If you really believe in the free market, you don’t think governments should bail out private entities. The whole essence of free marketeerism is the belief that markets will most efficiently allocate resources. Econ 101, and all that.
So why are so many “conservatives” defending too big to fail banks and pushing for Iceland to pay off investors in its private banks? Check out my friends at Baseline Scenario here and here for more investigation and analysis.
Tagged ayn rand, bailout, Business, economics, financial meltdown, free market, Politics
Posted in Business, Politics, Trends
Tagged bailout, Business, financial meltdown, goldman sachs, greed, Politics, wall street
This article in The Big Money discusses how Goldman Sachs’ defense in the Abacus CDO case – that the buyers were sophisticated investors – isn’t entirely accurate, since those sophisticated investors (banks and pension funds) get a significant amount of money from regular folks like you and me. This is true, but it only gets at half the story. In the context of Wall Street, banks and pension funds are not considered the most sophisticated players.
The reality is that Wall Street has a hierarchy, and it’s measured by compensation. Generally speaking, the smartest people go to where they can make the most money. So if you are really sharp, you’re not likely to end up managing a pension fund’s investments and being a civil servant making $200k per year. You might settle for being a bond portfolio manger at a bank, making $500k. But if you are really smart and aggressive – in other words, a sophisticated player – you are going to end up at an investment bank putting together deals that can pay you several million dollars per year.
So Goldman’s “these were big boys” defense has two flaws. One, as The Big Money points out, the big boys got their money from the little guys. But two, the buyers may have been big boys, but the Goldman bankers pushing the CDOs were men. Speaking metaphorically, of course.
Posted in Business, Politics, Uncategorized
Tagged Business, economics, financial meltdown, goldman sachs, Politics, TARP, wall street
The New Yorker recently (I am perpetually 4-6 weeks behind in my New Yorker, so I consider the March 1 issue to be recent) profiled Paul Krugman, the Nobel Prize winning economist and NY Times columnist. A section of this article made me realize that economists, despite being generally very smart and well-educated, are just incredibly stupid. And I say this as someone who was an econ major in college and very seriously considered going on for a Ph.D.
Krugman was exploring why there were geographic specialties in business: carpets produced in Georgia, cars in Detroit, technology in Silicon Valley, etc. This was an outgrowth of his work on international trade, for which he won the Nobel. He saw that once a company started in a place, an entire ecosystem built up in that place. Trained workers, relevant support businesses (eg. lawyers), and transportation infrastructure – all this tended to create an economy of scale which drew similar businesses to the area.
To this you undoubtedly say, as I did, “duh.” That theory just describes common sense. Which Krugman admits: he explained this idea to a non-economist friend “who replied in some dismay, ‘Isn’t that pretty obvious?’ And of course it is.” But Krugman was the first to mathematically model this common sense phenomenon. Before that, “because it had not been well modeled, the idea had been disregarded by economists.”
So just to be clear: even if a phenomenon is so obvious that my 16-year old nephew could figure it out, mainstream economists, all with Ph.D.s from Ivy League schools, choose to ignore it because a model for it doesn’t exist. No wonder the country just went through a financial crisis. We all knew there was a housing bubble. It was obvious to me and everyone I talked to that Starbucks baristas and migrant farm workers and cocktail waitresses can’t afford $750,000 homes. But the economists at Treasury and the Fed who were supposed to be watching this? Their models didn’t incorporate these sorts of housing hijinks, and so they ignored the gathering storm.
Economists: smart enough to understand Bayesian math, but too stupid to realize that meth heads can’t afford houses.
Posted in Business, Politics, Pop culture
Tagged Business, economics, economists, economy, financial meltdown, housing bubble, paul krugman, Politics
Finally, more than a year after the financial crisis began, the first legal action took place with the SEC charging Goldman with fraud. I don’t have much to say about the actual fraud charge, except that in prior cases like this, the first charge is rarely the last. Once discovery begins and subpoenas start being issued, all the dirty documents and emails start to come out, and the dominoes begin to fall.
