Thursday, September 18, 2008

A System That's Not Going to Survive

As I’m sure most of you know, the US government recently seized control of insurance giant American International Group (AIG) in an unprecedented $85 billion bailout. The Federal Reserve Bank made the deal on Tuesday to save AIG from collapse in what the New York Times describes as “the most radical intervention in private business in the central bank’s history.” Of course this move comes amidst a series of financial crises that are shaking Wall Street and global financial markets.

Last night, The Newshour’s Ray Suarez interviewed Allan Meltzer (pictured above), a professor of political economy and public policy at Carnegie Mellon University.

I found what Professor Meltzer had to say about the financial crisis in the U.S. to be very helpful in understanding what’s happening and why. Perhaps you will too.

Following are excerpts from this interview.


Ray Suarez: Professor Meltzer, did the Fed do the right thing [in bailing out AIG]?

Allan Meltzer: No. There were bids on the floor for AIG. AIG didn’t take the bids. It thought it could get a better deal from the government. That’s a bad way to run the system. . . . We can’t afford to run a system and we won’t be able to where the bankers make the profits and the public takes the losses. That just is not viable.

The government is here to protect the public interest. What it’s doing is protecting private interests. And that’s a big mistake and one that we shouldn’t continue to tolerate.

We’ve gotten through now a whole range of these firms. The government has salvaged a number of them. That just puts all those losses onto the taxpayers. That’s not where they belong.

Ray Suarez: But [it’ been said by some that] there were very few choices because of the unique status of AIG in the world markets.

Allan Meltzer: AIG has four parts. One of them was in trouble. The other three make money. It could be sold. It should have been sold. It should have gone as a private company to some other private company. And that was an option that was available.

. . . I've been following these problems for 40 or 50 years. You know, it always comes down at the end to this. Someone goes to the secretary of the Treasury or, in this case, the chairman of the Fed and says, “If we don’t do this, we’re going to have a terrible depression. It’ll be known as the Bernanke Depression. And if you don’t act, there’s going to be a disaster.” Well, that’s not always the case. And these disasters should be headed off early or should be left to the marketplace to settle. They made these mistakes, and they should pay for them.

Ray Suarez: What about [the] point that, given the amount of money that the federal government has already put on the line, the AIG bailout was necessary to make – to save those previous investments?

Allan Meltzer: Well I’m not in favor of those previous investments, either. I agree that the government has been going into this and, as it goes into this, it encourages people to say, “Well, we’re not going to take any of those deals from the marketplace because we might get a better deal from the government.” And sometimes they do.

I would say we ought to look at Lehman Brothers. They let Lehman Brothers fail. Within a few days, just a few days, Barclays was there buying up some of Lehman’s assets, the same thing.

AIG has a terrific insurance company all over the world. It has a premiere place in China, and it’s doing very well there. It has a big aircraft leasing business. It does very well there. It has three major divisions that make money.

It's hard to believe that somebody wouldn’t come in on a fire sale, just the way Bank of America came in on a fire sale of Merrill Lynch.

And, you know, this has been a crisis where people on Wall Street were telling us in January, “This is like the Great Depression.” Well, that was just an overstatement. It was a problem for them, a serious, major problem for them. But the rest of the economy is struggling along, doing pretty well, no depression.

Ray Suarez: Very briefly before we go, Professor, does the size of this intervention constrain the Fed from future action? If there’s another AIG waiting in the wings, will it be unable to act because it’s already got so much money on the line?

Allan Meltzer: Well, today, the Treasury came in to borrow money on a special issue for the Federal Reserve. Now, usually it’s the Federal Reserve which is financing the Treasury. Now we have the Treasury financing the Federal Reserve.

Well, that means they’re not going to run out of money. They’re not going to let them run out of money. And, indeed, the Federal Reserve can print money. So it’s not going to run out of money. That’s not where the risk is.

The risk is that, each time we do one of these bailouts, we encourage other people to take more risks and come for bailouts. So we end up with a system in which the bankers make the profits and the public takes the losses, in which the public interest is subverted to the private interest. And that’s not a system that’s going to survive.


Professor Meltzer’s perspective is similar to that of Michael Hudson (pictured at left), president of the Institute for the Study of Long-Term Economic Trends, an economics professor at the University of Missouri, Kansas City, and the author of the 1972 book, Super-Imperialism: The Economic Strategy of American Empire.

Hudson was
interviewed yesterday by Amy Goodman on Pacifica Radio’s Democracy Now! Here’s a brief excerpt:

Amy Goodman: Michael Hudson, we’re talking government bailout, which means taxpayers stuck with the bill. Do you think this is the right move?

Michael Hudson: No, it’s the worst possible move, and it puts the class war back in business with a vengeance. Wall Street has been preparing for this for years, because every financial analyst knows that the debts can’t be paid. And the question that Wall Street has, if you’re going to take a gamble on bad debts that can’t be paid, how are you going to come out a winner? And there’s only one way of coming out a winner, and that’s to make the government bail you out.

This has been known for years, because it’s inherent almost in the mathematics of compound interest. Every banker I know knew that the loans they were making were going to go bad. They were trying to sell them to somebody else, ultimately expecting them to end up with some sovereign wealth fund.

And now, McCain is saying that this is the result of fraud and incompetence. The government has now bailed them out. But by bailing them out—Wall Street was coming to terms with the bad debts. When Bear Stearns went under and when Lehman Brothers went under, this began to wipe away the bad debts. And when the debts exceed the ability to pay, there’s only one thing any economy can do, and that’s wipe them out. Instead, the government is trying to keep the fiction alive. And what Paulson did yesterday, in bailing out AIG, was to try to lock in whoever is the next president not only to further bailouts of Wall Street, ostensibly to protect the public money, but to make it impossible to write down the debts of the four million homeowners that are expected to default this year, impossible to write down the debts of companies that have issued junk bonds, impossible for the country to get rid of this excess of debts that can’t be repaid. And you’re having really a war now of creditors against debtors.

