Thursday, March 26, 2009

Let them eat cake

A quote from a vitriolic Rolling Stones article on AIG:

"In essence, Paulson and his cronies turned the federal government into one gigantic, half-opaque holding company, one whose balance sheet includes the world's most appallingly large and risky hedge fund, a controlling stake in a dying insurance giant, huge investments in a group of teetering megabanks, and shares here and there in various auto-finance companies, student loans, and other failing businesses. Like AIG, this new federal holding company is a firm that has no mechanism for auditing itself and is run by leaders who have very little grasp of the daily operations of its disparate subsidiary operations." (Source:

The point here isn't to debate bailing out the banks, which I fear I am not as far up the learning curve as I would need to be able to truly grasp all the details, but to look at the attitude that is being portrayed in the piece. By far this is one of the tamer quotes; another section calls Hank Paulson a "bald-headed Frankensteinian goon" and another talks about a "guy who acted like making huge bets with other people's money would make his dick bigger." Obviously very yellow journalism, but also very in tune with what the audience is feeling. If this had been my first article to read about the bank bailout, I could see myself falling into the trap the author lays, carefully layering facts and details with crass judgment. It's not necessarily misleading - there are very valid points about the lack of oversight and deregulation that should be taken seriously. The problem is that the article is not about AIG's deregulation - it's about class warfare.
No solutions are ever presented to the problem. The entire article is one big rant about how taxpayer money is being spent bailing out guys who are in an exclusive club, who caused the problem in the first place, and who expect to be catered to due to their lifestyle. In fact, the article takes the position that what the bankers are doing (working long hours, ulcers) and deliberately derides them for it - who cares since you guys caused the problem and have lots of money? Here's the quote so you don't feel I'm exaggerating:

The most galling thing about this financial crisis is that so many Wall Street types think they actually deserve not only their huge bonuses and lavish lifestyles but the awesome political power their own mistakes have left them in possession of. When challenged, they talk about how hard they work, the 90-hour weeks, the stress, the failed marriages, the hemorrhoids and gallstones they all get before they hit 40.

"But wait a minute," you say to them. "No one ever asked you to stay up all night eight days a week trying to get filthy rich shorting what's left of the American auto industry or selling $600 billion in toxic, irredeemable mortgages to ex-strippers on work release and Taco Bell clerks. Actually, come to think of it, why are we even giving taxpayer money to you people? Why are we not throwing your ass in jail instead?"

Here we find ourselves throwing anger not at the architects of the failure, but specifically at "Wall Street types", not at the government or even Secretary of the Treasury Tim Geithner's policy of bailing out AIG in specific, but workers which to most Americans are indistinguishable to anyone else who works in a suit and a tie. There is no clear idea of what a Wall Street type does - I'm assuming there are multiple jobs and tiers and involvement, yet we are to direct our anger at the mere image of wealth when we have none.

The reason I bring any of this up is because this is dangerous. It's the pendulum swing of anger and intolerance that continues to return in new incarnations every generation or so. Getting angry at Wall Street doesn't erase the degrees and hard work and moving up from the bottom level of the company that many of those (mostly) men have endured. Nor does it make them responsible for the situation we find ourselves in - again, the idea of the corporation, the segmented knowledge that one has working for such a place. Just because you have a desk there doesn't make you responsible for every move the corporation makes. Hell, the article pretty much admits that the CEO and Director had no damn clue what was going on yet directs its anger towards not the named, not those in charge, but the unnamed as well.

At the opposite end of the spectrum, it's unfair to everyone who's losing jobs and homes. Period. There is no qualifier that makes it right for the people caught up in this depression, no amount of blame cast about unqualified loans and union job bashing that will make up for the sheer scope of people whose lives were destroyed by this (and still will be - it's not over.) However, to frame this in an "us vs. those who get bonuses" argument is derailing the entire discussion from where it needs to be - how the fuck do we keep this from happening again? It's casting blame to a straw man while leaving the issue out of the discussion. Being angry about employees receiving bonuses doesn't regulate the business or propose solutions; in fact, it drives a wedge even further that began in the time Bush was elected - anti-intellectualism. Just because Joe Banker wears a suit and a tie and toddles off to Wall Street at dawn to put in a 14 hour day so he can pay off his Harvard grad school loans doesn't make him evil. We don't need to lose any more intellectuals; we just need to give them incentives not to screw us over.

