The Economy Is Still at the Brink

An op ed from the New York Times. An excerpt:

Instead of promising the imminent return of good times, why isn’t Mr. Obama talking more about the importance of living within our means and not spending money we don’t have on things we don’t need? We used to be a frugal nation. The president should be talking about kicking our addictions to easy credit, to quick fixes and to a culture of more is better (and Congress’s new credit-card legislation, while perhaps eliminating some of the worst aspects of that industry, certainly didn•t send the right message about personal finance).

Good point. More from the article:

Gas-guzzling S.U.V.’s, cigarette boats, no-income mortgages and private jets should be relegated to the junk heaps of history, or better yet, put in a museum dedicated to never forgetting the greed and avarice that led us so far astray.

I don’t see the connection between no-income mortgages and private jets. If a jet is legally, ethically, and honorably purchased — that is not wrong. The authors seem to have a decent vantage, but connections like that are circumspect. The piece concludes wisely:

We are in one of those ‘generational revolutions’ that Jefferson said were as important as anything else to the proper functioning of our democracy. We can no longer pretend that our collective behavior as a nation for the past 25 years has been worthy of us as a people. Many of us hoped that Barack Obama’s election would redress the dire decline in our collective ethic. We are 139 days into his presidency, and while there is still plenty of hope that Mr. Obama will fulfill his mandate, his record on searching out the causes of the financial crisis has not been reassuring. He must do what is necessary to restore the American people•s – and the world’s – faith in American capitalism and in our nation. Answering our questions may help us get back on track. But time is wasting.

14 thoughts on “The Economy Is Still at the Brink

  1. Interesting article. The government needs to get completely out of the finance business. No more providing financing for more than 50% of the country’s mortgages. No more student lending. No more insuring bank deposits. No more acting as the “lender of last resort.” No more centrally dictated interest rates. Until the government leaves these businesses, we will continue to see the endless moral hazard, unintended consequences, and boom/bust cycles that have characterized the past 100 or so years.

  2. People NEED to take responsibility for their own actions…. relying on the government wipe their noses and asses is one of the reasons we got into this mess……. That and this bullshit entitlement mentality ie. socialist.

  3. Ken,

    From wikipedia…

    “As of 2008, Fannie Mae and the Federal Home Loan Mortgage Corporation (Freddie Mac) owned or guaranteed about half of the U.S.’s $12 trillion mortgage market.[6]”

    http://en.wikipedia.org/wiki/Fannie_Mae

    Regarding the FDIC, please understand that the FDIC only has capital on hand to insure less than one half of one percent of all bank deposits. One large bank bankruptcy would essentially render the FDIC insolvent. Who is on the hook in that event? The United States government.

  4. To sum it up from another great observer during the Jeffersonian era: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money” — Alexis de Tocqueville

  5. cy Fannie and Freddie didn’t “finance” those mortgages, they bought those loans free and clear. “providing financing” implies a loan was used to acquire the mortgages and that is not the case. But regardless, if the lending standards were adhered to then that 50% number would be less. The lending standards were not followed, and thats why guys like Mozilo are headed to jail:
    http://www.marketwatch.com/story/former-countrywide-ceo-mozilo-charged-with-fraud

    In the 70+ yrs of the FDIC not a penny of insured money has been lost by bank customers. The premiums are set based on the prevailing risk.

  6. Ken-

    The gov’t shouldn’t be purchasing 50% of all mortgages. You can dress it up any way you want, but the fact remains that when the gov’t is lining up to purchase 50% of all product, some terrible incentives will be created.

    Had either BOA or citibank went bankrupt (like they should have), the FDIC would have been insolvent. Perhaps the gov’t would have demanded that non-bankrupt banks bail those depositors out, but what’s important is that this system provides incentives for banks to take inappropriate risks and for depositors not to give a shit.

    “The premiums are set based on the prevailing risk.”

    Ken, you’re a smart guy. I hope you can realize the absurdity of that statement. I’m pretty sure you agree that financial markets can in no way be accurately predicted. What makes you think that bank “risk” can be accurately predicted?

  7. I never said anything could be predicted. Im saying that for 70+ yrs the FDIC has worked well and did what it was designed to do. And its run by the bankers, so whatever they are doing to set premiums its working. Of course, like you said, things could change…but the odds are against change, just like with all strong trends. My overall point is that you were implying that insured deposits were somehow part of the problem, and I just don’t see that.

  8. Ken, imagine a friend or family member approached you and asked to borrow, say, $5000. It’s not all the money in the world, but its also not a trivial sum. What would your first question be? (actually think about it for a second)

    My guess is that you’d have two questions. 1. What are you planning on doing with the money? 2. How do you plan to pay me back? Does that sound about right? Perhaps some people would simply react by saying “ok” and not giving it a second thought, but I’d imagine most people would be interested in the two questions I posed above.

    So how does this apply to banking? When the average american (or even a high-income american) gets his paycheck, what does he do? He gives it to a bank. Does he care what happens to the money or is he worried about how he’s going to be paid back? No. Well, why not? The FDIC.

