Category: Economics

Economics Lesson for Reporters: Other Things Equal, a High Stock Market is a Transfer of Wealth from People Who Don’t Own Stock to People Who Do

Reporters on economics and business should know that, but from the reporting on the bailout, it is clear that very few do. There seems to be a view that stock market wealth is money from heaven.

Ownership of stock is a claim to the future profits of the corporations whose stock is owned. If the value of stocks increase because the economy is expected to grow more rapidly, and therefore future profits will be larger, then it is reasonable to say that a higher stock market is good news for everyone.

But suppose the stock market goes up because the markets think that the government will tax school teachers and fire fighters to hand money to Wall Street banks. Is this one good for everyone?

Finally, suppose that the Wall Street titans haven’t a clue what future profits will be (these are the folks that pushed the NASDAQ above 5000), and a rise in the stock market is driven by irrational exuberance. In this case, the higher stock market simply means that stockholders have a greater claim on the same amount of national wealth. This would be like handing out a trillion dollar bills and giving them only to shareholders. That’s good for the shareholders, but not for the rest of the country.

It would be nice if the folks who report the news understood that the stock market is not the economy.

—Dean Baker

Let’s just quote Dean Baker, shall we? (If the apparent date of the post is correct, this went up early Monday morning, before the House voted the bailout bill down.

Why Bail? The Banks Have a Gun Pointed at Their Head and Are Threatening to Pull the Trigger

If you have a real story, you don’t have to make up phony stories. That’s pretty straightforward.

I’ve heard lots of phony stories. Much of the country’s political and economic leadership has been running around raising the prospect of the Great Depression and a breakdown in the banking system (I actually had taken the latter seriously). These stories are absolutely not true.

There is no plausible scenario under which the no bailout scenario gives us a Great Depression. There is a more plausible scenario (but highly unlikely) that the bailout will give us a Great Depression. There is no way that the failure to do a bailout will lead to more than a very brief failure of the financial system. We will not lose our modern system of payments.

At this point I cannot identify a single good reason to do the bailout.

The basic argument for the bailout is that the banks are filled with so much bad debt that the banks can’t trust each other to repay loans. This creates a situation in which the system of payments breaks down. That would mean that we cannot use our ATMs or credit cards or cash checks.

That is a very frightening scenario, but this is not where things end. The Federal Reserve Board would surely step in and take over the major money center banks so that the system of payments would begin functioning again. The Fed was prepared to take over the major banks back in the 80s when bad debt to developing countries threatened to make them insolvent. It is inconceivable that it has not made similar preparations in the current crisis.

In other words, the worst case scenario is that we have an extremely scary day in which the markets freeze for a few hours. Then the Fed steps in and takes over the major banks. The system of payments continues to operate exactly as before, but the bank executives are out of their jobs and the bank shareholders have likely lost most of their money. In other words, the banks have a gun pointed to their heads and are threatening to pull the trigger unless we hand them $700 billion.

If we are not worried about this worst case scenario (to be clear, I wouldn’t want to see it), then why should we do the bailout?

There has been a mountain of scare stories and misinformation circulated to push the bailout. Yes, banks have tightened credit. Yes, we are in a recession. But the problem is not a freeze up of the banking system. The problem is the collapse of an $8 trillion housing bubble. (It was remarkable how many so-called experts somehow could not see the housing bubble as it grew to ever more dangerous levels. It is even more remarkable that many of these experts still don’t recognize the bubble even as its collapse sinks the economy and the financial system.) The decline in housing prices to date has already cost the economy $4 trillion to $5 trillion in housing equity. This would be expected to lead to a decline in annual consumption on the order of $160 billion to $300 billion.

Given the loss of housing equity, I have actually been surprised that the downturn has not been sharper. Homeowners had been consuming based on their home equity. Much of that equity has now disappeared with the collapse of the bubble. We would expect that their consumption would fall. We also would expect that banks would be reluctant to lend to people who no longer have any collateral.

This is the story of the downturn and of course the bailout does almost nothing to counter this drop in demand. At best, it will make capital available to some marginal lenders who would not otherwise receive loans. We should demand more for $700 billion.

For the record, the restrictions on executive pay and the commitment to give the taxpayers equity in banks in exchange for buying bad assets are jokes. These provisions are sops to provide cover. They are not written in ways to be binding. (And Congress knows how to write binding rules.)

Finally, the bailout absolutely can make things worse. We are going to be in a serious recession because of the collapse of the housing bubble. We will need effective stimulus measures to boost the economy and keep the recession from getting worse.