What strikes me as interesting is that all this kicked off during the Clinton administration, and Clinton is not a dumb man. Granted, it was during the time he had a Republican congress who liked to naysay his policies, but all the same I would be interested to hear his opinion. Taco?


Taco said...

This is all revisionism of the worst order. Let's take ourselves back the to the 90s for a bit and remember what it was like. At that time there was a huge expansion of markets built upon the successes of the dot com era which were followed by internal US migrations to centralized areas where these corporate expansions where happening. This, in turn fueled long lasting real estate booms which generated demand sufficient and sustained enough to cause a speculative market to appear (this is all natural economics so far). At that time, government was seen as artificially limiting the ability of the constituent corporate players (and eventually individuals speculating in the real estate markets) to expand and to provide a relatively deregulated environment whereby that expansion could happen. Appeals were made by corporations to the relevant government channels and politicians, seeing the wisdom of facilitating economic growth in their own constituencies, allowed for or encouraged legislation in keeping with this continued development.

Have we forgotten that many of the legislators who are a part of the economic bailout and are blaming industry for it where there when these regulations were being implemented to support its expansion? This is not only a function of rules set down in the SEC Act as amended (which is often quoted as the rules that were flouted) but rather also regulations set down in regular meetings of the Joint Economic Policy Committee (representing both houses) that determines day to day perspectives generating legislation in these areas.

Everyone, though, was behaving as we expect that they ought to and should. Why would a corporation, insurance company, or bank deny financial participation in a market on its own terms? Why would a politician not endorse activities that are seen as promoting growth in their areas? In neither case would the dissenter be in existence for very long.

The economics of the market dynamics of largesse and expansion are different from those of contraction. The short sightedness of trying to view that time frame during a puzzling time of downturn will always make it look problematic or the approach incorrect. But, the fact is, at the time and in order to ensure the economic prosperity commensurate with the potentials that existed in the market, many of the decisions that were made were made so that the expansion could continue. The error was in attempting to rationalize some correcting capabilities in these markets; and it was always a fallacy to think that it could ever be properly determined. These markets were expanded beyond their ability to be corrected by any internal forces understood by anyone allowing the expansion to happen (or, more directly, facilitating the expansion).

But, even then economists knew this. Why would Greenspan have popularized the term 'irrational exuberance' other than to state that the consumption patterns during a time of expansion were creating value where it did not actually exist? Greenspan's only error was in thinking that the natural action of the markets would correct themselves. Greenspan was assuming that everyone in the milieu at that time was being honest, which is a very poor assumption, indeed.

Loose credit terms exist in times of expansion because there generally is less risk in the sum total of market assets. That does not mean that everyone will be successful, only that diversified assets are less risky because the general market risk is lower. In times of contraction, the presence of fewer assets cause the general market risk to be higher and the value of assets that would have been decent or mid-range in the expansion market become "toxic" only because the chance that the borrower who financed the asset (usually combination of assets) will default.

Which gets us to the root of the problem. AIG is in trouble now because too many people took out home loans that they could not afford. After you stack up all the issues on top of issues and hedges on top of hedges, this is the root of it. So, if the American people are looking for people to blame for such a systemic failure they need look no further than at the end of their own noses.

The American capital system is sound and it works, generally, the way it is supposed to work. In order for a disaster of this magnitude to occur it must involve a large number of independent actors with a distributed capital base who, probably, all react in the same way to a market stimulus. The only place where that manifestly and uniformly exists is at the bottom.

If we want to point a finger of blame, it should be pointed at a huge group of middle and low income people who took out home loans that they could not afford and are now in the process of defaulting on them. The terms of those loans were clear and anyone accepting some 'exotic' loans with balloon payments was acting speculatively and is, even now, in the process of being burned on this. If these did not exist, the cascading effect of all of the additional problems would not be occurring to the extent to which they are.