I do want to talk about John Paulson’s role in this affair. Paulson was not charged with fraud, and rightly not: he didn’t misrepresent anything. From a legal standpoint, Paulson didn’t do anything wrong. But what he did – paying Goldman to create a security purely so he could bet against it – just feels wrong. As Daniel Gross of Slate put it, this is like paying a construction company to build a shoddy high-rise so that you can buy insurance that pays off if the high-rise collapses, which you know it will, because you built it out of crappy materials. I was discussing this with my friend Bark for Daddy yesterday, and I fully admit that I can’t logically make a case for why Paulson was wrong. But there is just something unseemly about it.
Although not only do Paulson’s actions feel wrong, but if you take a step back and look at the big picture, a case can be made that they really were wrong. Paulson, as much as anyone on earth, knew that we were in a housing bubble; that’s why he was betting so hard against mortgage securities. So when he paid Goldman to create a $1 billion security made up of mortgages, he was adding to the bubble, and he knew it. He knew investors were going to lose an additional $1 billion, just so he could make more money.
And make money he did: Paulson took home $3.7 billion in pay in 2007. And speaking of feeling wrong, the fact that hedge fund managers – individuals – are regularly making $1 billion per year is also unseemly. Yes, they are doing so by producing big returns for their investors, and working within the system, but then maybe something is wrong with the system. Scoring $1 billion paydays by simply trading stocks, compared to entrepreneurs who get rich by building companies, again, just feels wrong.
Posted in Business
Tagged financial crisis, financial meltdown, fraud, goldman sachs, hedge funds, john paulson, mortgages
The NY Times recently wrote a story about how business schools are, in the wake of the financial meltdown, realizing that they need to teach future business leaders to think in creative, flexible and interdisciplinary ways. This is news? I’m no captain of industry, but to me it seems incredibly obvious that in business, like in the rest of life, the right way to make decisions is to pull together disparate data points to draw a conclusion, and then be willing to change that decision as new data comes in. Maybe the fact that this is news is what has been wrong with business schools all along.
David Wessel of the Wall Street Journal wrote a column today in which he proposes that the US has to choose between economic stability and economic growth. I am usually on board with Wessel, who does not follow the Journal’s usual slash and burn libertarianism, but in this case I think he’s wrong. His dichotomy is false.
The regulation that Wessel is discussing is financial regulation to curb the boom and bust cycle that we have just lived through. He asks whether “wise government rule to prevent market excesses” would also prevent the dynamic innovation that fuels economic growth. I answer emphatically NO.
As I noted yesterday, financial innovation is unrelated to business innovation. In yesterday’s post, I pointed out that the companies driving recent growth – the Googles of the world – have not depending on the innovations coming out of Wall Street. But today I will go even further. Between World War II and the S&L crisis, we had a long period of mostly financial stability, without the crises we’ve seen since then, and with a regulatory regime that had general consensus on Wall Street and in Washington. That long period of stability didn’t hinder economic growth; in fact, as the graph below shows it was one of the greatest growth periods in our nation. Notice how much higher the growth is (the red lines) before the S&L crisis in the mid-1980′s.
Growth in GDP after WWII
I would argue that not only did financial stability and economic growth coexist during this period, but that the stability was actually helping the growth. After all, it’s a lot easier for companies to plan and budget if the financial markets are not booming and busting. And potential entrepreneurs are more likely to take the leap and start a new business if they aren’t worried about their retirement savings disappearing in a Wall Street flame-out.
So let’s not worry about financial regulation slowing down growth. Let’s focus on smart regulation that will spur growth.
Back in February the New Yorker wrote an article about how Florida was sort of the epicenter of the real estate madness, full of frauds and crooks, and that the entire state was essentially a giant ponzi scheme. The story mentioned one man in particular, Sonny Kim, who sold 90 properties, netting $4 million. Here is a link to a story in the local paper about Mr. Kim. The buyers were mostly in on the scam, putting no money down, getting liar loan mortgages from foolish loan officers, and then walking away, sticking the bank (meaning the taxpayers) with the house while Mr. Kim kept his proceeds.