However, the $700 billion outlay on the bailout is likely to be used as an argument against effective stimulus. We have already seen voices like the Washington Post and the Wall Street funded Peterson Foundation arguing that the government will have to make serious cutbacks because of the bailout.

While their argument is wrong, these are powerful voices in national debates. If the bailout proves to be an obstacle to effective stimulus in future months and years, then the bailout could lead to exactly the sort of prolonged economic downturn that its proponents claim it is intended to prevent.

In short, the bailout rewards some of the richest people in the country for their incompetence. It provides little obvious economic benefit and could lead to long-term harm. That looks like a pretty bad deal.

Now this is reassuring.

Bad News For The Bailout — Forbes.com

In fact, some of the most basic details, including the $700 billion figure Treasury would use to buy up bad debt, are fuzzy.

“It’s not based on any particular data point,” a Treasury spokeswoman told Forbes.com Tuesday. “We just wanted to choose a really large number.”

Thus Dean Baker.

Leonhardt is Wrong, Limiting CEO Pay is Not a Sideshow to This Bailout

In his weekly NYT column, David Leonhardt argues that limits on executive compensation are a sideshow to the bank bailout. Actually, they are an essential part of the story.

A key issue in the bailout is addressing moral hazard. The message to Wall Street should not be to get rich on fees from stupid loans and then run to the big government to save your rear when the loans go bad. We give this message to the shareholders by saying that we are going to own much or all of your bank if you come to us for help.

It is necessary to give a similar lesson to the CEOs. A major problem in corporate America is that top executives have been able to pillage their corporations at the expense of shareholders. This problem is nowhere worse than on Wall Street, where high level executives (not just CEOs) routinely earn tens of millions annually in compensation, and sometimes hundreds of millions.

It is therefore crucial that the CEOs also be forced to take big hits in this sort of bailout. Otherwise, their incentive is to rip off their shareholders in the good times with irresponsible lending policies (thereby getting huge fees) and then have the government kick the shareholders in the teeth in the bad times, but they themselves can escape unscathed.

In short, kicking the top management in the teeth as part of the bailout is both a necessary part of the bailout and good policy for stemming the growth in inequality over the last three decades.

—Dean Baker

The “New” New Deal

I am having a hard time keeping up with all of the bailouts and special facilities created for dealing with this crisis.  Am I missing any?

• Bear Stearns
• Economic Stimulus progam
• Housing Bailout Program
• Fannie & Freddie
• AIG
• No Short selling rules
• Fed liquidity programs (Term Lending facility, Term Auction facility)
• Money Market fund insurance program
• New RTC type program

If you are a fan of irony, consider this: The conservative movement has utterly hated FDR, and his New Deal programs like Medicaid, Social Security, FDIC, Fannie Mae (1938), and the SEC for nearly 80 years. And for the past 8 years, a conservative was in the White House, with a very conservative agenda. For something like 16 of the past 18 years, the conservative dominated GOP has controlled Congress.

Those are the facts.

We now see that the grand experiment of deregulation has ended, and ended badly. The deregulation movement is now an historical footnote, just another interest group, and once in power they turned into socialists. Indeed, judging by the actions of the conservatives in power, and not the empty rhetoric that comes out of think tanks, the conservative movement has effectively turned the United States into a massive Socialist state, an appendage of Communist Russia, China and Venezuela.

To paraphrase Floyd Norris, we have become Marxists, but of the Groucho, not Karl, variety…

You Have To Be Shitting Me:

This is unbelievable:

The federal government is working on a sweeping series of programs that would represent perhaps the biggest intervention in financial markets since the 1930s, embracing the need for a comprehensive approach to the financial crisis after a series of ad hoc rescues.

At the center of the potential plan is a mechanism that would take bad assets off the balance sheets of financial companies, said people familiar with the matter, a device that echoes similar moves taken in past financial crises. The size of the entity could reach hundreds of billions of dollars, one person said.

In other words, folks spent years making billions upon billions of dollars on risky transactions, more money on the stock of companies that was artificially high based on those transactions, more money bundling all those transactions into more transactions, and made a killing, and when it turns out the whole thing is a big pile of shit, you and I get the god damned bill.

I do not ever want to hear another damned word about the free market. I don’t want to hear another thing about letting the market regulate itself. I don’t want to hear about the free flow of capital. I don’t want to hear about government getting out of our lives.

None of it. From superfunds to super-bailouts, I am tired of other people getting rich being irresponsible and then being told I have to pay to clean it up. I didn’t read one punitive aspect of this new plan. Not one punishment for the people who did this.

As a rule I’m content to trust that my small band of readers will follow the excellent Dean Baker on their own (he’s the Beat the Press link on my Links list). But from time to time, I can’t resist reposting. This post recapitulates one of Baker’s themes, that the notion that corporate dividends are “double taxed” is fundamentally mistaken—or worse.

