A Positive Program for Laissez-Faire?

by Mario Rizzo

I am deeply impressed by Henry Kaufman’s opinion piece in today’s Wall Street Journal. I think he makes a very good case for  breaking up financial institutions deemed too-big-to-fail as opposed to the regulatory alternatives being contemplated. As much as it pains me to think about the government regulating the size of any firm, this may be an option that is far, far better than the politically feasible alternatives.  You can imagine the horrors that are out there being proposed.

Many of my readers will disagree but I am very willing to be persuaded otherwise.

Pain in the Fannie

by Chidem Kurdas

As Fannie Mae goes for its next withdrawal from the $200 billion kitty the US Treasury graciously made available to this government-created and -sustained mortgage financer, it may be useful to look beyond the current housing slump and consider what it augers for the future.

Having made yet another loss, the government-sponsored enterprise needs more money. A report Fannie filed with the Securities and Exchange Commission attributes the $19 billion third-quarter loss to the housing slump and mortgage defaults.  “We do not expect to operate profitably in the foreseeable future,” says  the company.

I always thought it was a great triumph of government public relations to come up with the sweet-sounding Fannie Mae moniker for an entity officially called the Federal National Mortgage Association.  Now I understand what the nickname really means—a pain in the taxpayers’ backside for the foreseeable future.

The business has been adversely affected by helping delinquent or imminently-in-default borrowers to modify their mortgages so as to reduce their monthly payments. As the economy recovers, defaults will decline, and presumably this aid will no longer be needed. But it is not clear when – or even if – the subsidy program will end.

In fact, it may be extended.  Fannie “may recommend supplementing the program with other initiatives that would allow us, pursuant to our mission, to assist more homeowners.”

Regulatory War of Choice

by Chidem Kurdas

“A just war” is how Treasury Secretary Timothy Geithner describes the movement to expand financial regulation.  “It’s a war of necessity, not a war of choice,” he  is reported as saying about  the battle to impose greater government control on the financial sector.

This is the man who presided over the New York Federal Reserve Bank as the Fed assiduously provided the monetary fuel for the over-expansion of credit and the associated property bubble. The eventual implosion  of the twin bubbles caused the financial crisis of 2008.

For sure, markets are prone to ups and downs, because people are prone to behaviors like herding. And yes, bankers drank the spiked punch, as did myriad others from mortgage originators and real estate developers to over-extended households. But the Fed provided the heady stuff, thereby creating a boom-and-bust cycle of extraordinary magnitude.

Now, does Mr. Geithner’s proposed regulations seek to prevent similar nefarious policies in the future by limiting the Fed’s discretionary powers? Of course not. Silly even to ask. His quest is to expand the authority of government agencies, not to regulate them.

The one attempt to get a sense of what the Fed is up to, a bill by Congressman Ron Paul, has been destroyed at a Congressional sub-committee—even though it had 308 co-sponsors.

Too Big to Fail Red Herring

by Chidem Kurdas

The Obama administration has perfected the fine art of taking a real issue and using it to justify a policy that will almost certainly make the problem worse. Claim to control medical costs, add another trillion dollar medical entitlement to truly break the bank—that sort of thing. Looks like we have another example coming.

The Treasury and House Financial Services chief Barney Frank are apparently cooking up legislation that will allow the government to wreck havoc with the creditors of large financial companies. This is in the name of imposing “market discipline” on institutions that may have to be rescued because they could endanger the system.

“The measure would make it easier for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution,” according to the New York Times report.

Scroll back to September 2008. Lehman Brothers files for bankruptcy, the credit market seizes up and stocks tank. What difference would the proposed law make in that situation? Lehman management is out and shareholders are wiped out anyway. Instead of regular bankruptcy, where the creditors exert influence, government directly takes over.

So the difference is that lenders will no longer be able to enforce their contractual claims. Oh yes, that will  be just the right remedy for a fragile credit market. You’ll tell lenders they’re toast! That will really get credit flowing.

Don Boudreaux’s WSJ article on “insider trading”

by Sandy Ikeda

Congratulations to Don Boudreaux for his article debunking insider-trading regulations, “Learning to love insider trading,” which covers the entire front page of the Weekend Journal section of this morning’s paper.