It may sound harsh, but we are more inclined to feel sympathetic for people whose actions, through ignorance or speculation, were at the root of creating this particular problem and, one layer higher, the people who encouraged them to do it by manipulating and selling them into a loan situation that they could not afford. However, I tend to take a very precise definition of responsibility and that would be to ask any of these people very closely what feature of the loan that they entered into at all made them think that they would be able to afford it for as long as the loan term specified? The answer, I am sure, would be that they never believed that they would have to carry the loan to its full term. That instantly makes them not potential homeowners (which I think everyone should aspire to be and we should support them) but speculators, who are individually aware and responsible for the possible complete loss of their investment.

That is the rule of any speculative market (and the same contract you have to sign when you're entering a speculative market). They should have treated their homes for what they are, homes, not options.

Kory said...

It started during the clinton years because alan greenspan was running the show at the fed. Greenspan was the ultimate hands off deregulate, let the market fix itself kind of guy. (he also had a wreath made of dollar bills delivered to the funeral of ayn rand.)

This pitchfork and torch attitude towards the guys in suits is the other side of the coin to the "unions are destroying the american workplace" crowd. People aren't really mad at any particular individual (save for bernie madoff, but how many of us honestly had the money to even invest with him). People are mad at what that effigy represents to them. Someone who gets what the other feels they are not entitled to. Just this morning Peggy Noonan was on Fox and Friends saying that in the coming years there is going to be a war between the makers in this country and the takers...if that isn't an incitement to class warfare I don't know what is. Personally I think everyone in the country should borrow Atlas Shrugged from the library, not because I think its well written (its not) nor do I think the philosophies are sound (I don't) but its become practically the bible of those who so desperately fear any sliver of socialism that they parrot government=bad, free market=good. Its a generalization and a hyperbole, and all generalized hyperbole's are wrong...except this one.

Frankly we've all been raised (even my gen who grew up in the 80's) to fear the commies, but we never were introduced to the idea that too much swing to either side can be bad too. Look at what happened after the gorging of mammon we did in the 80's...recession in the early 90's. Then we were told the most important thing needed to keep america running when we started an economic slowdown post 2001 was to spend spend spend, we were living on cheap credit because we could. Look at the result.

Populism and anger will always exist, it is stronger in some cases than others. What we need to be careful of is who proposes a solution and what that solution is. Do I think we need to line them all up against a wall? No, in most cases what these chumps did was perfectly legal, and thats the real problem. You can't let the fox guard the henhouse.

Fenixmagic said...

Kory and Taco:

It's interesting seeing both of your comments because they are at entirely different ends of the spectrum. Kory - you mention your lack of support for Ayn Rand's Objectivism while Taco - you pretty much directly come from an objectivist standpoint. I disagree with putting all the burden on people who took out loans; ultimately their defaults caused the crisis, yes, but the method, the reason why they are defaulting in huge numbers is not just because they were dumb and bought a house they couldn't afford. We are on the bust side of a boom market, an unsustainable boom, but even now it would be cheaper where I live as far as monthly payments (Southern California) to buy a house than it is to rent an apartment with comparable square footage. Consider these not as defaults, but as temporary rent reductions - it's an entirely different mindset. What if so many people got into homes they couldn't afford because they knew it was temporary, but it was better than the alternative? Of course, that's not going to be shown in the media - it's much more dramatic for the family forced out of their house to be presented as tragic rather than practical.
At the end of the day, the banks were the ones offering loans to people who couldn't afford to take them. They made these products available, and then didn't take into consideration the factors they should have, such as that the default rate or the oversaturation of the market with these loans. The foreign investors didn't do the homework when it came to what they were buying into. The grading commissions and watchdog agencies - well, you get the picture. Everyone involved in the system is responsible for this breakdown. It wasn't just at a consumer level. To say it is presents a very narrow, naive world view.

Taco said...

I do have a narrow and naive world view when it comes to accepting personal responsibility, but I'm not looking for people to blame. I only went through that complete description to reduce it down to its simplest parts. There is a huge disparity among the media portrayals of the situation (where they focus on very small groups of experts) and where the blame ends up. I completely agree that there were people culpable at all levels, especially regulatory ones. That is why I brought up the fact that Congress shared a burden for what has happened even though no one seems to blame them.