There is an old myth developed by rich people at some point in the distant past that paying taxes on dividends amounts to “double-taxation.” The argument is that profits are already taxed at the corporate level, so taxing money when it is paid out as dividends to shareholders is taxing the same profit a second time. Gregory Mankiw, a Harvard University professor and former top economist in the Bush administration, pushes this line in a column in the NYT.

The trick in this argument is that it ignores the enormous benefits that the government is granting by allowing a corporation to exist as a free standing legal entity. The most important of these advantages is limited liability. If a corporation produces dangerous products or emits dangerous substances that result in thousands of deaths, shareholders in the corporation cannot be held personally responsible for the damage. The corporation can go bankrupt, but beyond that point, all the shareholders are off the hook, the victims of the damage are just out of luck.

By granting corporate status, the government has allowed investors to shift risk to society as a whole. In exchange for this and other privileges of corporate status, the corporation must pay income tax on its earnings. We know that investors consider the benefits of corporate status to be worth the price in the form of the corporate income tax, because they voluntarily choose to form corporations. If investors did not consider the benefits of corporate status to outweigh the cost of the income tax, then they are free to form partnerships which are not subject to corporate income tax. In this way, the corporate income tax is a completely voluntary tax. Anyone can avoid the tax by investing in a partnership, or alternatively, any corporation can be restructured as a partnership.

The complaint about double taxation is an effort to get the benefits of corporate status for free. It is understandable that rich people would want to get benefits from the government at no cost, just like most of us would prefer not to pay our mortgage or electric bill. But, there is no reason for government to be handing out something of great value (corporate status) for free. If rich people don’t like the corporate income tax, they have a very simple way to avoid it — don’t invest in corporations. The problem is that the rich are just a bunch of whiners.

–Dean Baker

Dean Baker on one of his favorite subjects, the attribution of ideological motivations to political actors, quoted here mainly for its fine last line.

Frank-Dodd Bailouts: Arithmetic, Not Ideology

It is remarkable how often reporters/columnists feel the need to assert that political disputes are about ideological issues. Why do they feel the need to make assertions for which there is generally no evidence?
Politicians get elected by getting the support of individuals and groups with power. They don’t get elected by being political philosophers.

Contrary to what Gretchen Morgenson (ordinarily a very good reporter) tells NYT readers, the battle over the Frank-Dodd bailout plans is not about ideology. The bills are crafted in ways that make them very friendly to banks. The banks get to decide which loans get put into the program. Presumably they don’t make this decision unless they think they will benefit from the bailout.

In addition, the appraisals on which the government’s guarantee price is set are based on sale prices, which may still be seriously inflated in the bubble markets. It would have been easy to avoid the problem of inflated appraisals by setting the guarantee price based on a multiple of rents. However, the supporters of these bills chose not to go this route.

At least some of the opposition to these bills is based on the view that giving more taxpayer dollars to banks should not be a higher priority than paying for health care, child care and other important needs. It is not clear what ideological issue is at stake here, since the ideology that we all should pay higher taxes to keep the banks rich has never been well articulated.

Emphasis mine.

James Hamilton speculates on the consequences of a US move to a gold standard in 2006.

What if we’d been on the gold standard?:
If the U.S. had decided to go back on the gold standard in 2006, where would we be today? That’s a question my friend Randy Parker recently asked me. Here’s how we both would answer.
…
In 1929, the U.S. was on a gold standard, with the exchange rate fixed at $20.67 per ounce of gold. Geopolitical insecurity and financial worries warranted an increase in the relative price of gold, which, with the dollar price of gold fixed, required a decline in the dollar price of most everything else. Speculators bet (correctly) that Britain would abandon the standard in 1931, but the U.S. fought against the speculation, with the Federal Reserve Bank of New York raising its discount rate from 1.5% to 3.5% in October 1931. This sharp increase in interest rates at a time of great financial turmoil succeeded in defending the parity with gold, but produced an economic disaster.

What’s the alternative, he asks, to abandoning the gold standard when staying on it requires raising interest rates in the face of a declining economy?

Or the other option would be to say, no, we really mean it this time, honest, we’re serious about this whole gold standard thing. So, we drive interest rates higher and watch the deflation mount. Outstanding debt that is denominated in dollars becomes more and more costly for people to repay, and we’d see a really impressive level of bankruptcies and business failures. The cycle would continue until the politicians who promised to stay on the gold standard are driven out of office and the deflation spiral could finally be ended by the new leaders choosing option 1 [abandoning the gold standard] after all.