 when they inflated housing. Now, there’s nothing left to inflate and the contraction will be much more painful than it would have been if they hadn’t tried to fight it off the two previous times. So, it doesn’t matter when the Paulson plan was put into play, since it couldn’t have worked anyhow. I know Mr. Kudlow and your other mainstream Keynesian and Monetarist contacts will tell you otherwise; they are wrong, as you will see.
It’s a basic matter of defying economic gravity. After the boom, the bust must come eventually. And please don’t confuse the bounce coming next week with an actual recovery; because just when everyone breaths a sigh of relief and starts writing about how the worst has passed, the bear will return with a vengeance.
Posted by Lawrence Auster at October 10, 2008 08:12 AM | Send