And this is what Wall Street has been preparing for. It needed an emergency to do it. It’s really not an emergency at all. This has been building up for many years. Everybody expected it. And breathlessly now, the Secretary of Treasury has done it.

Amy Goodman: But, of course, the argument was, if you don’t bail out AIG, it could lead to a global financial meltdown.

Michael Hudson: It’s a meltdown of the gamblers. . . . These are people who’ve gambled. You had McCain saying they’re gamblers. If these people have gambled, we’re talking about derivative trades, billions of dollars of bets on which way interest rates will go, billions of dollars of bad loans beyond the ability of debtors to pay. Why on earth would you want to bail out these creditors?

Amy Goodman: So, what would happen if you didn’t?

Michael Hudson: Then you would prepare the ground for writing down the debts of the homeowners that have no way of repaying the exploding mortgages. Those interest rates are going to be jumping up this year. You would be able to bring the debts down to the ability of the economy to pay, and you would save these four million homeowners from defaulting and being kicked out of their houses. Now they’re going to be kicked out of the houses. The houses will be vacant. The cities are going to now say, “Gee, we’re going to have to cut the property taxes to enable the debts to be paid to save the financial system.” So, if they cut the property taxes, they’re going to have to cut back local expenditures, local infrastructure. The economy is being sacrificed to pay the gamblers.

See also the previous Wild Reed posts:
R.I.P. Neoclassical Economics
Capitalism on Trial
John le Carré’s Dark Suspicions

Recommended Off-site Links:
Panic Sell-Off on Wall Street - Barry Grey (World Socialist Web Site, September 18, 2008).
Europe Gripped by Fear of Global Crash - Stefan Steinberg (World Socialist Web Site, September 18, 2008).


Liam said...

Well, I never thought I'd see a Milton-Friedman loving laissez faire economist like Meltzer be the subject of such love on this blog.....

Anonymous said...

How do we "rightly divide" the

* "good" borrowers (who acted in good faith, exercised good judgment, and were still caught up in a crisis not of their own making)

and the

* "bad" (and they do exist) who simply gamble with large (VERY large) amounts of other people's money, fail to support the common good when profitable (i.e, pay taxes) and cry mightily when things go sour?

This is true for individuals as well as transnational corporations. My heart goes out to people who, in spite of their very best efforts to educate and prepare themselves for the privilege of home ownership, find themselves unable to pay a ballooning mortgage.

I am not so generous with people who took a gamble and bought more house than they could afford.

The self-corrective action of the market can't work if it isn't allowed to work. If banks make bad loans and lose money, maybe they won't make such risky loans again in the future. If someone buys more house than they can afford, and they lose the house and go bankrupt, then (once they are back on their feet financially) they'll buy a smaller, more affordable house the next time. And put more money down on that house and borrow less.

I know, I know - my approach doesn't do any good for anyone, "good" or "bad," who is about to lose the roof over their head. Again, my heart goes out to anyone losing a home. But there are wider social effects of this crisis than just the immediate effect on someone losing their home.

For example, within a 4 block radius of my house there are at least 6 houses for sale. One in particular has been on the market for 14 months. The asking price 14 months ago was in the 190K range. The sale price is more like the lower 170Ks. Assuming a similar decrease in value all 'round, my house, which I bought at 170K, may only be worth 155K, 'cause that's what someone will pay for it. However, I bought at 170K, paid 40K down, and pay a 130K mortgage, at 6% a year for 30 years. My property taxes went down, but my property value has also gone down. My house payments don't magically decrease just because my house is suddenly worth less. I signed the loan papers and a deal is a deal.

My point is, lets say 1 of those 6 houses for sale is for sale because the seller bought too much house and now can't pay. They lose their home and that is, indeed, very bad. But me and everyone else in the neighborhood has seen the value of our property decrease. Overall that's because of the way market's work. Nothing to be done about that. But its also, specifically (and partly) because somebody gambled and lost. They lost their home, and all their neighbors lost a couple thousand dollars market value on their property. Its almost like being punished for something I didn't do and have no part feels that way even if its not factually true.

media kingdom said...

from a historical point of view, it's hard to object to the government's mass bailouts since similar debt-producing methods were used to bring the U.S. out of the Depression... our economy has been supported and driven by debt ever since

Anonymous said...

Fabian Nancy Pelosi, backed by her socialist Barbara Lee and Congressman Miller, Frank, and Lantos -- are not giddy that they caused the "market system" to collapse. They are fully responsible for the collapse -- more so than BUSH.

The only "other" problem with their giddiness is that Bush was NEVER a "market oriented" president -- hell he's had more corporate welfare than Hitler, Franco, and Stalin combined -- and the collapse was anticipated by market economists as corporate subsidies, Democrats' transfer of payments, the Bushies' nationalization of insurance companies, concentration of financial services, and monopolies like Microsoft, make even socialist countries wince. But then they don't have WARS, DEFICITS, and ISRAEL to support.

Revel in your socialism's arrival by other means. But the market did not fail, it was undermined by Bush, Clinton, Pelosi, and Reid as their short term profit. If you think these last 18 years are "market" economics, I have a bridge to nowhere to sell you (if Sarah is not claiming it). That SHE doesn't get it, I expect. But why you?