Prohibitions on insider trading prevent the market from adjusting as quickly as possible to changes in the demand for, and supply of, corporate assets. The result is prices that lie. And when prices lie, market participants are misled into behaving in ways that harm not only themselves but also the economy writ large.

With last week’s arrest of Galleon hedge-fund founder Raj Rajaratnam, insider trading has been very much in the news.  And now Don has done an excellent job of using and extending arguments originating with Henry Manne to help us understand just what is and isn’t at stake.

Goldman Critics vs. Little Goldmans

by Chidem Kurdas

Goldman Sachs has become exhibit number one in attacks on Wall Street and capitalist greed. Last week’s announcement that the bank had strong third-quarter earnings and is on track to pay big bonuses added to the media feeding frenzy.

Let’s look at the logic – to the extent there is logic – in the mass fury.  The assault on Goldman contains at least three, related but distinct, complaints.

• The bank’s profits are not just obscene but the result of reckless bets. “Goldman is back to business as usual: making money by high-risk gambling,” writes Frank Rich in the NYT, to pick one out of a herd of writers sounding the same theme.

Citi Phibro Selloff Shows Government Sham

by Chidem Kurdas

You’d think that the federal government wants Citigroup to return to financial health—if for no other reason to recoup the $45 billion of taxpayer money spent to shore up the bank in the credit freeze. You’d think the government wants a real effort to boost efficiency and profits. You’d be wrong.

What the Feds chose is a political charade. The pay czar objects to the $100 million compensation due to Citi’s star energy trader. Since the trader is contractually entitled to a share of the profits from Phibro, the phenomenally profitable energy trading subsidiary, there is no legal way not to pay him. So instead Citi is pressured to sell Phibro.

The bank complies. Occidental Petroleum snaps up the business at a bargain basement price. The WSJ quotes Occidental’s president as saying, “If you’ve got to sell, why should I pay a premium? What leverage does the seller have?” The lucky buyer added that Citi would never sell Phibro if it weren’t for pressure by the government.

Citi’s balance sheet is now in worse shape. It lost one of the few businesses that made money last year and had to sell under the worst possible circumstances, created by the government. Instead of slimming down by gradually getting rid of inefficient divisions so as to become a better-run company, the bank was forced to almost give away a valuable asset. And this to make it look like the government combated excessive pay.

Ghost of Socially Useful Labor Haunts G20

by Chidem Kurdas

French president Nicolas Sarkozy reportedly wanted  the G20 leaders to introduce a special tax on all financial transactions, known as the Tobin tax. Mr. Sarkozy took the idea from Adair Turner, the head of the British Financial Services Authority. Lord Turner suggested last month that the tax might be used to shrink the financial sector, which has grown too big and is in part “socially useless.”

The argument that activities like securities trading add no social value and the labor is better channeled into other areas has now become popular. Hence the resurgence of James Tobin’s 1970s proposal of a tax on foreign exchange transactions to discourage speculative trading. But the notion of socially useful work dates back centuries. In fact, it reached its zenith with Marxian labor theory and Soviet planning.

According to Soviet ideology, any work in state-run factories or farms was socially useful, whereas private economic activities were likely motivated by greed and could harm public well-being. Another belief was that manufacturing and agriculture made “real” contributions but services like wholesale and retail trade did not.

This real vs. trade distinction is now to be found in commentaries on the financial sector. Thus a pundit writes that a Tobin tax “would squash the profitability of much of the short-term trading which swells investment bank profits without doing anything to create value in the real economy.”

Reflating the Bubble?

by Mario Rizzo  

The Fed has decided to extend, at least through early next year, its program of purchasing mortgage-backed securities. The Wall Street Journal reports:  

“The Fed’s action signals its belief that the economy, while in recovery, remains fragile and that housing, which has seen some improvement in recent months, has only started to pull out of its slump.”  

What is the objective of their action? When will they know they have succeeded?

“Causes of the Crisis Blog”

by Sandy Ikeda

Following up on its recent issue on the financial crisis, Critical Review has started a blog with contributors to that issue doing the posting.  So far they have “disputed the theory that bankers’ bonuses, irrational exuberance, or capitalism caused the crisis. And four posts have debated the role of economic theory in failing to understand the crisis.”

Contributors listed under the fold.