No Time for Utopian Anti-Interventionism
Anti-interventionist utopianism has no place in a financial crisis that is rapidly developing into a self-reinforcing debt deflation. The credit markets and this economy will not self-correct any more than a damaged ship that is taking on water will right itself. Righting a ship that is listing is expensive, but trying to raise one that has been allowed to capsize is vastly more so. After declaring victory yesterday over the defeat of the poorly conceived Paulson Wall Street bailout, it's time to get practical proposals in front of Congress now.
My friends and readers know me as a Libertarian. My experience is as an entrepreneur first and investor second. Rest assured I am not I am not a socialist third: you will not find among entrepreneurs and capitalists anyone who promotes the idea that government is the driving force behind a dynamic and growing economy.
That said, my libertarianism is practical not ideological. Markets determine prices and allocate economic resources better than governments can most of the time. But markets can fail, and when they do sometimes only government can provide a floor to stop their self-destructive, self-reinforcing collapse and get them moving again. A constructive, rational debate is over how to stop the collapse – and fast – not whether we should try to do so at all.
Today Jeffrey A. Miron, senior lecturer in economics at Harvard University, represents the Libertarian fundamentalist perspective on the financial and economic crisis in an article Bankruptcy, not bailout, is the right answer for CNN.
The essence of Jeffrey A. Miron's argument is this: "Talk of Armageddon... is ridiculous scare-mongering. If financial institutions cannot make productive loans, a profit opportunity exists for someone else. This might not happen instantly, but it will happen."
He believes that eventually the credit markets and banking system will self-correct. The problem with this assertion - and it's a big one - is that there is not a single piece of historical evidence to support it and many to contradict it.
No self-correcting debt deflations
US economic policy-makers awaited a self-correction in the 1930s as did Argentina in the 2000s. The policy failed. The problem is the antecedents; our financial system is experiencing a debt deflation following a period of credit expansion that resulted in over-indebtedness. Credit and banking contractions following periods of over-indebtedness result in a self-reinforcing process of debt deflation.
A summary of Professor Irving Fisher's theory of debt deflation, which was later more completely developed by Minsky, extracted from a lecture by Steve Keen Modelling Debt Deflation (PowerPoint file):
1. Debt liquidation leads to distress selling and to
2. Contraction of deposit currency, as bank loans are paid off, and to a slowing down of velocity of circulation. This contraction of deposits and of their velocity, precipitated by distress selling, causes
3. A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
4. A still greater fall in the net worths of business, precipitating bankruptcies and
5. A like fall in profits, which in a "capitalistic," that is, a private-profit society, leads the concerns which are running at a loss to make
6. A reduction in output, in trade and in employment of labor. These losses, bankruptcies, and unemployment, lead to
7. Pessimism and loss of confidence, which in turn lead to
8. Hoarding and slowing down still more the velocity of circulation. The above eight changes cause
9. Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.” (1933: 342)
10. With deflation on top of excessive debt, “the more debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to right itself, but is capsizing” (Fisher 1933: 344).
The Libertarian fundamentalist "let the market take its course" prescription is not a real world option under the circumstances of a debt deflation. It is a misapplied Utopian vision that is guaranteed to turn into a Depression nightmare for the US much as in the 1930s.
The key difference is that today the US is a net debtor versus a net creditor, making the circumstances of its debt deflation and financial crisis more similar to Mexico's in the mid 1990s and Argentina's in 2001.
A recent Forbes article lays out the real world choices the US faces, Lessons from a Mexican bailout:
"It's a long, complex road," said Carlos Nunez, head of equity consulting at Grupo Financiero Monex, a Mexico City brokerage. But while painful and expensive, the bailout was necessary to avoid inevitably worse consequences - like those seen when Argentina declined to shore up teetering banks in 2001, prompting a run and then a freeze on deposits, and ultimately, the world's largest-ever government default, he said.Which do we want? The Argentina 2001 financial crisis outcome or the mid 1990s Mexico financial crisis outcome? It's a two item menu – there is no real "sinking ships right themselves" choice. It's a myth, albeit an appealing one.