Here is how it works: “A common scam works like this: Someone with cash buys a crummy house cheap. A mortgage broker signs on and finds an appraiser to inflate the value. The broker shops the loan application, with false data about the borrower and the house. Bank loan officers approve it.”
Sonny Kim bought one house for $100, and three months later “flipped it for the sum of three hundred thousand dollars, with the help of a no-money-down mortgage from a subsidiary of Washington Mutual Bank, which later foreclosed on the house.”
I saved the article, so that I could go back to it later and see what happened to these folks. According to the St. Petersburg Times, which broke the story, nothing has happened. Sonny Kim hasn’t been charged with any crime. The title agent who managed a third of Kim’s deal, and was arrested on other fraud charges, hasn’t been charged for these deals. Nobody at WAMU is in jail. So all the people who made money on these fraudulent deals are sitting pretty, spending their money on mojitos, while the taxpayers are footing the bill for the bailout. That seems wrong somehow.
In fact, here is a quote from another house flipper, who started his real estate career while on probation from a cocaine conviction: “I drive a Hummer and own a 1970 vintage Oldsmobile 442. I always wanted diamonds and now I own them legally and no one can take them away.”
Posted in Business
Tagged Business, financial meltdown, florida, justice, Politics, real estate
Harvard Magazine recently published an article regarding bank regulation. Like many articles (in fact, like the vast majority of articles I’ve seen), it makes the case that the current situation virtually guarantees another financial meltdown, since all major financial institutions now have implicit government backing, under the “too big to fail (TBTF)” doctrine. However, this article is a little different than many because it’s written not by a journalist, but by David Moss, a professor at Harvard Business School, which is, of course, the main source of the overconfident financiers who created the recent meltdown.
Professor Moss suggests a number of solutions to the TBTF problem and the moral hazard it creates. Most of these suggestions revolve around making the implicit guarantee an explicit one, with transparent limits and with the government charging for the guarantee. He would also add a tight regulatory regime.
The most interesting thing about Moss’ article was the graph I’ve inserted below. This graph has the date on the X axis, from 1864 to 2000. The Y axis shows the number of bank failures during each year. As you can see, bank failures were a regular occurrence in the American economy until 1932, when in the wake of the Great Depression a whole series of regulations were implemented, including Glass-Steagall. Then there is a long, calm period with very few bank failures, running up to the early 1980’s, when bank deregulation began under the Reagan administration. This graph speaks volumes.
Bank Failures Over Time
Bank CEOs and Republicans are arguing strenuously against new bank regulations. CEOs have a good reason: they want to make as much money as possible. But Republicans are fighting regulation simply because they have an ideology that regulation is inherently bad. I think the last two years have proven this ideology wrong, but even if you don’t buy that, it’s hard to argue with the chart. So the question for Republicans is whether they are going to look at 136 years of data, or listen to the anti-government ramblings of people like former exterminator and creepy dancer Tom Delay, or fact-hindered quasi-philosopher Ayn Rand?
Tagged bailout, banks, Business, financial meltdown, Politics, republicans, wall street
If you have the time, I recommend reading this Rolling Stone article. It places Goldman Sachs at the center of every financial bubble since the Great Depression, and details how the firm has profited greatly from the travails of the average investor. I don’t necessarily agree with the author’s focus on Goldman. I think all the big investment banks have been doing this; Goldman just does it biggest and best. But I do think that the banks have been manipulating prices and selling securities that they knew were crap. And, as mentioned by John Talbott and Simon Johnson in my new favorite article, if there were just one criminal investigation that started to subpoena internal emails, we would see all kinds of nefarious behavior exposed. In fact, just yesterday the Commodity Futures Trading Commission came out with a study that blamed last year’s crazy oil prices on financial speculators, rather than on operating supply and demand.