    Please tell me you can at least partially recognize the distortions that will take place under this type of arrangement. If I don’t care how I’m going to get paid back, I don’t care which bank I give my money to. This eventually will result in money flowing to the most aggressive risk takers. Eventually these bankers will take risks too large for their capital. This system MUST end in bank panics. We witnessed this in 87 (S&L crisis) and in the current crisis.

    Before you get all worked up, I’m not trying to say that insured deposits were the sole cause of the current mess. I’m not even saying they were a main or primary cause. (Although I could probably make that case for the S&L crisis) I’m just saying that insured deposits create tremendous moral hazard and perverse incentives that will continually precipitate financial calamity.

    (Another point (but unrelated): if the FDIC is as successful as you claim it is, why not simply take the “F” out of “FDIC?” In other words, why not completely privatize the FDIC? If the government backstop you argue makes no difference (because its never been used), why not get rid of it entirely. Customers could then decide if they want to place their money in “DIC” (pronounced Dee Aye See, not DICK, haha) banks or not.)

  9. Does he care what happens to the money or is he worried about how he’s going to be paid back? No

    You say no, I say yes they do care. Did you see the 60minutes piece a couple weeks ago on the FDIC? Some guy went into the bank with a briefcase to withdraw all his money because he had no clue it was insured. Most americans have no clue what the FDIC is or that their savings are insured. And if they don’t know their savings are insured then how can that create moral hazard?

    And if moral hazard is being created then its being created by the bankers. But its a for-profit insurance system, so whats wrong with that? Its no different than medical, fire, homeowners, car, or any other type of insurance. Even with insurance most people are still very careful because they don’t want their premiums to rise. So I disagree with your premise that insurance creates moral hazard.

  10. And one other thing, there is a basic flaw in your logic.

    You are saying that if we insure deposits then we are more likely to get financial calamity because of the moral hazard created. In other words, what you are saying is the more you try to protect people from something, the greater risk you actually create for that thing happening and ultimately in a bigger way. So using that same logic you would have to say that the more you try to protect people from moral hazard, then you would actually create a more immoral society, right? If you try to protect and coddle people from being exposed to immorality, then in fact somewhere down the road you will have a huge “immorality calamity”. Using your logic, if protecting people from losing their money leads to financial calamity then you also have to say that protecting people from immorality would eventually lead to a morality crisis, right?

  11. Uh, hey, Ken. Sorry, was away yesterday…i could not participate in this riveting conversation.

    First of all, “Moral” hazard has nothing to do with our conventional definition of the word “moral.” It’s simply a term to describe excessive risk taking in light of limited loss. It has nothing to do with right or wrong, and therefore, no, I don’t think protecting people from moral hazard would create an immoral society. (Quite the opposite, in fact. I’d argue that taking excessive risk with other people’s money is highly immoral.)

    Regarding insurance- Again, why doesn’t the FDIC simply go private? I don’t think that the FDIC is for-profit (as you claim), but if it were, that’d be way, way worse. Why should the FDIC operate for profit, and keep profits during the good times, but the taxpayer is on the hook when the FDIC eventually bankrupts itself.

    You also equate deposit insurance to regular physical insurance, like fire, car collision, etc. This is a bad way to think about financial insurance. Whereas selling hurricane insurance will not make a hurricane any more or less likely, selling financial insurance will definitely make whatever you’re insuring against way more likely (this is essentially my whole point.) This is exactly what has happened in the current crisis, although the “insurance” in this case were credit default swaps. (CDS) As banks sold mortgage bonds, the buyers also purchased insurance against their default (CDS). Since the buyers didn’t really care about the quality of the bonds, worse and worse bonds were created. Again, the buyers didn’t care, because they thought they were insured. The insurers thought you could model financial risk just like you can hurricane risk, and they thought their premiums were high enough. Unfortunately, that’s not the way financial risk works (feedback loops present themselves), and when the financial hurricane hit (subprime) the bond insurers were basically all immediately bankrupt (AIG, MBIA, etc.).

    For a very good paper (if not a little thick) on why financial risk is very different than physical risk, read this (or read The Black Swan)…

    http://www.edge.org/3rd_culture/taleb08/taleb08_index.html

  12. By “for-profit” I meant the bankers set the insurance premiums with a profit motive just like any other insurance business. They don’t set them in such a way that they can stick it to the govt. And besides, the govt is under no legal obligation to insure anything under the FDIC.
    It’s completely funded by the bankers.

    Moral hazard is all about morals. Its about protecting people from the negative consequences of their actions, thats a morality issue. But regardless, there is still a flaw in your logic. On one hand you are saying protecting people is better, and on the other hand you are saying not protecting them is better.

    I disagree with you and Taleb about financial risk being different from physical risk. If that were true you would have to say the entire corporate structure is flawed. Why? because the whole purpose of incorporating is to protect the individual employees from financial losses sustained by the corporate entity. The corporate structure is a form of financial insurance. Bankruptcy is just another form of financial insurance. You can be absolved of billions of dollars in losses if you run the company into the ground and claim bankruptcy. Some companies knowingly abuse this (like AIG, Enron, etc) but most companies don’t. If what you and Taleb are saying (that financial insurance causes what you are insuring against more likely to happen) was correct then most companies would run rampant ripping off everyone they could in a mad dash to bankruptcy.

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