Home
Archive
Newsletters
Video
Blogs
Discuss
About
Search
Donate
Advertise

Treasury Continues to Fumble -- Will They Ever Get it Right?

By Dean Baker, Comment Is Free. Posted March 18, 2009.


Officials were wrong to let Lehman Brothers go bankrupt. Now they wrongly assume that all banks are too big to fail.

Share and save this post:

      

      

Share on Facebook       

AlterNet Social Networks:
follow us on twitter
find us on Facebook

In Special Coverage

Belief:
Is Blind Faith in God and the Bible a Modern Invention?
Devilstower

Corporate Accountability and WorkPlace:
Who's Paying for the Recession Most of All? Young Workers
Lizzy Ratner

DrugReporter:
Lies About Marijuana Drive People to a Much More Harmful Drug -- Booze
Steve Fox

Environment:
Why Max Baucus' 'No' Vote on the Climate Bill May Really Help Its Passage
Jeff Mcmahon

Food:
Soda Helps Make Americans Unhealthy and Fat -- Will Soda Tax Prevail Despite Pushback by Beverage Industry?
Christine Spolar, Joseph Eaton

Health and Wellness:
Do We Really Want to Enshrine Insurance Monopoly into Law? This and 5 Other Complaints About the Health Bill
John Nichols

Immigration:
NYC Marathon Raises Question of Who Is American Enough?
James E. Johnson, Jr.

Media and Technology:
How Biased Media Can Brainwash You
Melinda Burns

Movie Mix:
The Yes Men: Pranksters Out to Fix the World
Mark Engler

Politics:
4 Ways the Stupak Amendment Deprives Women of Access to Abortion
Jessica Arons

Reproductive Justice and Gender:
How the Stupak Amendment Radically Undermines Abortion Rights
Rachel Morris

Rights and Liberties:
"My Kids Want to Hide Their Identity; They're Scared Someone Will Attack Us": U.S. Muslims Being Targeted
Jaisal Noor

Sex and Relationships:
9 Silly Things People Say When They Hear You Don't Want Kids (And Ways to Counter Them)
Liz Langley

Take Action:
G-20 Meetings: Nothing Much Happened in the Suites, and There Was Too Much Punch in the Streets
Laura Flanders

Water:
Why Natural Gas Is Not a Clean Energy Panacea
Stan Cox

World:
10 Suicides a Month at Ft. Hood -- War Stress Is Taking Soldiers to the Brink
Dahr Jamail

More stories by Dean Baker

Advertisement
Upcoming AlterNet stories on Digg

There are few economists who would defend the decision to allow Lehman Brothers to go bankrupt last September. Its collapse induced a worldwide panic that sent stock markets plummeting and caused credit to freeze up. In the subsequent months, the downturn went into over-drive, with the United States losing almost three million jobs from October through February.

This set of events has led almost everyone to conclude that the trio who let Lehman go under -- Treasury secretary Henry Paulson, Federal Reserve chairman Ben Bernanke and the then-head of the New York Fed, Timothy Geithner -- erred badly in this decision. That seems a reasonable judgment.

However, the conventional wisdom includes a corollary that is much less obvious: because the Lehman bankruptcy was a disaster, U.S. taxpayers must honor in full all the debts of all the banks. This corollary could put U.S. taxpayers on the hook for trillions of dollars in commitments that the Wall Street boys apparently made on our behalf. Before we cough up the dough, we might want to consider whether Paulson, Bernanke and Geithner were not quite as stupid as the current conventional wisdom would imply.

The problems that followed from Lehman did not just stem from the fact that the government was not honoring Lehman's debts. This was an uncontrolled bankruptcy of a huge investment bank in a world where the official line was still that everything was under control. The Washington Post had even run a column the day before Lehman's collapse ridiculing those who were making negative comments about the state of the economy.

In this context, an uncontrolled bankruptcy of a major investment bank was sort of like a sledge hammer in the face: a rather rude and unexpected blow. The most immediate consequence was that Reserve Primary, one of the largest money-market mutual funds in the world, suddenly could not pay its shareholders in full, because it had tens of billions invested in Lehman. In the wake of Lehman's bankruptcy, Reserve Primary did not know how much, if any, of this investment it could recover. In the post-Lehman world banks could suddenly no longer trust each other, and the interbank lending rate went through the roof.

But now we have had six months to adjust. The Fed and Treasury are now guaranteeing deposits in money-market mutual funds. The Federal Deposit Insurance Corporation doubled the size of the bank accounts it guarantees, and non-interest-bearing accounts of any size are guaranteed. In addition, the Fed is now lending hundreds of billions of dollars directly to non-financial corporations, establishing a channel of funding that goes outside the banking system.


Digg!    Share on facebook   submit to reddit    Bookmark on Delicious   Stumble This  

See more stories tagged with: bailout, financial crisis, lehman brothers, aig, ecnomy

Dean Baker is co-director of the Center for Economic and Policy Research.

Liked this story? Get top stories in your inbox each week from AlterNet! Sign up now »


Advertisement
Advertisement

 

Comments Turn comments off sitewide Give us feedback »
Comments closed.
The comments for this story have been closed. Thank you to everyone who participated.
View:
Baker is on the Mark ... But It Goes Much Deeper ...
Posted by: mmckinl on Mar 18, 2009 9:57 PM   
Current rating: Not yet rated    [1 = poor; 5 = excellent]
Why should the US tax payer bail out the share and bond holders of these insolvent institutions? The answer has to be we can't and we shouldn't.