Like it or not, those are our options. It is unfortunate that there is among our leadership no one left with any credibility to explain this truth of our circumstances, and that many of my fellow Libertarians are taking an ideological versus a pragmatic approach.
As an alternative to doing nothing or the Paulson plan I support the plan proposed by Bill King, author of The King Report.
King Report Bailout PlanNon-intervention is not the answer. Congress needs to move quickly to draft legislation that conforms to the principles put forth in the King plan.
• The US credit system is broken.
• The Paulsen-Bernanke Bailout Plan does not insure that those banks and brokers that receive bailout aid will increase lending. The reality is the market is hoarding liquidity and these banks are likely to do the same. More importantly consumer lending has been a small, often insignificant part of their business. They made money by trading and through securitization of debt.
• It is necessary to create a new system parallel with the existing dysfunctional system in order to mitigate the inevitable economic and financial damage and to facilitate, as seamless as possible, the transition to a functioning financial system or new model of credit and banking.
• The Wall Street model, securitization and extreme leverage, is obsolete.
• US financial institutions need to recapitalize.
• Hank and Ben assert that it is paramount to keep credit flowing to consumers; the bail out is a necessary adjunct.
• Paulsen and Hank’s bailout plan is tantamount to bailing out Univac, Digital Equipment, etc, in the eighties, which would’ve retarded the development of Dell, Microsoft, Intel and other nascent technology companies.
• It’s wasteful & foolish to put more money in an obsolete non-functioning system
• Big banks and brokers made most of their earnings over the past several years in trading, not consumer lending. And now their derivatives are THE problem
• If you want to get money to the consumer: the less middlemen, the better.
• Decentralization of liquidity, lending and risk is necessary to refurbish the financial system. The illiquidity of a few large banks is collapsing the system.
Basics of the King Report Bailout Plan
• Directly recapitalize banks by the US government allocating $500B into a plan for community-type banks to increase their capital in partnership with the government.
• The government would match existing or some percentage of existing bank capital. If it would be better, a separate bank could be created. Place a limit of say $1B per bank.
• This would create $5 trillion of credit at conservative 10 to 1 leverage. This is more than the entire private mortgage market. It is a much better use of capital instead of absorbing $700B of losses with no means to discern resultant credit creation.
• Give the banks a tax rate of 15% on consumer and commercial lending for 5 years and the right to buy out the government share of the operation at some premium.
• Only banks that meet some metric, like a Texas Ratio of 50, are eligible.
• To help the big banks, allow them to create a consumer & commercial lending facility with the 15% tax rate benefit. This should entice private equity and sovereign funds as well as Wall Street remuneration that was garnered over the past decade or so.
• Prohibit trading, especially derivatives, in consumer & commercial lending operations. However, pure hedging would be allowed.
• Immediately increase FDIC-insured bank deposits and money funds to $1 million per eligible account.
• Foreign banks in the US could be included if they have respective funding from their government.
• The real estate problem is due to the fact that American incomes do NOT support current prices. Easy credit allowed them to purchase homes they couldn’t afford.
• Any solution to clear the real estate market must entail hiking income, which is very difficult, or allowing prices to drop to levels that the average American can support. This helps average Americans, not the big banks and investors stuck with overpriced mortgages.
• No bailout for the imprudent and reckless but a means to directly help Americans and procure capital from private and sovereign sources because a new financial system must be implemented.
• This is not likely to be the final model but it is a stop-gap measure that will resonate with average Americans. It’s a way to connect with Middle America because it benefits them directly and is not an exclusive Wall Street bailout.
• The cause of our current financial morass is Big Government + Big Business = Crony Capitalism + Funny Money = concentration of wealth and risk + declining US living standards.
• The solution is decentralization of the financial system, like the tech industry, which will lower systemic risk, foster competition and yield better ideas, services and companies.
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