Those small groups of experts reacted to the markets and the regulations in ways that made sense given the climate and their own obligations to their companies. Ah, and here's a bombshell that I am sure you guys will jump on, I don't think that AIG acted wrongly. I do believe that they acted distastefully and with an abhorrent sense of public sentiment, but I don't think that their bonus payouts were wrong. AIG understands something very important. All of those big guys that we resent for making a bunch of money are the same experts that we'll all go crying to in order to fix the problem. Having their most important assets (their exployees) scatter to the four winds because they can't afford to pay them the salaries that they can demand elsewhere would be the last nail in the coffin of the organization and pretty much destroy any hope that the company can navigate the complex recovery that it is trying to orchestrate. The public has a bad habit of talking about these organizations like anyone can run them. The fact of the matter is that there are less than 100,000 people in the entire world who are qualified to be at the senior levels of such financial organizations and fewer than 10,000 who are qualified to run them.

And, as Kory suggested, there is a propensity for the "little guy" to transfer blame to the "big guys" as those who were the decision makers and the only rational actors in the story. In that instance, the little guys are seen as victims. Why are they not seen as victims of their own choices? This was my only point, that there was a complete segment of society who was making choices outside of the scope of their experience and we paid dearly for that. I also mentioned the next rung up, as you did. But, I'm a little more careful with them. They are salespeople who are trying to sell products. But, this is where the understanding must be more acute. An exotic loan isn't like selling appetizers made of used battery parts, where it is easy to see that this is something bad all the time. An exotic loan is good at some times and bad at others. While the market was climbing, those loans made sense to everybody, seller and buyer. When the market tanks they start not making so much sense, and it is up to the buyer to be able to have some sense of proportion and of their own ability to deal with contingency. We are accusing the big guys at AIG of greed, but isn't this just plain old ordinary greed again? No rational person would think of any market as being sustainable forever. Welcome to the United States of Las Vegas.

I also don't suggest here that laissez faire is the correct application, either. Greenspan was a big fan of it because I think he saw clear answers to the difficulties faced by the Carter and Reagan eras with limiting market development in a more free form approach to markets. As we have learned, there is a balance that has to be maintained. But it is also important to note that the unrivaled world economic growth that has happened over the past 20 years required less regulation and the vast majority of it is real growth just not to the value quantities that we have all heard about. This downturn is a classic revaluation market correction, Economics 101.

The function of the relationship between renting and buying in Southern California is a demand function. The reason you have such a disparity is because of the quantity of people who want to live there and that drives up the prices. Also, the rent/buy balance in the communities has an effect as well and is related to the amount of migration that is expected in the communities themselves. Housing is now a localized/national phenomenon because we have populations that are so much on the move. If you live somewhere where everyone else wants to live because of the opportunities that are there, expect that the rental prices and home prices are going to actually function independent of one another. The reason for this is easily found in a monster search of available jobs that compares Los Angeles with Birmingham, Alabama. It's the premium you pay to live there. You'd be a proud homeowner in Kentucky with plenty of dog run room on the amount you pay in rent today.

Getting into a house that you can't afford if you actually intend to live there makes no sense at all. It only ever makes sense if you intend to treat it as an investment for which you expect some return. Let's say that you got into an exotic loan because the price of the loan in the first year was less than the rent in the same neigborhood. And, if the loan resets in the next year, the net is still lower. Congratulations, you have bought two years of lower rents and stored both equity and savings. In the third year the loan resets again to interest rates and now it is equal to rents. Any subsequent year after that based on loan resets would then be higher and would negate the gains you made in the prior years. What you were gambling was that by this year you'd be out of the property either into something actually cheaper or with a hefty sale profit as a down payment for something else. Help me with this, because in fact, I see no scenario at all where this is not a gamble, no matter how you dress it up in the logic of the moment. The only scenario where this works at all is if the market continues to climb, which no sane person could expect was indefinite. I'm not saying that they were not desparate (which is tragic) but those people were never practical, they were always gambling.

Class and capital re-distribution is about to become a global concern and an economic war that, as a nation, we may not win...I'll save Kory's well placed points for another rant on another day. :)