We can't bail out these institutions because the sums are staggering, trillions. That is the sums we know about. There are tens of trillions in CDS and other derivatives both on and off the balance sheets of these banks and insurance companies, tens of trillions of unknown value that can only get worse as the economy tanks.

We shouldn't bail out these institutions for two reasons. The moral hazard of rewarding behavior that can only be described as stupidity, ignorance, greed and fraud. The second reason for not bailing out these banks and insurance companies is that we will only be putting these companies on life support, life support that will cost the economy trillions to maintain just as it did in Japan.

Most have heard of Japan's lost decade due to the banking crash there. Some have called that a scenario for us here in the United States.

What these people don't say or don't realize is that Japan was in much better shape economically than we are today ... Japan had a trade surplus, a huge trade surplus that they could use to subsidize their comatose banks and this trade surplus allowed factories to keep unemployment under 5% the entire time.

We have no trade surplus, in fact we have the biggest trade deficit in the world. So, not only will these comatose banks and insurance companies drain us, the trade deficit will as well. We will not see unemployment level off. It will rise to 12- 15% depending on other measures taken, that is the base unemployment rate. The secondary unemployment rate will rise to above 20%. These are clearly Depression Level rates.

Aggregate US debt is now $53 trillion and rising, roughly 4 times our GDP. Even at the height of the Great Depression it was only 2 times GDP. In order to rationalize our economy we must rationalize the amount of debt that we owe. At least $25 trillion of debt must be resolved. Unfortunately most of it will have to be written off. We can't pay it off fast enough, inflation can only buffer part of it and hyper inflation will blow the system up.

What are our leaders trying to do? They are trying to salvage these debts because they are the assets of the interest groups that control the financial system, Congress and The White House. These interest groups, ie, The Peterson Foundation are now trying to undercut Social Security and Medicare to help pay to salvage the wealth of the super rich!

Make no mistake. What you are seeing is the so far successful attempt of the oligarchs by way of the Federal Reserve and the United States Treasury to leave tax payers with the bill to clean up their mess and guarantee their wealth.

A primer on writedowns and what is going on now ... from Naked Capitalism ...

Guest Post: It's the writedowns, stupid

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

"Moral Hazard?"
Posted by: oregoncharles on Mar 18, 2009 10:59 PM   
Current rating: Not yet rated    [1 = poor; 5 = excellent]
I don't like to question Dean Baker, because he's one of the illustrious few who got it right, but there's a problem with one of his points:

"Moral hazard." Granted, first, that liberals like to use it because it's a favorite conservative line that can be turned back to bite them; but it's also a load of bunk. It assumes that people make their investment decisions RATIONALLY. Do you?

In reality, "markets" are subject to tremendous emotional pressures: fashion, mob psychology, greed, wishful thinking, and so on. Professional marketeers are worse, because there aren't very many of them and they talk to each other; on trading floors, they can hear and see each other, the recipe for mob psychology. (This is less true on a very large scale, like all consumers, because the various irrationalities tend to cancel each other out. Still, fashion and culture have a huge effect.) Even Alan Greenspan finally realized this.

Thomas Friedman used an unintentionally revealing word for the bond markets (the core of our present predicament): he called them "herds." Very clever word-choice; since when do we expect intelligence from a "herd?" "Flock" might be better: sheep are even dumber than cattle or horses. And mobs, notoriously, lose their human qualities.

A better concept is "perverse incentives." That means paying people to do things you'd rather they didn't. If you pay them for it, they'll almost always do more of it (consider the number of people having sex in front of a camera, something most of us try to avoid. That's because they're being paid to do it.) - even, it turns out, if it's ultimately and pretty obviously a dumb, destructive thing to do. As systems get larger and more complex, it's harder to spot perverse incentives; stock options, for instance, looked like a good idea at the time, but they incentivized top executives to fake their profit picture and artificially inflate their stock values, swindling the shareholders. That's one reason to keep institutions, like businesses, as small as we can ("antitrust"). It's also a call for vigilance, and one of the main reasons we have regulators. At the very least, the present collapse has validated regulation - for all time, we would have thought. Of course, people thought that about the LAST depression, too. So soon they forget.

To sum up: "moral hazard" is beside the point, because markets and marketeers are NOT rational; but we need to watch very closely for perverse incentives.

Criminal penalties, another sense of "moral hazard," would make more sense, especially if they focus on forfeiture of ill-gotten assets. And let's face it: revenge is sweet.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

Limits to Growth
Posted by: oregoncharles on Mar 18, 2009 11:04 PM   
Current rating: 5    [1 = poor; 5 = excellent]
Even Baker thinks we can "grow" our way out of this one, because that's what economists always think. But we can't, because we've hit our environmental limits, just as a few people (Herman Daly; the Club of Rome "Limits to Growth") predicted. That's why the economy keeps blowing bubbles: it's pretending to grow.

Learning to live within our means is going to be quite a challenge. Best to get started right away.

Time to stop listening to economists and begin listening to ecologists.

[« Reply to this comment] [Post a new comment »] [Rate this comment: 1 - 2 - 3 - 4 - 5]

  • AlterNetYour turn

Support AlterNet
Do you value the information you're getting from AlterNet? Please show your support with a tax-deductible donation.


Feedback
Tell us how we're doing.

Advertisement
Advertisement